Investors have begun pricing in odds of a 100 basis points rate hike at this month's Fed meeting after the hotter-than-expected August inflation report

• Investors after Tuesday's CPI report were pricing in odds of a 100 basis point increase by the Fed this month.
• The CME FedWatch tool showed a 20% chance of a big rate hike at the September 20-21 meeting.

Investors on Tuesday were pricing in expectations of a big interest rate increase of 100 basis points at the Federal Reserve's upcoming policy meeting after August inflation numbers outstripped expectations.

The CME FedWatch tool showed a 34% probability of a rate increase of 100 basis points at the September 20-21 meeting after showing zero probability over the past month.

Meanwhile, the odds of a rate increase of 75 basis points fell to 66% from 91% a day prior and investors wiped out the odds of a 50 basis points rate hike from 9% on Monday.

US inflation showed some signs of cooling in August but figures within the government's report largely outstripped expectations. Among them, the Consumer Price Index rose 8.3% in the year through August. Economists surveyed by Bloomberg expected 8.1%.

"Stubborn inflation pressures are likely to force the Fed to turn up the heat on its tightening campaign, which puts the broader economy at further risk of a material downturn/recession within the next year," Jason Pride, chief investment officer of private wealth at Glenmede, said in a note. "Market expectations have shifted accordingly … with the potential for a 100 bp rate hike next Wednesday."

US stocks tumbled after the inflation data were released. The Nasdaq Composite sank 5.2% by the end of the session during the session, the S&P 500 lost 4.3% and the Dow Jones Industrial Average gave up 3.9%. Treasury yields spiked up as bond prices dropped. The 10-year Treasury yield gained 5 basis points to 3.41% and the 2-year yield soared 17 basis points to 3.75%.

The Fed delivered jumbo rate hikes of 75 basis points at its two previous meetings. The June increase was the first increase of three-quarters of a percentage point since 1994. Policy makers have raised the Fed Funds rate four times this year, pushing it to a range of 2.25%-2.5%.

Pride said underlying details of the August report suggest inflation may look increasingly sticky, particularly with a 0.7% increase in the rent and owners' equivalent rent components for the month.

With inflation still hovering around four-decade highs, policy makers are far from the central bank's inflation target of 2%.

"We continue to expect a 75bp rate hike in September and for a terminal funds rate of 4.0-4.25% early next year," Bank of America said in a note after the inflation report was released. "Solid employment gains alongside firm core inflation readings, in our view, point to additional monetary policy tightening and hard landing risks."

Month-over-month, CPI rose 0.1%, confounding expectations of a 0.1% drop. Core CPI inflation, which excludes volatile food and energy prices, rose 6.3%, higher than the median forecast of 6.1%.

The headline rate of 8.3% was lower than July's reading of 8.5%. Much of the August slowdown came from a drop in gas prices. The gas-price index fell 10.6%.