Consumer inflation rose in August at its fastest pace since spring, due in part to impacts from Hurricane Harvey on gasoline and shelter.
Traders immediately speculated that the hotter inflation data could persist as a result of both Harvey and Irma, which didn't hit Florida until September. As a result, they speculated the Fed may be more inclined to raise interest rates one more time this year.
The consumer price index jumped 0.4 percent, the biggest increase in seven months. That lifted year on year inflation to 1.9 percent, up from 1.7 percent in July. Core CPI, without gasoline and food, rose 0.2 percent.
Americans across the country are now seeing the first economic punch from Hurricane Harvey, with gasoline at the pump rising 30 cents nationally. That will most certainly impact inflation in September, which is when most of the increase occurred but it also could fade if prices begin to fall, as expected by energy analysts.
About 9 percent of the U.S. refining capacity was still off line this week after Harvey dumped unprecedented amounts of rain on the heart of America's refining center on the Gulf Coast in late August, according to IHS Markit.
Market odds of a rate hike, based on fed funds futures, jumped to about 45 percent for December, according to Cantor Fitzgerald. Last week, those odds were at about 20 percent. Goldman Sachs economists said based on the rise in inflation, they have raised their own odds for a rate hike to 60 percent from 55 percent, based on the increases in shelter and rent costs.
"You're basically at 50/50. The Fed I think is itching to get one more rate hike in this year, but the market has been discounting it," said Justin Lederer, Cantor Fitzgerald rate strategist. "We'll see next Wednesday what [Fed Chair Janet] Yellen and the statement have to say about it, and there's also tomorrow's retail sales which is a big number as well."
The Fed meets Tuesday and Wednesday, and it is expected to hold off on an interest rate hike but begin the process of shrinking its balance sheet. The Fed could issue new forecasts on interest rates and the economy, but currently it forecasts one more rate hike for this year.
Economists expect that hike to be in December, but the market has doubted the Fed will move based on months of persistently low inflation and mixed signals from Fed officials. The Fed has targeted a 2 percent inflation rate, and some Fed officials have said the lower inflation appears transitory.
"This is really going to complicate matters for the Fed. CPI is still 1.6 which is what it was in July. It's still too cool for the Fed, but there are some trends in here that are coming through from Harvey and Irma which will be hard to write off as one-time events," said Diane Swonk, CEO of DS Economics. The Fed has targeted a 2 percent inflation rate, and CPI has lately been lagging.
Swonk said the August data could be the start of a trend that could go on for a number of months. She said the government included some impact from Harvey in the August number, noting that costs for lodging away from home rose 4.3 percent for the month and gasoline was up more than 6 percent.
"This is with some Harvey, but there's no reason to expect it to go away. There's still tens of thousands of people in temporary hotels paid for by FEMA. This could definitely persist," said Swonk.
The Consumer Price Index was expected to rise 0.3 percent for an annual incrase of 1.8 percent, the highest reading in several months.