Strong Core Inflation Hints at January Rate Pause

The current economic climate in the United States is heavily influenced by recent Consumer Price Index (CPI) data for November, which has met expectationsThis development indicates a stagnation of the inflation decline observed over the past few months, suggesting that while enthusiasm remains in the stock market as it approaches year-end, the likelihood of interest rates being lowered next week is not a foregone conclusionThis uncertainty is amplified by potential inflationary pressures that may arise from upcoming tariffs and budget expansions set for the following yearThese factors contributed to fluctuations in the yields of 10-year U.STreasury bonds, which first dipped before rising again.

On December 11, specifically on a Wednesday, the U.Sreported that the CPI data for November aligned perfectly with forecasts, reinforcing traders' expectations that the Federal Reserve will decrease interest rates by 25 basis points in the upcoming meeting, with a slight increase in bets for a subsequent rate cut in January.

The figures reveal an increase of 0.3% in nominal CPI from October, translating to an annual growth of 2.7%. These percentages represent a 0.1% rise compared to October’s numbers

Notably, this marks the first time the nominal CPI has experienced two consecutive months of annual increases since MarchThe core CPI, which excludes the more volatile categories of food and energy, also recorded a month-over-month increase of 0.3%. This figure reflects a flat annual growth rate of 3.3%, maintaining the same level as the previous report.

Analysts have emphasized the implications of these CPI results, highlighting that despite meeting expectations, they also reflect the stagnation of inflation rates in recent monthsThe core CPI has remained steady at the high level of 3.3% for three consecutive months, significantly above the Federal Reserve’s more favored inflation indicator, the Personal Consumption Expenditures (PCE) Price Index, which aims for a return to a target of 2%.

According to the FedWatch tool by the Chicago Mercantile Exchange, the market's perception of the Federal Reserve likely enacting a 25 basis point rate cut next week surged to approximately 95% following the CPI release, up from 89% the previous day

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The yields on U.STreasuries demonstrated this bond market sentiment, with a notable decline from intraday highs to lows after the CPI data was publishedHowever, the odds of rate cuts continuing into January showed only a slight increase from 19% to 22%.

Despite the inflation data suggesting a continued path of gradual easing by the Federal Reserve for the new year, the stability of the stock market as it approaches the year's end has not waveredAnalyst Adam Crisafulli from Vital Knowledge describes this set of economic statistics as the most important at the year’s end, which has left the upcoming rate cut virtually assuredHowever, he also cautions that the outlook following rate cuts is not as crystal clearHe anticipates a subtle hawkish shift in the Fed's forward guidance after the meeting, which could suggest that the January gathering may maintain rates, and March might witness a pause in rate cuts.

Whitney Watson, Global Co-head of Fixed Income and Co-CIO at Goldman Sachs Asset Management, echoes this sentiment, stating that the core CPI meeting expectations paves the way for next week’s proposed rate cut

He contextualizes that the emerging data is not alarming enough to cause panic within the market, fostering a continued belief among Fed officials in the progress towards lessening inflation as they step into the new year.

Analysts from LPL Financial, particularly Jeffrey Roach, suggest that as wage growth continues to outpace inflation, American consumers find themselves in a favorable position entering the new yearThe stabilization of the trickier aspects of inflation indicates that the Federal Reserve may opt for a consistent and measured approach to rate cuts moving forward.

Market strategists David Russell from TradeStation and Tom Hainlin from U.SBank Asset Management both project that while inflation has ceased to decrease, it does not pose a significant threat to the ongoing bull market in U.SstocksRussell notably indicates that the effects of inflation and the Federal Reserve's role as a catalyst for market movements may begin to wane, drawing attention to the potential new government's tariff policies.

Concerns arise from some analysts about the implications of strong core CPI figures, suggesting that a segment of the Federal Reserve may be apprehensive about the stalling decline of inflation, making next week’s rate cut less certain

A closer examination of the CPI data highlights the “Owner’s Equivalent Rent” metric, which saw a marginal uptick of 0.23% month over month in November, marking its smallest growth since early 2021. Nonetheless, overall housing costs remain stubbornly inclined to drive inflation, accounting for close to 40% of the CPI increase, with the housing expenditure index climbing 4.7% year over year in November.

Additional factors contributing to the rising CPI include the upticks in food, used vehicles, and healthcare costs observed in NovemberPrices for both used and new cars have reversed a previous downward trend, with the Bureau of Labor Statistics noting that "nearly no major components experienced price declines."

In recent days, various Federal Reserve officials have expressed disappointment with the persistence of strong inflation levels, hinting that if the trend toward inflation moderation does not advance, rate cuts entering 2025 might require a slowed pace

Should the Federal Reserve proceed with a predicted rate cut of 25 basis points next week, it would mark a full percentage point reduction in the federal funds rate since September.

Renowned financial journalist Nick Timiraos, often termed as the "new Fed whisperer," pointed out that significant falls in core goods prices over the last 18 months have largely been influential in lowering inflation levels, and this dynamic has recently changedSpecifically, November saw an uptick in automobile prices that pushed core goods prices up by 0.3%, which dwarfs the insignificant month-over-month uptick of 0.05% in October, and a 0.17% increase the previous month.

Anna Wong highlighted the strength in the core CPI for November, igniting apprehensions among a minority within the FOMC pattern of thought who worry that inflation moderation may have plateaued, thus questioning the certainty of the upcoming rate cuts

Wong stated, “Indeed, housing rent inflation has finally seen some retracement, but goods prices have lost momentum on deflation; the current monthly inflation rate aligns with an annual inflation rate exceeding 3%, rather than returning to the Fed’s target of 2%.”

Bloomberg rate strategist Ira Jersey commented that inflation now extends its influence into service sectors; although new tariffs may elevate commodity inflation over time, the underlying factors driving current inflation remain unalteredJersey added, “Given that service inflation continues at an annual rate of 4.5%, core inflation unlikely to reach the Fed’s goal in the short run.”

The reaction in the markets saw a V-shaped rebound in the 10-year Treasury yield, returning to intraday highs, showing about a 6 basis point increase, reaching its peak in two weeksThe two-year Treasury yield, sensitive to interest rate shifts, also saw modest gains despite dropping nearly 5 basis points following the CPI data release.

There exists a consensus on Wall Street trending towards January, where expectations suggest that the Federal Reserve may pause interest rate reductions, placing attention on the potential inflationary risks associated with tariffs ahead.

Brian Coulton, the chief economist at Fitch Ratings, echoed this sentiment stating that the decline in core goods prices has been crucial to the overall moderation of inflation this year, suggesting that this trend now appears to be ending

He remarked, “With rising automobile prices, core goods increased 0.3% month-over-month in NovemberAlthough inflation in services is decreasing, it is doing so at a painfully slow pace, with current rent inflation stubbornly at 4.6%, substantially above pre-pandemic levels.”

Currently, mainstream expectations on Wall Street indicate that the Federal Reserve will refrain from cutting rates in January, as underscored by analyst Ali Jaffery from CIBC Capital Markets, who pointed out ongoing skepticism regarding the extent of interest rate cuts in 2025 if economic growth maintains its pace or if overall price pressures do not ease furtherRichard Flynn from Charles Schwab’s UK division stated that several Federal Reserve officials have voiced their dissatisfaction with the speed of inflation moderation, and that the November CPI figures did little to generate reassurance