Market pricing shifted sharply Thursday as traders raised the probability of a Federal Reserve interest rate hike next week to 70% in morning trading.
The move followed a producer price index report showing wholesale prices rose 0.4% in August, pushing the annual PPI level to 5.4%, slightly above forecasts.
The August PPI increase came on top of an upwardly revised 0.1% gain in July, signaling that pipeline inflation pressures remain persistent across the economy.
Simultaneously, escalating Middle East hostilities rattled commodities markets, sending U.S. crude oil prices up 4% to just past the $100-per-barrel threshold.
The CME Group’s FedWatch gauge captured the market’s shifting expectations, reflecting growing conviction that the Fed has little political or economic room to hold rates steady.
Traders also nudged the odds of a second rate increase in December to nearly 60%, suggesting Wall Street sees inflation as too stubborn for a one-and-done central bank response.
“As the conflict with Iran drags on longer than many expected, inflation pressures are becoming increasingly entrenched, leaving investors in search of a catalyst strong enough to change the inflation narrative,” wrote Jeffrey Roach, chief economist at LPL Financial. “At this rate, a hike in rates next week appears likely.”
The European Central Bank added further pressure to the global inflation picture Thursday by announcing a quarter percentage point hike and raising its own inflation forecast, citing concerns over the Iran war’s long-term economic impact.
“More pressure is coming because crude and refined products have kept rising since the August data was collected,” said David Russell, global head of market strategy at TradeStation. “The ongoing spike in oil, combined with low jobless claims, make it hard for the Fed to not hike next week.”
Federal Reserve policymakers will receive one final data point before their meeting when the Bureau of Labor Statistics releases the consumer price index Friday morning.
The Dow Jones consensus calls for a headline annual CPI reading of 3.4%, while core inflation excluding food and energy is forecast at 2.4%.
Fed Chairman Kevin Warsh has reemphasized that the central bank’s official inflation yardstick remains the Commerce Department’s personal consumption expenditures price index, which showed core at 3.3% and headline at 3.7% in July.
Bank of America senior U.S. economist Stephen Juneau estimated that the August PPI reading puts core PCE tracking at a 0.26% monthly rate, which would round up to 0.3%.
“This could move significantly tomorrow after CPI, but if we are correct, it should greenlight a hike at next week’s Fed meeting,” Juneau said in a note.
Bank of America holds one of the most hawkish Fed outlooks on Wall Street, forecasting three rate increases at upcoming meetings, well ahead of current futures pricing.
Peter Boockvar, chief investment officer at OnePoint BFG Wealth Partners, cautioned that a soft CPI print would not necessarily clear the Fed’s path to holding rates steady.
“Those who just look at consumer prices for their inflation information and interest rate predictions are not looking at the complete picture, and today’s PPI is evidence still of an inflation problem throughout the supply chain,” Boockvar said.
