For Federal Reserve officials hoping to find evidence in the data that they "don't need to hike again," the August Personal Consumption Expenditures (PCE) price index due Wednesday is unlikely to offer comfort.

As the inflation gauge the Fed watches most closely, PCE is expected to show that price pressures remain stubborn, while consumer spending has shown no obvious cooling. That means that after the September rate hike, the debate over whether to move again in October or December will only intensify.

According to market forecasts, both headline PCE and core PCE, which excludes food and energy costs, are expected to rise 0.3% month over month in August. On a year-over-year basis, headline PCE is expected to rise 3.7% and core PCE 3.3%, both unchanged from July and still far above the Fed's 2% target. In other words, there is little sign that inflation will fade in the near term.

The market sees a 0.3% monthly core PCE reading as a key dividing line. If the core monthly figure reaches 0.4%, after the September hike the Fed will find it hard to brush that off, potentially reinforcing expectations of another increase at the October 27-28 meeting. Conversely, if core comes in at just 0.2% or lower, policymakers will have more reason to wait and assess subsequent data. If the figures are broadly in line with expectations, both October and December moves will remain on the table.

Making matters more complex, the US Bureau of Economic Analysis (BEA) will carry out its annual update of the national accounts alongside the August report, meaning the recent inflation history may be revised. The BEA will adjust its price measurement methods for legal services, software and computer accessories, and portfolio management services, going back to 2021. Economists at Bank of America estimate these changes could make the relevant indexes 0.2 percentage points lower than under the old method.

Some Wall Street institutions expect July PCE year over year to be revised down by 0.2 to 0.3 percentage points as a result, with the headline annual rate possibly falling to around 3%. Traders therefore should not focus only on the August year-over-year figures but also pay close attention to the revised three-month and six-month annualized inflation rates.

Goldman Sachs expects inflation data in coming months to be "slightly unfavorable" before a milder trend reappears. Scott Anderson, chief economist at BMO Capital Markets, said bluntly that in many respects the August data is "already stale," because the renewed Middle East conflict in September has driven fuel prices sharply higher.

Consumers Are Still Spending, and the Bond Market Has Already Bet on a Hike

Consumer spending is another factor making the Fed uneasy. The market consensus expects consumer spending to rise 0.8% in August, versus just 0.2% in July, partly because of another surge in gasoline prices. Personal income is expected to rise about 0.5%. Bank of America reported that in the week ended September 19, debit and credit card spending rose 6.9% year over year, with gasoline spending jumping 26.5%; even excluding gasoline, spending still rose 5.7%. Although consumer sentiment has weakened amid persistent price increases, consumers remain willing and able to support the economy.

The bond market is sending a similar signal. The policy-sensitive 2-year US Treasury yield closed at 4.93% on Monday, continuing to test a more than two-year high; since the September 16 rate hike, the 2-year yield has matched a 25 basis point increase, showing that market expectations for further tightening are unchanged. The 10-year Treasury yield broke through recent highs to close at 5.24%, the highest level in nearly two decades.

Economists are debating how much of the rise in yields is driven by inflation anxiety, swelling federal debt, stronger economic activity and huge financing demand from the artificial intelligence (AI) boom. Regardless, these factors are all pushing up borrowing costs.

Meanwhile, diesel prices are becoming a new inflation concern. As a key input for freight and industrial activity, higher diesel prices tend to pass through to broader consumer prices. Discussions in Washington about restricting US diesel exports highlight the concern, but a ban could backfire: disrupting refining economics and global fuel markets, weakening production incentives, causing supply shortages and ultimately pushing prices even higher.

Gbenga Ajilore, chief economist at the Center on Budget and Policy Priorities, said: "The rise in diesel prices is worrying, but the main driver is the Iran war. End the Iran war, open the Strait of Hormuz, and diesel prices will fall."

Inside the Fed: Hawks Still Worried, Doves Emphasize Patience

At its September meeting, the Fed raised the target range for the federal funds rate by 25 basis points to 3.75% to 4.00%, its first hike since 2023, aimed at restraining borrowing and spending and rebalancing supply and demand. The dot plot showed that most officials expect at least one more 25 basis point increase by year-end; among the 18 Federal Open Market Committee officials who provided projections, all but two expect at least one further move.

Fed Chair Kevin Warsh said at a press conference earlier this month that hiring data, business investment and private-sector profits show the economy is in good shape. He noted: "I find it hard to describe broad financial conditions as restrictive." Financial conditions are an important input as the Fed calibrates rate policy.

Fed Governor Michael Barr is more concerned. He said the combination of tariffs and a prolonged war with Iran means "we have been knocked off track in our progress toward 2%." He added: "I have not yet seen a clear trend of a timely return to 2%." Barr reiterated that the Fed may still need to keep raising rates, but did not specify the level. "In my baseline scenario, further policy adjustment may be needed to ensure inflation falls to target in a timely way. We want to support sustainable, durable growth to support maximum employment, and price stability is essential to that," he said.

New York Fed President John Williams pointed to a third driver of persistent inflation: the AI buildout and related demand for goods. However, he also said other indicators were more encouraging: housing services prices have already decelerated, the labor market is not adding inflation pressure, and tariff pressure on goods prices has largely faded. On policy, Williams is more dovish than Barr, saying "there is no urgency, we have time to gather more information," but he still expects "one further increase" may be needed this year.

Dan North, senior economist at Allianz Trade, summed up that the Fed will see core inflation has not moved and has no reason to believe it will fall in a convincing way. "It is still well above target... I think it is embedded, and the Fed cannot ignore it or explain it away."

For now, although market expectations for an October Fed hike cooled somewhat after Williams spoke, the latest CME "FedWatch" data show that the market still sees a 50.4% probability that the Fed will raise rates by 25 basis points at its late-October meeting. Wednesday's PCE report is the last PCE release before the October meeting, and it will undoubtedly directly affect US Treasury yields, the dollar and broader risk sentiment. After months of hoping inflation would gradually fade from view, investors are once again confronting the possibility that price pressures may remain stubborn. The PCE report may not settle the debate, but it will certainly shape the next chapter in the ongoing tug-of-war between inflation and interest rates.