Cool Inflation Cuts Fed September Hike Odds to 35%

July's flat producer price index and a tepid consumer price report cut the market-implied probability of a Federal Reserve rate hike in September to 35 percent, from 55 percent a week earlier, according to CME FedWatch data.

"Following yesterday's CPI release, today's figures are further cooling market expectations for a September Fed rate hike, bringing the implied probability down to around one-third," Mohamed El-Erian, chief economic advisor at Allianz, said.

The producer price index was flat month over month in July, missing the 0.2 percent consensus forecast, while annual wholesale inflation slowed to 4.7 percent from 5.5 percent in June. The consumer price report showed headline inflation rising 0.1 percent monthly and 3.4 percent year over year, with core prices up 0.2 percent monthly and 2.5 percent annually. The 10-year Treasury yield fell 0.051 percentage point to 4.640 percent, and the two-year slipped 0.059 percentage point to 4.139 percent.

The re-pricing matters because the Fed holds its policy rate at 3.50-3.75 percent, unchanged since the July 29 meeting, and the September 15-16 decision now hinges on whether the soft inflation trend holds. A 30-year Treasury auction settled at a high yield of 5.216 percent, the highest since 2001, keeping long-end pressure intact even as short-dated yields fall.

Rate-Hike Odds Collapse to a Third

The data chain extended beyond bonds. Weekly jobless claims rose to 209,000 from an upwardly revised 200,000, while July retail sales fell 0.6 percent to $763.6 billion, the largest monthly decline in more than a year and well below the 0.1 percent gain analysts expected. The University of Michigan's preliminary consumer sentiment index dropped to 51.0 in August from 55.2 in July, near the 2nd percentile of the gauge's history.

Each print reinforced the same argument against tightening. At the July 29 meeting, the committee held rates in a 9-3 vote, with three members dissenting in favor of a hike. This week's data shifted the balance: the probability of a hold in September now stands at 69.4 percent, compared with roughly 42 percent a month ago, when half of participants expected a 25-basis-point increase.

HSBC economists said they expect the CPI report to show "surprising softness across many core categories, leading both headline and core CPI to undershoot consensus expectations." Richmond Fed President Tom Barkin said Friday that the labor market appears to be in a "weak balance," continuing the low-hiring environment of the past year, and that he does not see wage inflation contributing to price pressures.

The cross-asset transmission was immediate. Gold traded near $4,390 an ounce, up about 0.9 percent on a rolling 24-hour basis and more than 10 percent above where it opened the month. The dollar index fell 0.1 percent to 99.895. Oil prices moved lower after OPEC and the International Energy Agency cut their 2026 crude demand forecasts, with Brent near $86.88 a barrel and WTI near $81.12.

Hormuz Remains the Hawkish Counterweight

The counterweight is the Strait of Hormuz. Fresh tanker attacks on Thursday dashed hopes for a deal to reopen the waterway, keeping Brent near $87 a barrel, up about 24 percent versus pre-war levels. Just 14 vessels per day transit the strait today, down from roughly 120 before the U.S.-Israel war on Iran began in late February. Sustained disruption keeps energy inflation elevated, giving Fed hawks their strongest remaining argument for a September hike.

For the four and a half weeks before the September 15-16 FOMC decision, each incoming print will be weighed against the same question. If inflation stays soft and Hormuz traffic remains impaired, the hold case strengthens; a renewed energy spike would reset the hawkish clock. The FOMC minutes due Tuesday offer the next signal on how the committee reads the data.

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