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Just when a range of economic data got weak enough to give the Fed a pass on hiking rates, there was a surprise pickup in inflation last month.
The government's consumer price index rose 0.2 percent in August, but the closely followed core measure rose 0.3 percent, for an annualized pace of 2.3 percent. Meanwhile, the Fed's favorite inflation measure, the PCE deflator, is up 1.6 percent on an annualized basis but is still below the Fed 2 percent inflation target. The PCE deflator looks at the average price increase for all domestic personal goods and services.
JPMorgan economists said in a note that the rise in inflation does not change their view that the Fed will wait until December to raise rates, but they did point to a surprise 1 percent jump in medical costs — the biggest monthly rise since 1982.
"Inflation data is warmer than expected, and it will give fodder to those (Fed officials) who already coalesced around a rate hike. But we're going to see a hawkish hold," said Diane Swonk, CEO of DS Economics.
A batch of weakish data — including Thursday's 0.3 percent drop in August retail sales; the slowdown in August employment growth; and the decline in industrial production — all reinforced the majority view of economists that the Fed will stay on the sidelines at its meeting next week.
The central bank's dual mandates are to maximize employment and to control inflation, and while employment has recovered after the financial crisis, inflation has stayed stubbornly low. Some of the more dovish Fed officials would like to see rising inflation before they hike interest rates.
After the CPI data, Fed funds futures odds for a September hike ticked up to 20 percent, from 18 percent Thursday, according to RBS. The bond market's measure of inflation expectations also rose, after the inflation report. The yield difference between 10-year Treasury notes and the 10-year Treasury Inflation Protected Securities, or TIPS, was at 1.52 percent, a bit more than 2 points wider than Thursday's level.
Core CPI, which excludes gasoline and food, saw its biggest increase since February and rose on higher medical costs and rising rents. Owners' equivalent rent of primary residence rose 0.3 percent, but medical costs jumped by 1 percent, double July's pace. Hospital services were up 1.7 percent, and prescription medicine climbed 1.3 percent.
"While it doesn't change the minds of doves, they'd like to see a couple more months of it, but this is where we're moving," said Swonk. "It doesn't matter if it's September or December. It's where we were a year ago, the Fed wants to get a rate hike in this year. Once-a-year-Yellen."
Fed Chair Janet Yellen and other central bank officials had hoped to raise rates several times this year, but market turbulence, June's surprise Brexit vote and now softish data held them back. The Fed last hiked rates in December 2015, and that was its first rise off zero in the fed funds rate. That hike also came after the market was set up for a September hike, which the Fed held off on.
"To keep the dissenters at bay, you need to have a statement that's a little more hawkish. This isn't quite the punt it was a year ago in September when there was chaos in the market and China was on the edge. This time we're getting very, very close. I think (noted dove Fed Gov. Lael) Brainard will get to say let's wait. I think the mixed economic data gives them enough reason to pause," said Swonk.
The JPMorgan economists did point to the difference between CPI and the Fed's favorite PCE measure.
"The glaring disconnect between the CPI and PCE for medical care prices — and for core prices more generally — underscores the importance to the current monetary policy setting of (former Fed Chairman Alan) Greenspan's seemingly minor decision in early 2000 to switch from focusing on the CPI to the PCE price index," the economists said in a note.
The JPMorgan economists said given the CPI number, and Thursday's PPI, they expect to see core PCE increasing to 1.64 year over year in August.