August CPI makes Fed decision a 'close call'

"Today's August CPI report delivered a modest upside surprise that likely narrows the ambiguity around next week's Fed decision. The firmer core print suggests underlying price pressures remain stickier than the disinflation narrative implies, and should, we think, be just about enough to sway the committee's naysayers toward a hike.

"The decision itself is set to be a close call, however, and the doves on the committee will not be without ammunition. They will likely point to annual core inflation having now fallen for three straight months, with no clear signs of second-round effects.

"Rising Treasury yields further complicate matters, as they are already doing some of the Fed's tightening for it, while raising the risk that a hike deepens the sell-off in an already strained debt market.

"Futures have moved to reflect the hawkish read and are now pricing in around a 90% chance of a rate increase next week. We would argue, however, that the strongest case for a hike now rests on the Fed preserving its inflation-fighting credibility, as a surprise hold could signal to markets that the committee is willing to tolerate a slower return to target than its mandate implies.

"Close call or not, standing still may now be the bigger gamble."