August inflation report is the 'worst' setup for the Fed

Economic Overview - The service sector is driving a 0.4% topline growth, indicating a stronger-than-expected performance in this area [2][4] - Inflation in the service sector appears to be sticky and potentially stubborn, complicating the Federal Reserve's efforts to return to a 2% inflation target [4][10] - The recent jobless claims reached 263,000, the highest since 2021, suggesting a weakening labor market [10] Federal Reserve Actions - The Federal Reserve is expected to cut rates by 25 basis points next week, but this decision is influenced by rising inflation and downside risks to employment [8][13] - There is a conflict in the Fed's mandates, as inflation remains elevated while employment data shows signs of weakness [9][16] - The Fed funds futures market anticipates a sub-3% rate by the end of next year, which may be overly optimistic given current inflation levels [14][30] Inflation Dynamics - Inflation remains elevated, with specific increases noted in food prices and shelter, which are impacting lower-income Americans disproportionately [18][22] - The food at home price index increased by 6.1%, while the shelter index rose by 0.4%, indicating persistent inflationary pressures [18] - Apparel prices also saw a 0.5% increase, suggesting that tariffs may be influencing these costs [20] Market Sentiment and Consumer Behavior - Consumer sentiment has shown some improvement, but there remains a general pessimism regarding job prospects and wage growth [25][26] - The economic environment is characterized by a K-shaped recovery, where wealth inequality is evident, impacting policy decisions [19][39] - The Fed's credibility is under scrutiny, particularly regarding its ability to manage inflation expectations while navigating political pressures [42][43] Interest Rates and Treasury Yields - Long-term yields, such as the 10-year Treasury yield, are not expected to fall significantly due to persistent inflation and fiscal concerns [29][30] - Mortgage rates are unlikely to decrease much further, as they are influenced more by long-term yields than by the Fed's short-term rate cuts [33][34] - The yield curve is steepening, indicating that investors are becoming more cautious about the Fed's independence and its implications for monetary policy [37][38]