The July CPI report has put the Federal Reserve in a “predicament” regarding a September rate cut, as stubbornly high core inflation conflicts with a weakening labor market, fueling fears of “stagflation-lite.”

What Happened: The inflation report, released Wednesday, showed headline annual inflation holding steady at 2.7%, but core inflation—which strips out volatile food and energy prices—accelerated to 3.1%. This rise in underlying inflation for a second consecutive month complicates the Fed’s path, forcing it to weigh its mandate of price stability against supporting a potentially ailing jobs market.

While some analysts see the persistent inflation as a barrier to easing policy, the majority of commentators believe the central bank will prioritize the labor market.

“Two consecutive months of higher 12-month inflation will make it difficult for the Fed to justify a rate cut,” argued Larry Tentarelli, Chief Technical Strategist for Blue Chip Daily Trend Report. He added that while his firm remains bullish on the S&P 500, they “do not expect a September rate cut” unless the job market deteriorates drastically.

This view, however, is increasingly in the minority. Most analysts believe the Fed will look past the inflation figures, focusing instead on recent reports of a higher unemployment rate and a miss in payroll forecasts.

“Despite the increase in core inflation, we expect the Fed to cut rates next month as they pay closer attention to the weakening labor market,” said Jeffrey Roach, Chief Economist for LPL Financial. He warned that the combination of hotter inflation and slower growth is “setting things up for stagflation-lite.”

Chris Zaccarelli, CIO for Northlight Asset Management, echoed this sentiment, stating, “we don't believe that this report will deter the Fed from cutting rates next month.”

Drilling down into the CPI data, Roach highlighted that rising costs for shelter, medical care services, and a surprising increase in used vehicle prices were primary drivers of the monthly increase.

Adding another layer of analysis, Eric Teal of Comerica Wealth Management pointed to a “bull steepening yield curve,” a market signal suggesting that “rate cuts are more likely as inflation appears temporarily contained” to help the economy avoid stalling.

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Why It Matters: Financial markets appear to agree, pricing in a high probability of an imminent rate cut.

According to Louis Navellier, the bet on a September cut “jumped to over 90% from less than 84%” following the report’s release. This expectation fueled a relief rally in the stock market, with Navellier noting the market is showing “no fear of labor issues or inflation.”

The CME Group's FedWatch tool‘s projections show markets pricing a 94.2% likelihood of the Federal Reserve cutting the current interest rates for the Sept. 17 decision.

Price Action: Following Wednesday’s July CPI report, both the S&P 500 and Nasdaq 100 indices rallied during market hours and closed at record highs.

The SPDR S&P 500 ETF Trust ( SPY ) and Invesco QQQ Trust ETF , which track the S&P 500 index and Nasdaq 100 index, respectively, closed higher on Tuesday. The SPY was up 1.06% at $642.69, while the QQQ advanced 1.26% to $580.05, according to Benzinga Pro data.

On Wednesday, the futures of the S&P 500, Dow Jones and Nasdaq 100 indices were mixed.

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Disclaimer: This content was partially produced with the help of AI tools and was reviewed and published by Benzinga editors.