Fed will begin cutting interest rates in September as the labor market weakens and inflation presents less risk

Following July’s relatively positive inflation report, expectations for a Federal Reserve rate cut in September have surged. As of Aug. 18, CME Group’s FedWatch tool put the probability at about 83%, up sharply from 59% just a month earlier.

Market sentiment has shifted quickly. President Donald Trump has been vocal in pressing the Fed to lower rates, arguing the economy can absorb the move. But Fed Chair Jerome Powell and others have leaned toward caution, citing the uncertain effects of tariffs and still-strong economic data that might argue against immediate cuts. If the Fed does move in September, it would be a rare step given the current backdrop.

Why July’s CPI changed the outlook
The July Consumer Price Index (CPI), released Aug. 12, gave investors fresh confidence that a cut is on the table. The CPI tracks monthly and annual price changes across a basket of goods and services, serving as a key measure of inflation.

In July, CPI rose 0.2% month over month on a seasonally adjusted basis and 2.7% year over year—slightly below consensus by 0.1 percentage point. Core CPI, which excludes food and energy, increased 0.3% from June and 3.1% annually, with the yearly figure just above expectations.

The market reacted strongly, with equities rallying and U.S. Treasury Secretary Scott Bessent urging the Fed to cut by half a percentage point. Despite continued price pressures in areas such as dining out (+0.3%), used cars (+0.5%), shelter (+0.2%), transportation services (+0.8%), and medical care services (+0.8%), the headline inflation numbers were in line—or slightly softer—than anticipated.

That was enough to convince many traders that the Fed now has sufficient justification to lower rates at its September meeting.