A hotter-than-expected spike in wholesale inflation is throwing buckets of ice water on the frothy expectation of a big, beautiful Federal Reserve interest rate cut next month.
Treasury Secretary Scott Bessent earlier this week touted a steep series of interest rate cuts beginning with the Federal Reserve’s September meeting.
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He conceded that the Fed needed to take a beat after the Producer Price Index surged 0.9% month-over-month and 3.3% year-over-year on Aug. 14.
These figures were well above the roughly 0.2% and 2.5% forecasts.
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Tariff-driven inflation: a hidden spike?
Mounting evidence suggests that tariffs are feeding into producer prices particularly through elevated trade margins, food costs, and services inflation.
Nearly half of the services PPI price surge stemmed from trade margins among machinery wholesalers.
Food and energy prices also climbed sharply.
Goldman Sachs economists in a note estimated that consumers could soon bear up to 67% of tariff costs, up from 22%, thus escalating broader inflation risk.
Related: Producer price inflation shocks Fed interest rate cut bets
Markets rethink the September outlook
Before the Aug. 14 PPI report, markets were nearly unanimous in pricing a September Fed interest rate cut of up to 0.50%.
The latest data has shifted expectations: The chance of a 0.50% cut is practically off the table for now, and the likelihood of a 0.25% cut has also dropped.
The CRE Group FedWatch Tool, which surveys futures traders, dropped the probability of a 0.25% cut back from nearly 100% down to 91.8%.
“Today’s PPI surge is unwelcome given last week’s jobs figures,” Mahoney Asset Management CEO Ken Mahoney told The New York Post. “It may be a one-off, but markets will watch if that trend persists.”
Related: Surprising CPI report sparks mixed Fed interest rate cut forecasts
Bessent had said in news reports following the Aug. 13 tamer-than-forecast CPI report that the Fed should consider a 0.50% cut in September followed by a series of cuts to get the rates down at least 1.50 percentage points.
He walked back those comments Aug. 14, saying in a Bloomberg interview that he wasn’t trying to tell the Fed how to act. Rather, he said he was highlighting modeling outcomes that imply the neutral rate is about 1.5% lower than the current Federal Funds Rate of 4.25% to 4.50%.
Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, notes that “this PPI spike still raises caution.”
Labor market: A silver lining?
Though inflation readings are flashing red, there is a glimmer of relief from the labor front.
Continuing jobless claims dipped, and initial claims fell to about 224,000 according to the most recent data.
But the labor market has also shown signs of cooling compared to earlier strength, which had been bolstering interest rate cut expectations.
At the heart of the Fed’s dilemma is its dual mandate: promote maximum employment while ensuring stable prices.
Recent comments from Fed officials underscore how tariffs and resulting wholesale-price pressures intensify this balancing act.
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Alberto Musalem, president of the St. Louis Fed and a voting member of the FOMC, said services represented 80% of the inflation increases in both the PPI and CPI.
“Can the Fed look through that in September,” Musalem told CNBC Aug. 14, adding that unemployment rates were still low.
Chicago Fed President Austan Goolsbee, a voting member of the policymaking Federal Open Market Committee, has warned of a stagflation threat from tariffs, saying: “It makes both sides of the mandate go bad at the same time…there’s not an obvious answer.”
What’s ahead before the Sept. 17 vote
As the Fed approaches its Sept. 16-17 FOMC meeting, several key data points will influence its decision:
- Retail sales (expected Friday, Aug. 15), crucial for insights into consumer demand and economic momentum
- Jackson Hole speeches (Aug. 21-23), where Powell may signal a policy direction change
- Further labor data, especially nonfarm payrolls and unemployment
- New tariff developments, which could push prices further upward and complicate disinflation efforts
Related: White House taps more potential candidates to head the Federal Reserve
