Market expectations for a big interest rate cut by the Federal Reserve (Fed) next month are fading after US PPI inflation surged at its fastest pace in three years.
Producer Price Index (PPI) data for July came in much higher than expected, signaling that higher import costs due to tariffs are now being passed on to consumers, an early warning for investors who were overly optimistic about aggressive policy easing.
This is a significant U-turn from earlier in the week, when slower consumer inflation data and dovish comments from US Treasury Secretary Scott Bessent had the market fully confident of a 0.25 percentage point rate cut in September. Some even bet as high as 0.50 percentage point.
However, that confidence has now waned, with the probability of a September cut down to around 90%, as investors begin to reassess how far the easing cycle can go given persistent inflationary pressures.
The PPI rise halted the rally in the US Treasury bond market and reminded policymakers that policymakers face a difficult challenge in balancing slowing economic growth with persistently high inflation.
While Bessent’s earlier comments that rates could be cut by up to 1.50 percentage points in stages still haunt the market, the latest data has clearly tempered short-term optimism.
Traders are now taking a more cautious approach, awaiting further confirmation from the next inflation data and an official Fed statement before betting on a new course of action.
On the geopolitical stage, Russian President Vladimir Putin praised US President Donald Trump’s diplomatic efforts to end the war in Ukraine, while signaling a willingness to deepen economic ties and possibly sign a new arms control agreement.
Markets are now focused on the Trump-Putin summit, which is seen as a potential turning point for global geopolitics and energy markets. European assets are cautiously positive, with investors weighing the possibility of a de-escalation of tensions against the risk of a spike in market volatility if talks fail.
The inflation shock poses a two-way risk to Fed easing expectations. Softer data following this could reinstate expectations of an aggressive rate cut, while a higher surprise reading would strengthen the Fed's stance and support the US dollar.
In currency markets, the strength of the USD will be tested against the G10 major currencies which are sensitive to changes in US bond yields, while geopolitical news could trigger significant moves in oil prices and European stocks.
