Market pricing on Thursday pointed firmly toward a Federal Reserve interest rate hike next week, with traders growing increasingly convinced that stubborn inflation will force the central bank’s hand.
The CME Group’s FedWatch gauge showed the probability of a rate increase climbing to 70% during morning trading, a significant shift driven by two converging forces hitting markets simultaneously.
A report showing wholesale prices rose 0.4% in August combined with U.S. crude oil prices jumping past $100 a barrel rattled investors already on edge about persistent inflation pressures.
The producer price index reading, while in line with forecasts, followed an upwardly revised 0.1% increase in July, pushing the annual PPI level to 5.4%, slightly above what analysts had anticipated.
Intensified hostilities in the Middle East spooked commodities traders, sending U.S. crude up 4% to just over the $100 barrier and adding to fears about entrenched inflation across the global economy.
“As the conflict with Iran drags on longer than many expected, inflation pressures are becoming increasingly entrenched, leaving investors in search of a catalyst strong enough to change the inflation narrative,” wrote Jeffrey Roach, chief economist at LPL Financial. “At this rate, a hike in rates next week appears likely.”
Traders also pushed the chances of a second rate increase in December to close to 60%, suggesting markets now see a more prolonged tightening cycle ahead than previously expected.
The European Central Bank added to the hawkish mood by announcing a quarter percentage point hike and raising its inflation forecast, citing concerns that the Iran war would deliver a longer-term hit to consumer prices.
“The ongoing spike in oil, combined with low jobless claims, make it hard for the Fed to not hike next week,” said David Russell, global head of market strategy at TradeStation, who also noted that “more pressure is coming because crude and refined products have kept rising since the August data was collected.”
Federal Reserve policymakers will receive one final inflation reading before their meeting, with the Bureau of Labor Statistics set to release its consumer price index on Friday morning.
The Dow Jones consensus forecasts a headline annual CPI reading of 3.4%, while core inflation, excluding food and energy, is expected to come in at 2.4%.
Fed Chairman Kevin Warsh has reemphasised that the Fed’s official inflation yardstick remains the Commerce Department’s personal consumption expenditures price index, which showed core at 3.3% and headline at 3.7% in July.
Bank of America senior U.S. economist Stephen Juneau estimated that core PCE is tracking at a 0.26% monthly rate for August based on the PPI data, which would round up to 0.3%.
“This could move significantly tomorrow after CPI, but if we are correct, it should greenlight a hike at next week’s Fed meeting,” Juneau said, with Bank of America holding one of Wall Street’s most hawkish forecasts, expecting three hikes at upcoming meetings.
Peter Boockvar, chief investment officer at One Point BFG Wealth Partners, warned that even a soft CPI reading could simply reflect companies struggling to pass higher costs on to consumers, arguing that “today’s PPI is evidence still of an inflation problem throughout the supply chain.”