Fed Hike Odds Plunge to 25%, But Energy Costs Keep Inflation Alive

The recent decline in September Fed rate hike odds has left investors wondering if the betting markets are getting ahead of themselves. Energy costs, still elevated after the Iran war, have kept inflation alive and contributed to a sharp increase in gas prices, currently at $4.06 per gallon, which is 38% above its February 28 pre-war level.

According to Yale Budget Lab estimates, the tariff burden has added up to roughly $1,100 per household under certain assumptions. The Bureau of Labor Statistics reported that energy prices were still 15.7% higher year-over-year in June, with gasoline at 26.7% higher. This feeds into transportation, manufacturing, utilities, and eventually consumer prices.

After three Fed officials voted for a quarter-point hike in July, the case for another increase was already on the table. The inflationary mechanics are less debatable than the politics surrounding the issue. Two recent inflation reports have delivered friendlier numbers, but investors should remember that these markets measure the price of a bet, not a guarantee.

Three important inflation reports remain before the September FOMC meeting: July PCE on August 26, followed by August PPI on September 10 and August CPI on September 11. The Cleveland Federal Reserve's Inflation Nowcasting model already sees July core PCE inflation running around 3.3% year-over-year.

Economic growth remains resilient, with the Institute for Supply Management's manufacturing index jumping to 55.6 in July, its highest reading since May 2022 and seventh consecutive month above 50. This gives the Fed more room to tighten without immediately tipping the country into recession.