To The Moon

The US August CPI report, scheduled for release next Friday, will directly determine whether the Federal Reserve can resume interest rate hikes at this month's meeting. Major Wall Street institutions hold clearly divergent views on this report — BofA Securities believes the data will be strong enough to support a September rate hike, while Citi expects core inflation to cool further, making it more likely the Fed will hold steady.

According to trading desk sources, BofA Securities forecasts August core CPI to rise 0.22% month-over-month, corresponding to a core PCE increase of approximately 0.24%, with the annual rate climbing to 3.4%. The firm believes this level would be sufficient to convince Fed Chair Warsh that inflation is not yet fully under control, thereby supporting another rate increase. BofA views the August CPI as the "critical battle" for a September hike.

Citi, on the other hand, projects core CPI to increase only 0.184% month-over-month, with the annual rate falling to 2.3% — if realized, this would be the lowest annual core CPI reading since it surpassed 2% in April 2021, enough to lead most officials to choose to keep rates unchanged.

Meanwhile, some analysts warn that if the CPI data comes in hotter than expected, combined with super-core PCE inflation already rising to 3.9%, and strong August employment data, the Fed could be forced to adopt a more aggressive tightening path. This could push interest rates above 5% and actively invert the yield curve, subjecting US stocks to significant downside pressure.

The Key Threshold: Waller's Vote Holds the Balance

The rate hike decision at the September meeting depends considerably on the vote tally within the Fed. According to analysis, the hawks and doves within the Fed are evenly matched, with Governor Waller viewed as the key swing vote.

Waller previously told Reuters, "If inflation continues to make progress toward the 2% target, I am willing to support maintaining the current policy rate," and explicitly stated that August inflation data would be a key basis for his decision. The BofA report notes that Warsh signaled clearly hawkish tones at the Jackson Hole meeting, seemingly lowering the threshold for another rate increase, while Williams and Waller hold relatively dovish stances.

According to BofA's analysis, Waller's implied threshold is: he would only support a rate hike if August core PCE exceeds 0.30% month-over-month. BofA Securities forecasts core PCE at approximately 0.24%, below this threshold, but believes that if Warsh supports a hike and the data broadly meets expectations, a sufficient majority within the committee could still form to support another rate increase.

Citi argues that following Waller's comments this week, the market's threshold for determining "overheating" inflation has shifted upward — any data showing a 0.2% month-over-month increase after rounding could be considered moderate enough for most officials to support a pause.

Core Divergence: CPI and PCE Tell Different Stories

The deeper reason behind these divergent forecasts lies in the structural differences between the CPI and PCE inflation metrics, which are currently telling distinctly different inflation narratives.

According to analysis, housing accounts for approximately one-third of the CPI basket's weight, while PCE assigns significantly lower weight to housing. Over the past year, the cooling of housing inflation has been the primary driver pushing core CPI lower, and is also the core reason for the widening gap between CPI and PCE. Meanwhile, PCE places greater weight on healthcare and includes Medicare, Medicaid, and employer-paid medical expenditures, while CPI primarily measures consumer out-of-pocket costs. Therefore, rising medical costs are pushing up core PCE, especially super-core PCE.

The Cleveland Fed's inflation nowcasting model shows core CPI is expected to further decline to 2.3% in September, approaching the Fed's 2% target, while core PCE is expected to rise to approximately 3.5% over the same period — a clear divergence in their trajectories.

Fed Chair Warsh confirmed in his Jackson Hole speech that PCE inflation is the Fed's preferred policy reference indicator, with particular focus on super-core PCE — PCE services inflation excluding energy and housing. This metric has now risen to 3.9% and continues to climb, reflecting persistent wage-driven services inflation pressures.

Energy and Employment: Two Cards Strengthening the Hawks' Hand

Regardless of the final data outcome, the August employment report has already provided strong support for the hawks.

August non-farm payrolls added 162,000 jobs, significantly exceeding market expectations of 55,000, with annualized wage growth of 3.1%. This data was released after Waller made his aforementioned remarks, meaning the Fed must re-evaluate wage-inflation dynamics accordingly.

On the energy front, both BofA Securities and Citi expect August energy prices to rebound after several months of declines, pushing overall CPI month-over-month gains to approximately 0.34% to 0.37%, with the annual rate rising further from around 3.4% in July.

Analysis notes that escalating tensions in the Middle East, with the Strait of Hormuz yet to resume normal passage, and declining global oil inventories, could significantly impact prices. If energy prices surge dramatically, it would not only push up headline inflation but could also transmit to core inflation through a wage-price spiral, further strengthening the Fed's tightening pressures.

Rate Hike Expectations Rekindled, Equity Markets Under Pressure

For investors, the market implications of this CPI report are equally significant.

The S&P 500's Shiller P/E ratio currently exceeds 42 times, placing it in bubble valuation territory. Historically, this has corresponded to the late stages of economic cycles and has been further amplified by the AI capital expenditure boom. Analysis suggests that if the Fed is forced to adopt a more aggressive tightening path, pushing rates above 5% and actively inverting the yield curve, US stocks would face significant P/E compression risk.

BofA Securities believes that even if the composition of August inflation data does not trigger major alarm, it is unlikely to provide sufficient justification for the committee to delay a rate hike. The September 11 data release will be the most critical test for the Fed's near-term policy direction.

Following the CPI report, August PCE data will be released at the end of September, two weeks after the Fed's September rate decision.

Citi further notes that the uncertainty surrounding this August PCE data is higher than usual — the Fed has made methodological adjustments to several key components, meaning the conventional mapping relationship from CPI and PPI data to PCE has become less clear this month. Additionally, five years of historical PCE data will be subject to revision, expected to lower the core PCE annual rate by more than 30 basis points to approximately 3.0%. This technical factor adds to the difficulty of interpreting the final PCE reading.