Fed hike is now expected after August CPI, though it remains a 'close call'

We have changed our call for this week’s meeting and are now expecting a 25-basis point rate increase, with the modest upside surprise in the August inflation data narrowing the ambiguity around the decision.

The firmer core print, which edged up to an above consensus 0.3% MoM, suggests that underlying price pressures remain moderately stickier than the disinflation narrative implies and should, we think, be just about enough to sway the committee's naysayers toward a hike. Investors agree, with futures now pricing in around a 90% chance of a rate increase on Wednesday.

The decision itself is set to be a close call and we see tangible reasons for caution, with the doves on the committee not without ammunition. Treasury yields continue to climb - the 10-year yield last week rose to 2023 highs. This both acts as a form of tightening - taking pressure off the Fed to do the heavy lifting itself - while also raising the risk that a hike simply compounds the sell off in a debt market that is already under heavy strain.

The inflation driver also remains a supply shock, rather than overheating demand, and higher rates do nothing to bring down oil prices.

As we see it, the strongest case for a hike does not necessarily lie in the data, but with the Fed’s credibility, both in maintaining its independence and fighting inflation.

Trump’s extraordinary outburst - where he threatened to cut ties with trading partners unless the Fed lowers rates - has further raised fears over the former, concerns that would only amplify should the FOMC stand pat. With markets almost fully discounting a hike, a surprise hold could also signal to markets that the committee is willing to tolerate a slower return to target than its mandate implies, which would perhaps do more harm than good.