The importance of this week's PPI and CPI lies in their eventual impact on the Federal Reserve's judgment regarding PCE inflation trends.

Source: Jin Ten Data

The Federal Reserve's interest rate decision next week may depend on the inflation data released this week, with the differences that could ultimately affect the decision being only a few tenths of a percentage point.

The market is currently oscillating between expectations of interest rate hikes and maintaining the status quo. Investors will next focus on the Producer Price Index (PPI) released on Thursday and the Consumer Price Index (CPI) released on Friday. If the inflation data shows a significant uptick, it will strengthen the case for raising rates; if monthly inflation shows signs of easing, Federal Reserve officials may lean towards keeping rates unchanged.

CPI and PPI May Become Policy Dividers

Evercore ISI economist and central bank policy chief Krishna Guha stated, "The interest rate decision will mainly depend on inflation data, but it will also depend to some extent on the expectations formed by the market after the data is released. The threshold for the Federal Reserve to raise rates has not been strictly defined at this time."

Wall Street economists expect the PPI for August to rise 0.4% month-on-month and 5.3% year-on-year. For the CPI, the market expects an overall CPI increase of 0.4% month-on-month and a 3.4% year-on-year increase, with core CPI increasing 0.2% month-on-month and 2.4% year-on-year.

However, the Federal Reserve does not primarily use CPI or PPI for formulating monetary policy but rather the Personal Consumption Expenditures Price Index (PCE). The data released this week will be used to estimate the PCE to be published at the end of the month, thus helping policymakers assess inflation trends.

Guha believes that if the core PCE corresponds to a monthly increase of about 0.21% or 0.22%, it may prompt the Federal Open Market Committee (FOMC) to opt for inaction; if it reaches 0.23% or 0.24%, then "it is very likely to turn towards rate hikes."

Guha bluntly stated that such precise policy judgments, accurate to 0.01 percentage point, are "absurd." He and other Wall Street forecasters predict that the CPI and PPI data may ultimately point to a monthly PCE increase of 0.2% to 0.25%, meaning a very small deviation could change policy choices.

Warsh Faces a Crucial Decision, Official Positions Are Not Aligned

This delicate policy environment highlights the pivotal role of Federal Reserve Chairman Kevin Warsh in the September meeting.

At the Jackson Hole annual conference, Warsh publicly emphasized that the Federal Reserve has not achieved the 2% inflation target for more than five years. The market interpreted this as a signal that he might push the FOMC to raise rates by 25 basis points on September 16.

However, the market has not formed a strong consensus on this. As of Tuesday, market pricing indicated a roughly 60% probability of a Federal Reserve rate hike, which is just around the usual experiential dividing line used to judge whether a central bank might take action.

Guha expects the probability of inaction to be slightly higher than that of a rate hike, but the outcome is far from certain. He stated that this assessment is based on inflation data potentially being lower than expected, while Warsh's demands for maintaining rates post-Jackson Hole have become higher than before, but "not high enough to be unachievable."

Recently, there has also been a clear divergence in positions among Federal Reserve officials. Hawkish officials like Cleveland Fed President Beth Hammack continue to advocate for rate hikes; Federal Reserve governors Christopher Waller, Michael Barr, and New York Fed President John Williams tend to emphasize making decisions based on economic data.

Hammack's predecessor, Loretta Mester, also stated on Tuesday that the Federal Reserve needs to raise rates to prove its commitment to curbing inflation.

"I would indeed advocate for a rate hike," Mester said in an interview with CNBC, "I do not believe the Federal Reserve will necessarily raise rates. Chairman Warsh needs to clearly explain after the meeting why they reached their final decision, regardless of what that decision is."

PCE Revisions and Trump's Pressure Add Uncertainty

Even if this week's inflation data settles, there remains another layer of uncertainty in the Federal Reserve's policy judgment. Economists expect the PCE to undergo revisions on several key indicators, potentially retroactively lowering previously published inflation figures by several percentage points.

Therefore, the September decision could be based on a very minimal data difference. Guha believes that if the market is significantly betting on interest rate hikes before the meeting, and Warsh faces reputational pressure, then maintaining rates will become more challenging.

Meanwhile, Trump is also increasing uncertainty in the policy environment. Last Friday, Trump threatened that if the Federal Reserve does not lower rates, he may cut trade ties with countries that maintain a trade surplus with the U.S. This action is seen by some as another attack on the Federal Reserve's independence and may, in turn, prompt policymakers to strengthen their stance.

Guha stated, "If the market prices in a clear preference for a rate hike before the meeting, then it will be difficult for Warsh to choose to stand pat. Thus, within this gray area, market reactions themselves may affect the final decision."

Currently, the key for the September meeting is not just whether "inflation is high," but where the PCE ultimately reflected by the CPI and PPI falls, and whether Warsh can persuade the divided officials to support the final policy choice.