Sticky July Inflation Increases Bets on Federal Reserve Rate Hike

The Federal Reserve System is facing internal divisions over interest rate policy after July data showed the Personal Consumption Expenditures (PCE) price index remained at an annual pace of 3.7%, exceeding economist forecasts. Core PCE, which excludes volatile food and energy costs, held steady at 3.3%. Both figures remain significantly above the central bank's 2% target, marking the 65th consecutive month of elevated inflation. Contributing factors include high energy prices linked to the war in Iran, AI infrastructure spending, and a trade war with Canada.

Market reactions were mixed, with the US dollar gaining its largest increase in nearly four weeks. While the Federal Open Market Committee held rates at 3.50% to 3.75% in July, three members voted for an increase. Market-implied probabilities for a September rate hike rose to approximately 44%, though some traders expect the Fed to hold steady until December. To combat rising 30-year Treasury bond yields, Treasury Secretary Scott Bessent announced the U.S. Treasury Department will double its buybacks of longer-term bonds starting next month.

Policymakers remain split. Boston Fed President Susan Collins suggested tightening policy if inflation progress does not materialize, while New York Fed President John Williams viewed a 0.2% monthly increase as a sign of returning to target. Meanwhile, analysts warned that flat inflation-adjusted consumer spending combined with sticky prices signals a risk of stagflation. Investors are now awaiting a keynote address by Federal Reserve Chair Kevin Warsh at the Jackson Hole symposium for guidance on the September 15-16 meeting.