Misleading Strength?

by | Jan 20, 2025 | Economic Perspectives

Last month, we said that the December inflation report “argued vigilance, not panic, on inflation”. And we concluded that three rate cuts in 2025 still made sense as a baseline expectation. That remained our view even in the aftermath of the hawkish December dot plot showing just two cuts and despite market pricing that has shifted into an even more hawkish direction.

The January inflation report was therefore reassuring. It by no means settles anything in and of its own, but it offers a counterpoint to the inflation fears that have once again gripped investors. Overall consumer prices increased 0.4% m/m, in line with expectations, lifting the headline inflation rate two tenths to 2.9% y/y. There was a sizable contribution from energy (up 2.6% m/m) and especially fuel oil and gasoline (each up 4.4% m/m). Food prices rose 0.3%, in line with recent trends. The good news is that core prices rose just 0.2%, breaking a string of four consecutive 0.3% gains and lowering the core inflation rate by a tenth to 3.2% y/y. Performance was mixed across categories, which we see as a positive: we’d be more worried with every category that posted unusually soft readings as that would not be sustainable. That was not the case. Within services, for instance, airfares jumped 3.9% m/m; within goods, new vehicle prices rose 0.5% and used vehicle prices increased 1.2%. But shelter, medical care, and other services such as insurance were encouraging. Rent of shelter increased a low 0.3% (0.25%) m/m, a reading that sit between the October and November ones and appears to confirm the ongoing downtrend in shelter inflation. Ongoing disinflation in this space is a key factor supporting our Fed Funds view. Rent of shelter inflation peaked at 8.3% y/y in March 2023, eased to 6.2% y/y by December 2023 and ended 2024 at 4.6% y/y. Market rent data suggests that getting to the low 3.0% range by end of this year is achievable. Motor vehicle insurance increased 0.4% m/m; this follows two extremely benign readings and still allowed the inflation rate to ease 1.4 percentage points to 11.3% y/y (the least since September 2022).

All in all, it’s probably best to think of this report as simply a step along the windy road of 2025 macro releases. It offers an encouraging but far from a definitive signal on the inflation outlook since that outlook can be heavily skewed by policy forces (trade, immigration, etc.) not yet at play. In the same vein, we welcome the dovish comments from Fed Governor Waller this week, but also see them as a highly conditional statement. He commented that if incoming inflation reports mirror December’s, three or four cuts in 2025 might be possible. Then again, the upsurge in small business sentiment since the election and the explosion higher in the latest Philly Fed manufacturing index say “maybe not”. Only time will tell.

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