After somewhat positive inflation data in July, the chances of the Federal Reserve cutting interest rates in September are at roughly 83%, according to CME Group's FedWatch tool calculations on Aug. 18. One month earlier, roughly 59% of traders betting on changes in the federal funds rate thought an interest rate cut would occur in September.

In this market, apparently, opinions change fast. While President Donald Trump has been aggressively urging the Fed to cut rates because he thinks the economy can manage the cuts, many, including Federal Reserve Chair Jerome Powell, have opted for a wait-and-see approach, given the uncertainty of the impact of tariffs on inflation and some data indicating economic strength that would point to keeping rates where they are. Interestingly, if the Fed does cut rates in September, it would be a nearly unprecedented move, considering where the data stands.

In the past, the Fed has rarely cut in this situation

The July Consumer Price Index (CPI) report released on Aug. 12 gave investors all the confidence they needed that the Fed will cut rates in September. The CPI tracks the monthly and yearly price changes of a basket of consumer goods and is viewed as a key data point that the market uses to gauge the level of inflation.

Two people looking at chart on computer.

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In July, the CPI rose 0.2% from the prior month on a seasonally adjusted basis and was up 2.7% year over year. The annual number came in 0.1% below what consensus estimates called for. Meanwhile, core inflation, which strips out more volatile food and gas prices, rose 0.3% from the prior month and 3.1% higher year over year, with the annual number slightly above consensus.

The market ripped higher on the news and U.S. Treasury Secretary Scott Bessent called for the Fed to cut rates by a half point. Looking at the specific report, many items are still experiencing monthly increases, including food away from home (0.3%), used cars (0.5%), shelter (0.2%), transportation services (0.8%), and medical care services (0.8%). But with the headline CPI number coming in around consensus or even slightly better, the market now thinks the Fed has the evidence it needs to cut rates.

Powell has been in pause mode because he and the majority of other members of the Fed's Board of Governors are unclear what impact tariffs will have on inflation. While there certainly has been some impact thus far, it has not been as immediate or severe as many had expected. The Fed wants to avoid any kind of stagflationary environment at all costs, in which both unemployment and inflation rises. So with some weaker labor data in recent months, if inflation data comes in tamer than expected, the Fed is in a better position to cut.

But if the Fed does go ahead and lower interest rates in September, it would likely be a near-unprecedented move, says Jim Bianco, who runs his own research firm, Bianco Research:

As stated by Bianco, the Fed puts more weight onto core inflation because energy and food prices are more volatile and can be influenced by other factors, meaning they aren't always the best indicators of inflation. The Fed's preferred inflation target is 2%, although many like Bianco have argued that the Fed has more or less abandoned this metric and may be more focused on the labor market.

Unchartered territory

While estimates of the Fed's likelihood to cut rates change constantly, seeing such a high chance for a cut in September is certainly a hard number to ignore. There are only a few key data points still to be reported before the Fed's September meeting, so new data would need to clearly show higher inflation to dissuade the Fed from cutting. They would also need to be of more concern to Fed board voters than the weakening labor market data.

That said, Bianco's messaging makes sense. It's possible the Fed views inflation as artificially high, given the amount of support put into the economy during the brunt of the pandemic, and that inflation will fall closer to the Fed's 2% target over time. The jobs data have shown weakening in the labor market in recent months, with the economy only adding about 73,000 jobs in July and revising prior-month numbers significantly lower. Recent unemployment claims growth is also of concern.

The U.S. economy is powered by consumer spending, so if unemployment begins to rise, that could blunt the key force driving economic growth. It's also not quite clear how the Trump administration's immigration policies will impact the labor market. For instance, fewer immigrants in the country can skew data on job growth and unemployment rates, creating a false narrative about how overall employment is actually faring.

The fact that the Fed is strongly predicted to cut rates despite the data Bianco cited shows the economy is in uncharted waters. Investors should understand that this means things may happen differently than in past cycles. That could mean higher highs or perhaps a potential pullback on the horizon. We don't know, but it's something for all investors to be aware of so they can make calmer, less rash decisions.