Markets Still Price a 45% Chance of a September Fed Rate Hike

The latest CPI release pushed those odds slightly lower. Futures-implied probability of a 25-basis-point September hike fell to about 42% from 46% before the report. The shift is modest. Markets are still pricing two realistic outcomes for September rather than treating another hike as a remote possibility.

July Payrolls Cut the Odds

The July employment report delivered the strongest argument against further tightening. U.S. nonfarm payrolls fell by 23,000, compared with expectations for an increase of around 80,000. The unemployment rate slipped to 4.1%, while previous estimates for May and June were revised lower.

The payroll decline matters more for the September decision than the small drop in unemployment. Raising rates again would tighten financial conditions at a time when hiring is already losing momentum. Before the report, persistent inflation had pushed markets toward another increase. The jobs data disrupted that trade.

CPI Gave the Fed Room to Wait

July consumer prices increased 0.1% month over month and 3.4% year over year, down from 3.5% annual inflation in June. Core CPI, excluding food and energy, rose 0.2% on the month and 2.5% from a year earlier.

Neither figure provided a strong reason for an immediate rate increase. Core inflation continued to moderate, while headline inflation moved slightly lower. But 3.4% headline inflation remains well above the Fed's 2% target. The July report weakened the case for September without eliminating it.

The September Setup

The imbalance is clear: most of the latest economic data point toward no change in September. The main threat to that scenario is another increase in inflation before the meeting.

August Energy Prices Are the Wild Card

Energy helped suppress July inflation. That effect could reverse in August. Crude prices and refining margins have moved higher, pushing fuel costs back up. U.S. gasoline prices have risen from roughly $3.87 to $4.03 per gallon over the past month.

That creates a potential timing problem for the Fed. July CPI showed inflation cooling just as some of the forces that produced that decline began moving in the opposite direction. Higher gasoline prices would primarily affect headline inflation, but a sustained energy shock can spread into transportation, production and distribution costs.

If August inflation rebounds, the September debate changes again.

45% Is Too High to Ignore

Markets briefly priced a roughly 82% probability of a September hike in late July. After the employment report and July CPI, those odds have fallen to around 45%. That is a major repricing, but not a rejection of the hike scenario.

At 10% or 15%, another increase could be treated as a tail risk. At 45%, investors have to price both outcomes.

That uncertainty is most visible in short-term Treasury yields, which respond directly to changes in Fed expectations. A higher probability of tightening can also support the dollar and pressure equity valuations. A move toward a clear September hold would push those trades in the opposite direction.

The Next Data Will Set the September Trade

July payrolls weakened the case for higher rates. July CPI weakened it further. August energy prices are now working against both signals. That leaves the September decision unusually dependent on the next round of data.

Another weak employment report alongside moderate inflation would make a hike increasingly difficult to justify. A rebound in inflation, particularly if accompanied by stronger economic data, could quickly push market odds back above 50%.

For now, 45% captures the problem: neither the Fed nor traders have enough evidence to close the September rate debate.