The latest inflation reading is set to disappoint investors looking for evidence that the Federal Reserve will start cutting interest rates as early as March.
Inflation on the Rise
Despite the recent plummet in gasoline prices, Thursday’s Consumer Price Index report is expected to show headline inflation rose 3.2% year over year in December, according to economists surveyed by FactSet. That’s up from the 3.1% pace recorded in November.
Base Effects at Play
There are some base effects coming into play for the data, as the annual headline inflation rate fell significantly the previous December, to 6.5% on an annual basis from 7.1% in November 2022. Even so, economists forecast that prices also grew by 0.2% on a monthly basis in December 2023, up from the 0.1% rate seen in November.
Potential Impact on Federal Reserve’s Plans
If there is a slight uptick in headline inflation, it could bolster support for Fed policymakers’ plans to hold the current high federal-funds rate steady for longer—rather than initiate cut rates as many investors are hoping—to prevent inflation from reigniting and bring about price stability at the bank’s 2% target.
Risks and Concerns
The risk of a resurgence in inflation is not unrealistic, given current conditions.
“The underlying inflationary backdrop is still inherently unstable due to various crosswinds, such as relatively tight labor conditions and persistent fiscal deficits,” writes Matt Eagan, portfolio manager and co-head of the full discretion team at Loomis, Sayles & Company. There also is some concern that the recent Red Sea attacks could fuel short-term supply chain inflation.
Eagan also says there is the possibility the U.S. starts getting monthly CPI prints of 0.3% or higher, though that isn’t his base case. If that occurs, however, it would throw into question the Fed’s entire rate strategy, Egan writes.
Better News for Core CPI
That said, the inflation picture actually looks better for the core CPI reading, which excludes the more volatile food and energy prices and is thought to be a better indicator of underlying price growth trends. Economists expect core CPI to have slowed to 3.8% year over year in December, down from the 4% rate notched in November.
Inflation Is Still a Concern, but Some Optimism Is on the Horizon
According to J.P. Morgan strategists, while the pace of inflation has slowed from 5.7% in December 2022, it still remains high at almost double the Federal Reserve’s 2% target. However, they predict that core CPI inflation will stabilize at around 3% due to the expected moderation in shelter costs and a slight reacceleration in goods prices.
For the month of December, FactSet estimates that monthly core inflation will decrease to 0.2% from 0.3% in November.
The anticipated increase in headline inflation can be attributed to rising prices in various sectors, which have outweighed the decline in gasoline prices. Despite gas prices reaching a national average of $3.09 by the end of last year, there was an unexpected surge in used car prices, as well as higher prices for medical goods and services and continued increases in car insurance. Additionally, James Knightley, ING’s chief international economist, expects the cost of shelter to remain steady.
Knightley also points out that the “supercore” inflation measure, which excludes energy and shelter costs, is expected to display resilience. This measure is particularly important to Fed policymakers as it is more sensitive to the labor market. If the labor market remains tight, it could lead to elevated price pressures for longer.
While there is some cause for optimism regarding disinflation trends, as gasoline prices continue to decline and rent prices are expected to drop, Knightley suggests that annual headline CPI readings will likely fall below 3% by the second quarter of this year.
Unless any significant surprises emerge, it appears that the Fed won’t consider rate cuts until at least the June Federal Open Market Committee meeting.
The release of the Consumer Price Index report is scheduled for Thursday, Jan. 11, at 8:30 a.m. ET.