Latest CPI inflation report makes a rate cut in January very unlikely

The December CPI report showed an acceleration in year-over-year headline CPI inflation to 2.9%, the highest rate since July 2024. Meanwhile, core CPI remained sticky and elevated, but eased slightly from 3.3% to 3.2%. Due to high year-over-year consumer inflation rates and strong recent jobs data, financial markets are reflecting expectations that the Fed will not change interest rates on January 29. A change in Fed policy in March also appears unlikely. However, if consumer inflation eases in Q2 2025, it could pave the way for a Fed rate cut in May or June 2025.

Overall CPI consumer inflation accelerated in December

The release of the December consumer price index on January 15 showed an acceleration in the December year-on-year overall CPI to 2.9% from 2.7%. In fact, headline CPI inflation accelerated for the three consecutive months through December to the highest year-over-year rate since July 2024, moving further away from the Fed’s 2% inflation target. Meanwhile, core CPI was higher but eased slightly to 3.2% from 3.3%.

The report also showed a modest increase in the monthly headline CPI of 0.2% and a more marked increase in the monthly core CPI, which excludes food and energy, of 0.4%.

Despite already elevated inflation rates, Prestige Economics warned that the December CPI report is likely to show an acceleration in overall CPI consumer inflation year over year, which is what the CPI report revealed. Fortunately, overall CPI remained below 3% year-on-year.

Headline producer inflation accelerated in December

The CPI for December was just one of two major US inflation reports released this week. Both the CPI and producer price index inflation reports were expected to be critical for Fed policy and markets this week. While these reports showed relatively modest cost pressures month-on-month, headline CPI and headline PPI inflation rose year-on-year.

The January 14 release of the December PPI report showed a modest increase in monthly producer prices, with the overall PPI rising 0.2% and the core PPI, which excludes food, energy and trade, rising 0.1%.

As with the December CPI report, the PPI report showed an acceleration in overall PPI year-on-year and an elevated year-on-year core PPI inflation. Year-on-year aggregate PPI accelerated to 3.3% from 3.0%, while core PPI fell modestly to 3.3% from 3.5%.

Year-on-year PPI inflation rates for goods accelerated in December from 1.1% to 1.8%, which is still relatively modest inflation.

Consumer Inflation Implications for Fed Policy

The December Federal Open Market Committee projections for the federal funds rate reflected expectations of just two rate cuts of 0.25% by the end of 2025. Although these forecasts were based on the acceleration in year-over-year consumer inflation reports for November, the additional acceleration in December year-over-year consumer price index inflation could keep expectations of future rate cuts down.

Prestige Economics previously predicted that inflationary pressures would likely keep the Fed from cutting interest rates in January. Last week’s jobs data reinforced that outlook, as did this week’s CPI and PPI reports.

The December CPI report did not change the immediate probabilities of a rate cut in January, which are effectively zero. The odds of a Fed rate cut in January 2025 were just 2.7% the night before the report was released on January 14 at 12:00 p.m. 9:46 PM ET, according to the CME FedWatch Tool. The probability of an interest rate cut on 20 January was unchanged on 15 January at 8:31 a.m. ET immediately following the release of the December CPI report.

The further acceleration in December year-on-year headline CPI inflation may dampen expectations of future rate cuts after January – and throughout 2025. However, Prestige Economics expects the recent acceleration in year-on-year headline CPI inflation likely will be transitory, with lower year-on-year inflation rates in Q2 2025 due to base effects. Indeed, the aggregate year-over-year CPI and PCE consumer inflation rates may still fall to the Fed’s 2% target in 2025, although they are currently well above the target.

On the downside, core inflation rates could remain above the Fed’s 2% for most or even all of 2025, with the first potential to fall below 2% only occurring in 2026.

Because jobs data and the economic growth outlook are solid, the Fed is unlikely to cut rates this month or in March 2025. However, a 0.25% rate cut in May 2025 still seems possible given the potential slowdown with consumers from year to year. inflation in Q2 2025 due to base effects. Also, if there is no rate cut in May, a 0.25% rate cut in June would be most likely.

Future inflation report implications and risks for the financial markets

While a near-term Fed rate cut is unlikely, more rate cuts are still likely in 2025 and 2026. Additionally, the FOMC’s projections often deviate widely from reality, and if year-over-year consumer inflation rates fall significantly in Q2 2025, there may be a reason for the Fed to cut interest rates by more than 0.5% in 2025. This will also have a significant impact on the financial markets.

If year-on-year consumer inflation rates decline in the second quarter due to base effects, market participants may underestimate the potential for two or more rate cuts in 2025. This could reverberate across financial markets as investors quickly try to reposition ahead of more rate cuts from Fed than is currently factored into expectations, supporting bond, stock and industrial commodity prices in the second quarter, while weighing on bond yields and the greenback.

Of course, Q2 2025 is still several months of data in the future, and another rate cut by the Fed seems unlikely for some time in the wake of the December CPI report.

With rate cuts on hold, stocks are likely to depend more on earnings reports for strength than on hopes of dovish Fed monetary policy. Meanwhile, the dollar and bond yields may continue to find support due to relatively low expectations for Fed rate cuts on the back of solid US jobs and growth data.

What do you think about December CPI report and the future outlook for inflation and Fed rate cuts?

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