The Fed faces a tight, data-driven rate decision as inflation metrics approach thresholds.

Source: Jin10 Data

The Federal Reserve's interest rate decision next week may depend on this week's inflation data, with the final difference influencing the decision potentially being only a fraction of a percentage point.

Market expectations continue to fluctuate between further rate hikes and holding rates steady. Investors will now closely monitor the August Producer Price Index (PPI), to be released on Thursday, and the Consumer Price Index (CPI), to be released on Friday. If inflation data comes in significantly hotter than expected, it would strengthen the case for a rate hike; if monthly inflation shows signs of cooling, Fed officials may be more inclined to hold rates unchanged.

Krishna Guha, Head of Economics and Central Bank Policy at Evercore ISI, said: "Interest rate decisions at that time will depend primarily on inflation data, and to some extent on the expectations ultimately formed in the market following data releases. The threshold for Fed rate hikes has not been firmly set."

Wall Street economists expect the August PPI to rise 0.4% month-over-month and 5.3% year-over-year. For CPI, the market anticipates an overall CPI increase of 0.4% month-over-month and 3.4% year-over-year, with core CPI rising 0.2% month-over-month and 2.4% year-over-year.

However, the Federal Reserve does not use CPI or PPI to set monetary policy—it uses the Personal Consumption Expenditures Price Index (PCE). The data released this week will be used to estimate the PCE, which will be published at the end of the month and help policymakers assess inflation trends.

Guhar believes that if core PCE ultimately aligns with a monthly increase of approximately 0.21% or 0.22%, it could prompt the Federal Open Market Committee (FOMC) to hold rates steady; if it reaches 0.23% or 0.24%, it would "likely shift toward a rate hike."

Guhar bluntly called this level of policy judgment—precise to 0.01 percentage points—“absurd.” He and other Wall Street forecasters expect CPI and PPI data to ultimately point to a monthly PCE increase of 0.2% to 0.25%, meaning even a very small deviation could alter policy decisions.

This delicate policy environment also highlights the key role of Federal Reserve Chairman Kevin Warsh at the September meeting.

Wash publicly emphasized at the Jackson Hole symposium that the Federal Reserve has not achieved its 2% inflation target for over five years. Markets interpreted this as a signal that he may push the FOMC to raise interest rates by 25 basis points on September 16.

However, the market has not formed a strong consensus on this. As of Tuesday, market pricing indicated a roughly 60% probability of a Fed rate hike, right near the typical threshold used to judge whether a central bank may act.

Guhar expects the probability of holding rates steady to remain slightly higher than a rate hike, but far from certain. He noted that this assessment is based on the possibility that inflation data may come in below expectations, and although Waish’s call for maintaining rates unchanged after his Jackson Hole speech has become stronger than before, it is “not so high as to be unattainable.”

The positions of recent Federal Reserve officials have also shown clear divergence. Hawkish officials, such as Cleveland Fed President Beth Hammack, continue to advocate for rate hikes, while Fed Governors Christopher Waller and Michael Barr, along with New York Fed President John Williams, tend to emphasize making decisions based on economic data.

Loretta Mester, Hamrick's predecessor, also said on Tuesday that the Fed needs to raise interest rates to demonstrate its commitment to curbing inflation.

“I would indeed advocate for a rate hike,” Meister said in an interview with CNBC. “I don’t think the Fed will definitely raise rates. Chairman Walsh needs to clearly explain why they made their final decision, whatever that decision may be, during the post-meeting press conference.”

Even though this week’s inflation data has been finalized, another layer of uncertainty remains in the Fed’s policy assessment. Economists expect the PCE to revise several key indicators, potentially lowering previous inflation readings by several percentage points retroactively.

Therefore, the September decision may hinge on a very small data difference. Guha believes that if the market clearly anticipates a rate hike before the meeting and Walsh faces pressure on his credibility, maintaining rates unchanged will become more difficult.

Meanwhile, Trump is also increasing uncertainty in the policy environment. Last Friday, Trump threatened to cut off trade with countries that maintain a trade surplus with the U.S. if the Federal Reserve does not lower interest rates. This move has been viewed by some as another attack on the Fed’s independence and could, in turn, prompt policymakers to harden their stance.

Guhar said: "If the market prices in a rate hike as clearly dominant before the meeting, it will be difficult for Wash to choose to hold steady. Therefore, within this gray area, the market’s reaction itself could in turn influence the final decision."

Currently, the key issue at the September meeting is no longer just whether inflation is high, but rather which range the final PCE will fall into, as reflected by CPI and PPI, and whether Walsh can persuade the divided officials to support the final policy decision.