Inflation Stays Stubbornly High in August. Here's How Likely a Fed Rate Hike Is Next Week

Something strange is currently happening with interest rates and inflation.

The United States Federal Funds Rate -- essentially the price banks charge each other to borrow money overnight -- currently sits at 3.75%. The rate has remained at 3.75% throughout 2026.

For much of 2023 and 2024, the Fed Funds Rate was pegged at 5.5% to battle stubbornly high inflation. As inflation fears eased, the rate was gradually lowered to today's 3.75% level.

Despite a low and stable Fed Funds Rate, however, mortgage interest rates have begun to climb. According to the Wall Street Journal, average U.S. mortgage rates have climbed to a 15-month high of nearly 7%. Treasury yields, meanwhile, are approaching multi-year highs.

On Sept. 11, we also learned that August inflation numbers continued to rise. The Consumer Price Index (CPI) rose by 0.4% for the month, an annual rate of 3.4%. That figure doesn't even include fuel or gas price inflation, both of which have recently outpaced the top-line CPI figure.

"America still has an inflation problem," the chief economist at Navy Federal Credit Union warns.

Will the Federal Reserve raise rates next week to combat the uptick in inflation? Right now, there seems to be a mismatch between what inflation, mortgage rates, and treasury yields are telling us versus the Fed Funds Rate.

Here's what analysts and betting markets are predicting.

The odds of a rate hike have spiked sharply

Wall Street experts are attributing a lot of importance to August's inflation numbers. "The fate of the September meeting lies with August CPI," Citigroup (NYSE:C) economists stressed. Even before August figures were released, the bank cautioned clients that "there's a bit more risk of a September rate hike than markets are accounting for."

Citigroup had previously called for rate cuts in October and December, followed by another rate cut in January of next year. Last week, the bank abandoned those predictions. Betting markets were a little slower to react.

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On Sept. 10, certain betting markets were pricing in a roughly 50-50 chance of either a rate hike or no action. After August's inflation report went public, the odds of a rate hike spiked above 80%. No change in rates garners an 18% probability, with a rate cut projected to have less than 1% odds.

"The upside surprise to core CPI in August means the Fed looks set to hike next week," concludes Stephen Brown, an economist at Capital Economics.

How should investors react? Citigroup stresses that a rate hike "wouldn't be the worst thing" for stocks. The bank doesn't believe a rate hike would indicate a structural environment where rate hikes become the norm. A rate hike could even deliver a "bullish shock" to markets, the bank says, as it could anchor long-term yields and ease market uncertainty over the uptick in inflation.

Regardless of what happens, the vast majority of investors are likely best off maintaining a long-term investment horizon. Over the decades, interest rates have risen and fallen dramatically many times. Inflation, too, has ebbed and flowed. Patient investors who held through these periods of volatility have largely come out as victors versus traders attempting to continually time the market.

Citigroup is an advertising partner of Motley Fool Money. Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.