The last letter closed on a wager: a chair who had tightened by talking had bought himself time, and the September data would show what he bought it for. The data have now arrived, and they cut in opposite directions, with a hot core consumer price reading on one side and a labor market that has quietly stopped being the problem on the other. Markets responded by pricing a rate hike at this week’s meeting.

Executive Summary

• Core Consumer Price Index (CPI) inflation surprised to the upside in August at 0.3% month over month, with headline CPI up 0.4%, though the same source data translate into a more benign 0.2% gain in the core Personal Consumption Expenditures (PCE) index that the Federal Reserve actually targets.
• Financial markets now price a rate hike at the September 15-16 meeting almost in full, plus a further 25 basis points before year end, while some forecasters, including Oxford Economics, call for the Federal Open Market Committee (FOMC) to stay on hold.
• Nonfarm payrolls rose 162,000 in August against a consensus of 55,000, July’s reported decline flipped to a 21,000 gain and the three-month average climbed to 71,000 from 38,000, comfortably around the 50,000 breakeven pace.
• Wage growth kept cooling, with average hourly earnings growth easing to 3.1% year over year and the Oxford Economics wage tracker below 3% for the first time in five years.
• The Beige Book showed activity improving in 10 of 12 districts with no district contracting for a second consecutive report, even as employment rose only very slightly and five districts reported no change at all.
• The nowcast for third-quarter growth now runs at a 3.5% annualized rate, helped by a 1.1 percentage point contribution from equipment spending that largely offsets a trade drag of more than a point.
• Consumer sentiment dropped to 47.8 in early September from 51.7, and short-run inflation expectations jumped to 4.6% from 4.0% as gasoline climbed.

The Fed: A Decision on a Knife’s Edge

The FOMC meets on September 15 and 16 with less consensus around the outcome than at any meeting this year. Following the stickier August CPI report, financial markets have moved to price a hike almost in full, along with another quarter point before the end of the year. The rate decision may not even prove the most informative part of the meeting, since the updated projections and Chair Kevin Warsh’s press briefing will say more about where policy goes next, and internal research now suggests the neutral policy rate has risen since the start of the year.

Governor Christopher Waller supplied the clearest map of how a committee member might vote, departing from the chair’s reserved tone to make plain that this is a live meeting: continued progress toward 2% would let him support holding, while inflation coming in hot would have him consider a hike. August obliged with something in between, which is precisely why the meeting sits on a knife’s edge. Markets had already leaned hawkish after the strong August payroll report, penciling in two full hikes by March 2027.

The case for patience rests on a technical point that deserves more attention than it usually gets. Nonmarket services prices, primarily financial services and insurance, accounted for roughly half the increase in core PCE prices in the prior month’s report, and those prices are imputed rather than observed, which means they move for reasons that have little to do with what anything costs. A Bureau of Economic Analysis methodology change due at the end of September should lower annual core PCE inflation by two tenths of a percentage point, with the treatment of stock-trading fees doing much of the work, and this combination could be the support the Fed needs for a protracted hold through the rest of this year and into 2027. Measuring inflation partly by imputing what people would have paid for services nobody billed them for is a reasonable way to build a price index and a difficult way to set an interest rate.

The Beige Book pointed the same direction. The in-house prices index fell for a second consecutive report, consistent with the recent run of moderate inflation readings extending into August, even as a growing number of Federal Reserve officials appear to be running short of patience with inflation that keeps sitting above target. Energy remains the live risk on the other side, since global oil prices surged after United States military strikes on Iranian targets revived fears of supply disruption, and gasoline prices will likely stay elevated without a meaningful end to the war. President Donald Trump’s announcement of access to 65 billion barrels of Venezuelan oil reserves offers no near-term relief, since that figure describes reserves in the ground rather than shippable supply, and Venezuelan production runs at about 7% of United States capacity.

• Key Takeaway: This is the closest call the committee has faced all year, and the gap between what markets price and what some forecasts assume has rarely been wider. The resolution turns on whether the Fed reads the hot consumer price print or the tamer reading from its own preferred gauge, and a methodology change at the end of September may quietly settle the argument either way.

Inflation: One Gauge Runs Hot, the Other Does Not

August core CPI rose 0.3%, above both estimates and consensus, while headline CPI rose 0.4% as gasoline perked up. The trouble sat in non-housing core services, the category the Fed watches most closely because it reflects domestic demand, where airfares, motor vehicle maintenance and repair, lodging away from home and wireless telephone services all accelerated. Transportation services carry a particular warning, since they suggest energy costs are working their way into a broader set of consumer prices, a risk the central bank will watch closely as the Middle East situation could worsen ahead of the midterms.

Nearly everything underneath offered reassurance. Core goods prices decelerated, with weakness in apparel, some recreational goods and motor vehicle parts, while computer software and accessories declined outright, a detail that matters because those artificial intelligence (AI) related prices carry outsized weight in the PCE measure; tariff effects are adding roughly three tenths of a point to core CPI inflation and should fade from here. Housing came in as expected, and a jobless expansion paired with a rising rental vacancy rate should prevent any reacceleration in the single largest CPI category. Small businesses corroborated the calm, since actual and planned selling price increases held unchanged in August despite the run-up in diesel.

Producer prices told the energy half of the story plainly. The August Producer Price Index (PPI) rose 0.4% with core prices up 0.3%, lifting annual headline producer inflation to 5.4% from 4.8% and core to 4.6%. Energy did the lifting at 4.2% on the month, and another increase looks likely in September, with diesel up nearly 60 cents and gasoline close to 20 cents within the survey window. The passthrough already shows in transportation and warehousing costs, up 2.3% for their largest monthly rise since April. Food prices rose a benign 0.1%, though diesel feeds grocery costs with a lag of up to nine months, so the reprieve looks temporary.

Put the two reports together and the Fed’s own gauge looks considerably calmer than the headline that moved the market. Mapping the CPI and PPI details points to a 0.37% rise in headline PCE prices and a more modest 0.19% increase in the core, a path that would nudge annual headline PCE inflation down to 3.6% from 3.7% while the core holds at 3.3%. Two thermometers hang in the same room, and this month they disagree by enough to decide an interest rate.

• Key Takeaway: Core consumer prices ran hot in exactly one place, non-housing core services, and that place carries the fingerprint of energy rather than of broad domestic overheating. The Fed’s preferred measure looks tamer, so the September decision may come down to which instrument the committee trusts.

The Labor Market: Solid Enough to Leave the Stage

The August employment report beat everyone. Nonfarm payrolls rose 162,000 against a consensus of 55,000, July’s reported 23,000 decline turned into a 21,000 gain, June moved higher too and the three-month average of job growth climbed to 71,000 from 38,000, still in the neighborhood of the roughly 50,000 breakeven pace. A 40,000 rebound in state and local government employment supplied much of the lift, exactly the payback that the July collapse implied, while manufacturing appears to have turned a corner and job losses in information and financial activities may carry an AI fingerprint. The unemployment rate rose five hundredths to 4.14% unrounded, for the encouraging reason that the labor force and household employment both grew, with participation up two tenths to 62.6%, though the prime-age rate stayed flat.

One strong month does not make an overheating labor market, and the rest of the evidence describes something closer to stillness. Private payrolls in the Automatic Data Processing (ADP) report rose only 38,000 in August, with the three-month average cooling to 60,000 from 107,000 in June. The July Job Openings and Labor Turnover Survey (JOLTS) showed the hiring rate falling to 3.2% from 3.4% while the layoff rate ticked down to 1%, the familiar no-hire, no-fire arrangement. The quits rate slipped a tenth to 1.9%, which is what happens when workers doubt they could find something better. Openings edged up 89,000 to 7.27 million even as June saw a 177,000 downward revision, leaving the ratio of openings to unemployed workers above one and the market roughly in balance.

Layoffs stayed conspicuously absent. Initial claims ticked up 2,000 to 206,000 in the week ended August 29, with announced job cuts from Challenger, Gray and Christmas the lowest for any August since 2022, then eased 1,000 to 206,000 in the week ended September 5, matching a four-week average at the same level. Unadjusted claims now run nearly 14% below year-ago levels, and continued claims fell to 1.774 million, some 7% lower than a year ago. Small firms echoed the reading, with hiring intentions dipping in August only after July had carried them to their highest level in nearly four years.

Wages are the part that matters for policy, and they keep cooling. Average hourly earnings rose 0.3% on the month while annual growth eased to 3.1% from 3.2%, and the broader Oxford Economics wage tracker fell below 3% for the first time in five years. The ADP measure for all workers slipped a tenth to 3.2%, and the only series still trending up covers job changers, a group whose ranks the low quits rate keeps thin. Set 3% wage growth against productivity running above 2% and the arithmetic points down rather than up.

• Key Takeaway: August was a strong month inside a stable trend, not the start of an overheating. Hiring stays slow, firing stays rare, and wage growth below 3% against productivity above 2% means the labor market has handed the inflation argument back to energy prices and imputed services.

Growth, Trade and the Ledger

The expansion keeps running on productivity rather than payrolls. The Beige Book found activity improving in 10 of 12 districts in the six weeks to August 24, with the in-house activity index easing to 0.74 from 0.80 and no district reporting contraction for a second consecutive report —the longest such streak since mid-2024. Employment, by contrast, rose only very slightly: five districts reported no change, and AI turned up more often in the commentary, boosting efficiency while cutting both ways on hiring, with some districts seeking AI engineers and contacts in Cleveland, Richmond and New York rethinking entry-level and administrative roles. Where wages did rise meaningfully, they rose in construction and manufacturing, the trades the AI buildout actually employs.

The productivity data supply the mechanism. Second-quarter productivity growth held at 1.4% for an annual pace of 2.2%, with manufacturing contributing heavily as a 5.4% rise in output met a 2.9% increase in hours. The more interesting detail sat in the non-financial corporate sector, where capital and technology spending concentrates: productivity there grew 2.2% and has run ahead of the nonfarm business measure since the second quarter of 2025, which may offer an early read on gains spreading to the rest of the economy as adoption widens. Unit labor costs, revised down a tenth to 1.2% annualized, confirm that none of this is coming out of a wage spiral.

Both purchasing manager surveys pointed to steady growth with the same lagging component. The Institute for Supply Management (ISM) manufacturing index eased a point to 54.6 while new orders and order backlogs held well inside expansion and customer inventories stayed in territory that signals firms need to restock. Its employment index slipped 1.6 points to 51.2 yet managed two consecutive months of expansion for the first time since 2022. The services index rose 1.3 points to 55.4, its strongest since February, and a weighted average of the two points to growth above 2% annualized in the third quarter, though the services employment index remained in contraction. Prices went the wrong way on both: manufacturing input costs held at an elevated 71.1 after a post-war peak of 84.6, and the services prices index jumped 2.3 points to 72.6, its highest since August 2022, with respondents naming the Middle East conflict and tariffs.

Trade delivered the paradox this letter keeps returning to. The July deficit widened to $88.6 billion from $73.3 billion, the largest since March 2025, as imports rose 2.8% against a 2.1% fall in exports, and the strength in imports sat entirely in capital goods, where a $14.4 billion rise left the category a staggering 46% above year-ago levels on computers, computer accessories and semiconductors. Net trade looks set to subtract more than a point from third-quarter growth, almost exactly offset by a 1.1-point contribution from the equipment spending those same imports represent. Construction told a two-sided story as well, falling 0.5% in July and dragging the residential investment nowcast to a 3% annualized decline from 1.6%, while business structures improved to a 1.5% decline from 4.1% as data-center construction kept running and power structures picked up. Add it together and the third-quarter growth nowcast now tracks 3.5% annualized. The ledger, as ever, quietly worsens. Treasury reported a $167 billion August deficit against $345 billion a year earlier, an improvement that is entirely a calendar fiction, since the August gap would have come in $9 billion wider on comparable terms. The fiscal year-to-date shortfall of $1.966 trillion sits $7 billion below last year, yet absent the same quirks it would stand $81 billion higher. Corporate receipts have fallen 24.3% under the One Big Beautiful Bill Act, customs receipts managed a 1.3% annual gain and roughly $40 billion of an anticipated $160 billion in tariff refunds has yet to go out the door. Against that backdrop, the President floated $5,000 checks for all adult citizens should Republicans hold both chambers after the midterms, a program costing as much as $1.25 trillion, or 3.8% of gross domestic product (GDP), and exceeding what Treasury will spend this year on defense, Medicare or interest. There is a very low probability the trifecta would allow it.

• Key Takeaway: Growth is tracking well north of 3% on productivity, equipment spending and a restocking cycle, with jobs contributing almost nothing to the total. The pattern is durable while it lasts, and the fiscal arithmetic keeps deteriorating underneath it in a way no single quarter makes urgent.

The Consumer and Housing: Wealth Holds, Mood Breaks

Consumers are spending like one group and answering surveys like another. The preliminary September reading of the University of Michigan sentiment index fell to 47.8 from 51.7, below the 51.4 forecast, with the assessment of current conditions falling and the view of the year ahead falling harder. Short-run inflation expectations jumped to 4.6% from 4.0% as gasoline climbed, and the long-run measure ticked up a tenth to 3.4%. The split by income keeps widening, since sentiment deteriorated among lower- and middle-income households while rising among upper-income ones, and economists anticipate that the upper tier will carry consumer spending growth of around 2% through the rest of the year.

The spending data are considerably more cheerful than the mood. Consumer credit rose $18.1 billion in July, with nonrevolving credit up $15.3 billion against a more modest $2.8 billion in revolving credit, whose annual growth slowed to 3.6% from 4.1% as the tax-refund tailwind faded. Excluding student loans, nonrevolving credit rose $10.2 billion, essentially an auto lending story. Student loans grew just $0.3 billion in the first month that the borrowing caps and stricter repayment rules under the One Big Beautiful Bill Act applied, and since borrowers need not switch to the new income-driven plan until 2028, the effect will show up only gradually.

Vehicles made the point in the plainest terms available. Sales jumped to a 16.8 million annualized pace in August, the strongest since April 2025 when buyers were front-running tariffs, leaving third-quarter sales tracking 1% above the second. Higher pump prices have tilted the mix toward hybrids, whose share peaked at 17.1% in May against 13.9% in February, and gasoline has averaged above $4 a gallon since mid-July. Fully electric and plug-in hybrids account for just 6.8% of sales after averaging above 9% in 2025. The top fifth of the income distribution buys more than half of all new vehicles by dollar value, which is why sales can boom while sentiment sinks, and the September baseline looks for 16 million sales this year against 16.2 million in 2025.

Housing remains where the cost of higher-for-longer shows up most plainly. Existing home sales fell 2% in August to 3.98 million, down 1.2% from a year earlier, adding downside risk to a forecast of residential investment declining at a 2.1% annualized pace. The more telling signal was inventory, which rose 3.2% on the month and 5.9% over the year, an unusual direction once the spring selling season has passed and a plausible sign that homes are sitting longer, leaving 4.9 months of supply at the August pace. The median price fell 1.7% on the month while holding a 1.6% annual gain, with the forecast still near 2% growth. The cause sits in the bond market rather than at the Fed: after briefly touching 6% before the war with Iran, mortgage rates now run near 6.75%, which has pushed the monthly payment on a median-priced home up nearly $300, or 15%.

• Key Takeaway: The consumer who owns assets keeps buying cars while the consumer who buys gasoline keeps answering surveys badly, and the aggregate numbers describe neither one accurately. Housing is the clearest casualty of long rates that higher oil prices, heavier public borrowing and a surge in corporate issuance have pushed up regardless of what the Fed decides this week.

Final Thoughts

The question left hanging two weeks ago has an answer, and the answer is that nobody agrees. Core consumer prices ran hot at 0.3%, the labor market delivered a 162,000-payroll gain that removed any excuse for worrying about jobs and markets promptly priced a hike this week plus another before year end. Against that, wage growth slipped below 3%, the Beige Book price index fell for a second straight report and the Fed’s own preferred gauge looks set to come in near two tenths for the core.

Growth, meanwhile, has quietly become the least controversial thing in the economy, tracking 3.5% annualized on productivity, equipment spending and a restocking cycle that owes almost nothing to hiring. That is a comfortable place for an expansion to sit and an uncomfortable place for a central bank, since an economy this strong offers little cover for patience if the next price print misbehaves. Wednesday settles one question and opens several more, and for once the interesting part of the meeting may be the projections rather than the decision.

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