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September Rate Hike Remains Uncertain

The Fed Five-Year Forward Breakeven Rate, which uses Treasury Inflation Protected Securities (TIPS) to calculate implied inflation expectations of investors and represents a notable measure of inflation for the Federal Reserve, recently slid back below the Fed’s Target Inflation Rate of 2% (Exhibit 1).

Exhibit 1: Fed Inflation Gauge Slides Below Target Rate

The recent devaluing of the Chinese yuan appears to have impacted inflation expectations to the downside, likely due to heightened concerns regarding global economic growth. The decline in Energy prices, as reperesented by WTI Crude Futures also appears to have impacted inflation expectations to the downside. The recent decline in WTI Crude Futures (Exhibit 2) is observably correlated with the recent decline in the Breakeven Inflation Rate shown in Exhibit 1.

Exhibit 2: WTI Crude Futures Price

Despite such significant declines in implied inflation expectations, the most recent implied probability of a September rate hike based on Fed fund’s futures trading is 46% (Exhibit 3), down from a high of 54% prior to the devaluing of the Chinese yuan, and off the lows of nearly 20% in early July. Given the backdrop of mixed economic and inflation indicators, a September rate hike remains uncertain. Although exogenous factors, such as geopolitical risks and foreign central bank intervention may have an impact on the Fed’s interest rate strategy, the outcome is most likely data dependent. With the September Fed meeting only one month away, all eyes will be on the Consumer Price Index (CPI) released today, and the Non-Farm Payrolls number in early September, among other measures of the economy.

Exhibit 3: Implied Probability of September Rate Hike

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