Fed September hike odds hinge on CPI as oil surges 21%

Two inflation reports over the next month will decide whether Federal Reserve chair Kevin Warsh pushes a September rate hike, with markets pricing 11 basis points of tightening after July payrolls fell 23,000.

"The -20k payroll print was not the only concern," said James Knightley, chief international economist at ING. "More than 100k of downward revisions leave average payroll growth at just 20k over the past three months."

The softer labor data pushed the 10-year Treasury yield to 4.60% before it settled at 4.64%, 4 basis points lower on the day, while the S&P 500 closed 0.6% higher to extend its weekly advance past 3%. The Bloomberg Dollar Spot Index fell to its lowest level since the start of June, and Brent crude eased near $82 a barrel after the U.S. signaled it would lift its blockade of Iranian ports.

The stakes are high for the Sept. 15-16 FOMC meeting. Five inflation reports land before policymakers vote — July CPI on Aug. 12, PPI on Aug. 13, PCE on Aug. 26, then PPI and CPI on Sept. 10-11. If the data runs hot, Warsh has signaled openness to a hike; if it cools, markets have room to price out the 11 basis points still implied for September, 28 for December and 40 for April.

Oil's 21% July surge complicates the inflation path

The energy shock is the wildcard. Oil prices climbed roughly 21 percent in July after Iran-related conflict disrupted supply, threatening to lift consumer inflation broadly just as the Fed weighs its next move. Long-term inflation swaps still imply 2.4 percent average inflation, and 30-year Treasury yields hover near 20-year highs, a sign that bond investors remain skeptical the central bank has inflation contained.

ING's forecast for Wednesday's July CPI release points to a dovish read: headline inflation at 0.1 percent month on month versus a 0.2 percent consensus, with core at 0.2 percent in line with expectations. A softer print would strengthen the case for a hold and increase the chances of EUR/USD breaking above 1.160 this week, with the next resistance at the 200-day moving average of 1.1630.

The dollar's downside if the Fed holds

The dollar has already absorbed much of the dovish repricing. Despite Friday's payrolls move, 11 basis points are still priced for September, 28 for December and 40 for April, leaving room for further dollar weakness if the Fed holds. The yen, highly sensitive to U.S. rates, has returned to the 158.30-158.50 area against the dollar, though intervention risk and expectations of a September Bank of Japan hike have not been enough to counter the bias to rebuild yen shorts.

The Fed has held its policy rate steady through the year, and the September decision now hinges on whether the inflation reports confirm the cooling trend or revive the oil-driven pressure. Fed arch-hawk Beth Hammack speaks today, offering an early read on the committee's leanings before the data lands. If the CPI print surprises to the upside, the case for a hike strengthens and financial conditions tighten; if it lands at or below consensus, the dovish repricing that began with Friday's payrolls has further to run.

This article is for informational purposes only and does not constitute investment advice.