The July US inflation data aligned with expectations, leaving the Federal Reserve with a temporary reprieve before its September meeting. The figures were neither weak enough to permanently rule out a rate hike nor strong enough to force immediate action, though deeper policy divisions and uncertainty persist.
Wall Street Journal reporter Nick Timiraos noted Thursday that the inflation report, largely in line with forecasts, has somewhat eased pressure on the Fed to raise rates next month. However, it offered no clear answers for the longer-term outlook. Meanwhile, the employment report released last week showed no signs of renewed acceleration in labor demand, further weakening the case for additional tightening.
According to CME Group data, following the release of the July CPI figures, the market's implied probability of a September rate hike has fallen below 50%. Yet, the internal hawk-dove debate within the Fed continues, with multiple officials holding sharply divergent views on the policy path. The outcome of the September 15-16 meeting remains highly uncertain.
Data Meets Expectations, Easing Rate Hike Pressure
July's core CPI, which excludes food and energy, rose 0.2% month-over-month, matching market expectations, with an annual increase of 2.5%.
Renaissance Macro analyst Neil Dutta said the result "hurts the hawks more than the doves." He argued that because the inflation data is not decisive, the outcome of the next few meetings is essentially a "coin toss." He also noted that if the Fed can hold off on action through the fall, the data by then might be good enough to support a continued pause.
Fed officials will receive one more inflation report before the September meeting—the August CPI data, due on September 11, a week before the meeting. Additionally, the Fed's preferred inflation gauge, the PCE price index, will be released later this month. This indicator has been running higher than CPI, with the core PCE rising 3.3% year-over-year in June.
Internal Divisions Widen, Policy Path Disputed
Timiraos pointed out that despite the decision to hold steady at the July meeting, divisions within the Fed were already clear. Among the 12 voting members, at least six have recently signaled a potential inclination to support a rate hike, with three directly voting for an increase at the July meeting.
The majority's stance is built on the judgment that current interest rates are already sufficiently restrictive to bring inflation back to the 2% target. They argue that persistently high inflation stems from temporary factors like tariff shocks and energy prices, rather than excessively loose policy. However, this view is facing growing challenges—these shocks are not only persisting but are also combining with surging demand from AI infrastructure construction, pushing up prices for tech equipment and software.
Cleveland Fed President Beth Hammack voted for a rate hike at the July meeting. She stated this week that a single 25-basis-point increase "would likely not do much to the economy" and that the Fed might need a series of adjustments. She compared this choice to braking—the earlier a gentle press is applied, the less likely a hard slam will be needed later.
San Francisco Fed President: Potentially Larger Action Needed
Timiraos noted that the comments from San Francisco Fed President Mary Daly have further increased the complexity of policy decisions. Speaking in Japan last week, she outlined two potential economic scenarios. In the first, recent shocks gradually fade, allowing the Fed to hold rates steady. In the second, shocks persist and compound, leading to self-reinforcing inflation momentum. She indicated the first scenario remains her base case, but the gap between the two is narrowing.
Daly pointed out that if the second scenario materializes, the required policy response might exceed the Fed's typical 25-basis-point moves. She said small, gradual adjustments would be insufficient to address the "underlying dynamics that need to be confronted head-on," and directly questioned, "If we see the second scenario unfolding, why would we act incrementally?"
This statement effectively raises the stakes for decision-making. If a misjudgment of the economy would require at least a 50-basis-point response, some officials naturally want more certainty before acting.
Chairman's Ambiguous Stance, Markets Seek Signals
Against this backdrop, Fed Chair Jerome Powell’s stance has become increasingly ambiguous. He has gradually stepped back from providing forward guidance to markets and expressed skepticism about the Fed's ability to fine-tune the economy, stating bluntly, "I don't think we're good at fine-tuning."
With the Chairman reducing his public statements, investors are now looking for clues from other Fed officials. Several officials have previously hinted that inflation data will dominate the September decision. Following the release of July CPI, market expectations for a rate hike have fallen below 50%. However, the final answer may not be clear until the August inflation data is released on September 11.
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