This Inflation Report Says No Rate Cut In September

The recent CPI report, despite consensus implying a 93% probability of a September Fed rate cut, is argued to signal persistent inflation rather than disinflation. While headline CPI was in line, core CPI rose 0.3% MoM and 3.1% YoY, exceeding estimates and marking its largest gain in six months, primarily driven by services. The author emphasizes that the Fed's preferred core PCE could reflect an even higher inflation rate due to its weighting in medical care, further exacerbated by tariffs potentially adding 0.6-0.7% to core PCE by year-end, pushing it near 3.5%. Given the Fed's historical reluctance to cut rates with core inflation above 3% outside of recession, the market's current expectations may prove overly optimistic.

Analysis

Despite market pricing implying a 93% probability of a September Federal Reserve rate cut, a contrarian analysis of the latest CPI report suggests underlying inflationary pressures may prevent such a move. While headline CPI rose an expected 0.2% for the month, the core rate, which excludes food and energy, accelerated 0.3%—its largest gain in six months—pushing the year-over-year figure to 3.1%, above the 3.0% consensus. This increase was driven primarily by services inflation, with medical care and transportation services both rising 0.8% MoM. Critically, the Fed's preferred "supercore" services metric (excluding shelter) has also re-accelerated to 3.2% from an April low of 2.7%. The composition of this inflation is significant, as the Fed's primary gauge, the core Personal Consumption Expenditure (PCE) index, has a larger weighting in medical care services than the CPI, suggesting the upcoming PCE report could be even hotter. Furthermore, the pass-through of tariffs to consumers is still in its early stages. An analysis from Goldman Sachs indicates that while U.S. companies have absorbed 64% of tariff costs to date, the consumer's share is projected to rise from 22% to 67%, potentially adding another 0.6-0.7% to the annualized core PCE by year-end and pushing it toward 3.5%. This is set against a historical backdrop where, according to Bianco Research, the Fed has cut rates with core inflation above 3% only once in the past 40 years, at the onset of a recession.

Key Decisions for Investors

• Investors should exercise caution regarding positions that are heavily reliant on a September Fed rate cut, as the accelerating core inflation data presents a significant headwind to further monetary easing.
• Closely monitor the upcoming core PCE data release, as its component weightings may reflect a more pronounced inflation picture than the CPI, and track the impact of tariff pass-through on consumer prices as a key forward-looking risk.
• Consider the potential for increased market volatility and a reversal in rate-sensitive assets should the Fed disappoint market expectations, given the historical precedent of not cutting rates when core inflation is above 3% in a non-recessionary economy.