Was the August CPI just the right amount of "hot"? Wall Street is heavily betting on a Fed rate hike next week, and Warsh can't cry wolf this time.

The better-than-expected core inflation in the US in August is becoming a key factor in pushing the Federal Reserve to raise interest rates next week. Although some Wall Street analysts believe that one-off factors such as the surge in telephone service prices in the monthly data are insufficient to prove that inflation has accelerated across the board again, a growing number of economists believe that the Federal Reserve can no longer ignore the renewed warming signals from the inflation data for two consecutive months.

Data released by the U.S. Bureau of Labor Statistics on Friday, August 11th (Eastern Time) showed that the Consumer Price Index (CPI) rose 0.4% month-over-month and 3.4% year-over-year in August, both in line with market expectations. The core CPI, excluding food and energy, rose 0.3% month-over-month, higher than the market expectation of 0.2%, and rose 2.4% year-over-year, also in line with expectations. Against the backdrop of a similarly strong PPI report released on Thursday and international crude oil prices breaking through the $100/barrel mark, this CPI report further reinforced market expectations of a Federal Reserve rate hike next week.

The interest rate futures market immediately increased its pricing in a rate hike. After the CPI release, the market initially pushed the probability of a 25 basis point rate hike at the Federal Reserve's September 15-16 meeting to about 90%, before slightly declining to around 85%, significantly higher than the approximately 70% before the CPI release. The market also began pricing in a second rate hike this year. The probability of at least one rate hike this year rose from 94% a day earlier to 97%.

"The New Fed's Watchdog" Analyzes CPI: Core Inflation Annualized Rate Cools, But Short-Term Trend Resurfaces

Nick Timiraos, chief economics reporter for The Wall Street Journal, often referred to as the "new Fed mouthpiece," further dissected the CPI on social media.

He pointed out that the core CPI rose 0.29% month-on-month in August without rounding, which translates to an annualized growth rate of 3.5%. The three-month annualized growth rate rose from 1.6% in the previous month to 2%, while the six-month annualized growth rate rose from 2.4% to 2.6%. Although the year-on-year growth rate of core CPI over the past 12 months has slightly decreased from 2.5% to 2.4%, the decline has been very limited.

In other words, from a 12-month perspective, core inflation is still slowly cooling down; however, from three-month and six-month perspectives, which better reflect recent trends, the cooling process has stalled or even reversed.

Timiraos also pointed out that core service prices, excluding housing, rose 0.51% month-over-month in August, the highest since January this year, and 3% year-over-year; core goods prices rose 0.11% month-over-month and 0.7% year-over-year; and housing prices rose 0.26% month-over-month and 3% year-over-year.

However, Timiraos specifically pointed out an important "noise" in the August data: telephone service prices surged 5.4% in a single month, the largest increase on record, contributing about 0.10 percentage points to the core CPI.

Brian McClard, chief investment officer at Blue Trust, pointed out that telephone service prices have generally been in a deflationary trend for the past 30 years, but saw an unusual surge in August. Timiraos responded that not only in August, but also in June, telephone service prices significantly contributed to the core CPI.

Therefore, the better-than-expected core CPI in August cannot be simply equated with a full-scale re-acceleration of underlying inflation in the United States.

A shift in the mainstream on Wall Street: Not necessarily due to runaway inflation, but sufficient to justify a September rate hike.

Despite the aforementioned noise, Wall Street is increasingly inclined to believe that the Federal Reserve will find it difficult to remain on hold next week.

Nationwide chief economist Kathy Bostjancic said that the renewed rise in oil, gasoline, and diesel prices is raising concerns about further energy price transmission to other goods and services and pushing up inflation expectations, so she has now turned her attention to expecting the Federal Reserve to raise interest rates next week.

Bank of America senior economist Stephen Juneau believes that the August data alone is not enough to make him more concerned about the inflation outlook. He argues that the sharp rise in telephone service prices "is often noise and will reverse," but this does not preclude the Federal Reserve from raising interest rates next week.

Bloomberg's chief U.S. economist Anna Wong and economist Troy Durie also believe that the August CPI may not be enough to convince the doves within the FOMC to keep interest rates unchanged. Coupled with the market's hawkish reaction, the Fed may have no choice but to raise interest rates next week.

The Wall Street Journal quoted Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, as saying that while the CPI was not as "hot" as the previous day's PPI, it still left the Federal Reserve with "less room for maneuver" in maintaining its credibility in fighting inflation.

Skyler Weinand, chief investment officer of Regan Capital, was even more direct: Although the August CPI was largely in line with expectations, inflation "is still overheated," the Fed's "hands are tied," and a rate hike next week is "almost certain."

Sharif: The Fed has reached a point of "either act or shut up."

Among the economists who have released their comments so far, Omair Sharif, founder of Inflation Insights, has been particularly hawkish.

Sharif stated that the Federal Reserve has reached a point of "either act or shut up"—if the Fed has already signaled the need for action at the Jackson Hole conference, then it must deliver on its promise with an interest rate hike next week, otherwise it may become a case of "crying wolf."

Sharif's assessment was in response to Federal Reserve Chairman Warsh's speech at the Jackson Hole central bank symposium in August. Warsh stated that if the Fed could not be certain that underlying inflation was moving toward the 2% target at a "clear and fast enough" pace, policymakers "still had work to do."

Sharif specifically pointed out that the surge in wireless communication service prices in the August core CPI did indeed have a clear anomaly; if this item were excluded, the core inflation rate would have been much more moderate. However, the problem is that with the market pricing in a rate hike next week at nearly 90%, the Federal Reserve can no longer explain the overall data based on anomalies in a single sub-item.

Now, with the core CPI rising 0.3% month-on-month in August, coupled with oil prices breaking through $100 and the energy shock brought about by the situation in the Middle East, Warsh's policy space to remain on hold next week has narrowed significantly.

Oxford Economics leaves a glimmer of hope: Core PCE may rise by only 0.2%, and the decision remains on the line.

However, not all economists believe that the CPI is sufficient to determine policy.

Analysts at Oxford Economics point out that the Federal Reserve is actually monitoring the Personal Consumption Expenditures (PCE) price index, not the CPI itself. Given the relatively modest price increases for some core goods, they expect the core PCE to rise by only 0.2% month-over-month in August, a relatively modest level.

If this prediction holds true, the Federal Reserve still has reason to postpone raising interest rates next week.

However, Oxford Economics also believes that the policy decision is already on a "knife's edge".

The problem is that several other institutions expect a higher increase in core PCE in August. If these predictions come true, it could further exacerbate concerns within the Federal Reserve—especially among officials who previously believed that the cooling inflation in June and July might have started a virtuous cycle, and who may reassess that assessment.

Reuters points out that at least two Wall Street firms have changed their previous policy forecasts as a result: they had previously expected the Federal Reserve to hold rates steady in September, but now they predict a rate hike next week.

TD Securities strategists have abandoned their prediction of holding rates steady and now expect the Federal Reserve to initiate the first of its three rate hikes in September.

In a research note released Friday, TD strategists, including Oscar Munoz and Gennadiy Goldberg, wrote, "We expect a total of three rate hikes in this cycle, with the latter two occurring in October and January. The Fed is unlikely to provide forward guidance, but the dot plot should be hawkish." The report noted, "After the August CPI showed a lack of progress in inflation, we expect the Fed to begin its rate hike cycle in September."

Hodge: It's not that inflation is accelerating again, just "bumps on the road to deflation."

Natixis economist Christopher Hodge offered a relatively mild assessment.

He believes that the August CPI does not mean that core inflation has accelerated again, but rather that it is more like "a bump on the road to inflation".

But this doesn't mean he's against a rate hike next week. Hodge believes the Fed may feel the need to give the economy a "gentle nudge" with one or two rate hikes, which could very well begin at next week's meeting.

This assessment also explains the current contradictory market reaction: Wall Street does not necessarily believe that US inflation has returned to a state of being out of control, but more and more people believe that with inflation cooling stagnating and oil prices rising again, the Federal Reserve needs to make a policy adjustment as an insurance measure by raising interest rates.

One rate hike or a return to a rate hike cycle? Divergence emerges on Wall Street.

Therefore, after the August CPI was released, market attention gradually shifted from "whether there will be an interest rate hike in September" to "what to do after the September interest rate hike".

Peter Williams, a global macro analyst at 22V Research, believes that this inflation report is "clearly not the kind the market fears most," but it's also not a report that can completely solve the US inflation problem. He argues that the market's reaction to the data even suggests that inflation is "hot enough" to prompt the Federal Reserve to tighten policy, which might actually be seen as a good thing, since the market had already begun to worry about overly loose or even inflationary policies.

Florian Ielpo, Head of Macro Research and Multi-Asset Portfolio Manager at Lombard Odier Investment Managers, also believes that this is clearly not the inflation report the market is most worried about, but it is far from a complete solution to the inflation problem.

Chris Zaccarelli, chief investment officer at Northlight Asset Management, said that while it's not certain the Fed will raise rates next week, it's hard to imagine the Fed finding a reason to keep rates unchanged given the data.

Jim Baird, chief investment officer at Plante Moran, believes that higher-than-expected core inflation in August makes next week's policy meeting even more crucial. If the Federal Reserve holds off again, market questions about "what exactly is the Fed waiting for" will become even more acute.

Bret Kenwell, an investment and options analyst at eToro, focused on the aftermath of the rate hike. He believes that if the Federal Reserve describes this action as an "insurance rate hike" to address renewed inflation, rather than the start of a new round of sustained tightening, the market may interpret it as a "dovish rate hike."

In this scenario, short-term US Treasury yields may remain high, but the upward pressure on long-term US Treasury yields may actually be contained.

Market expectations for a September rate hike have surged, making the possibility of another hike in December a new point of uncertainty.

Following the release of the CPI, interest rate futures have quickly reflected this shift in policy expectations.

The market initially pushed the probability of an interest rate hike at the September meeting to around 90%, before falling back to around 85%, still significantly higher than the approximately 70% probability before the CPI was released. At the same time, the possibility of a second interest rate hike this year has also increased.

This means that the debate over a September rate hike is rapidly cooling down, and the bigger question is: is this an "insurance rate hike" or the start of a new rate hike cycle?

Looking at Timiraos's breakdown of the three-month and six-month core annualized inflation indicators, the recent inflation trend is indeed not as smooth as it seemed before; according to Oxford Economics's assessment, the PCE figure may be more moderate than the CPI; and according to Hodge et al., the August data may just be a brief fluctuation on the road to inflation.

Therefore, what's truly worth paying attention to at next week's Fed meeting may not just be the 25 basis points themselves, but how Warsh will explain this action and whether he will hint at the need for further rate hikes in the future.

If the Fed defines its September action as an "insurance rate hike" to address inflation risks, the market may perceive it as a "dovish rate hike." However, if Warsh signals continued tightening, the repricing pressure on Treasury yields and risk assets may have only just begun.

Risk Warning and DisclaimerInvesting involves risk; please exercise caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Any investment decisions made based on this information are at your own risk.