January inflation ran hot, and the odds of Fed interest rate cuts fell as Consumer Price Index total CPI inflation accelerated to 3.0%, the highest rate since June 2024. Core CPI inflation also accelerated to 3.3% from 3.2%. Due to elevated year-on-year consumer inflation rates and strong recent jobs data, financial markets reflect expectations that the Fed will not change interest rates on March 19 or May 7. As long as consumer inflation remains at these elevated levels, the U.S. Federal Reserve may be unable to cut rates. Plus, if year-on-year CPI inflation rates rise further, analysts and economists may begin to factor in the potential risk of Fed rate hikes in 2025.
Total CPI Consumer Inflation Accelerated In January
The risk landscape for interest rates, growth, and markets shifted greatly with a further acceleration in the January CPI inflation report on February 12, which showed an acceleration in year-on-year total CPI and Core CPI. Rising inflationary pressures are unwelcome for market participants and business leaders eager to see interest rates fall.
In addition to showing accelerations in year-on-year total CPI and core CPI inflation rates, there were also significant month-on-month increases, with total CPI up by 0.5% and core CPI, which excludes food and energy, up by 0.4%. These significant month-on-month inflationary pressures greatly reduced the potential for base effects to pull down year-on-year consumer inflation rates, and they also drastically reduced the probability of a Fed rate cut before the midyear.
Consumer Inflation Implications For Fed Policy
The December Federal Open Market Committee projections for the federal funds rate reflected expectations of only two 0.25% rate cuts by the end of 2025. The further subsequent accelerations in year-on-year CPI consumer inflation are keeping expectations for future Fed rate cuts low.
Prestige Economics previously predicted that inflationary pressures would likely keep the Fed from cutting interest rates in January and that a March Fed rate cut was unlikely.
According to the CME FedWatch Tool, the January CPI report lowered the probability of a March Fed rate cut to effectively zero while also lowering the odds of either May or June rate cuts.
The odds of a March 19 Fed interest rate cut fell to 2.5% on February 12 at 8:46 a.m. ET, immediately after the release of the CPI report. The odds of a March rate cut were 4% the night before the report’s release on February 11 at 9:00 p.m. ET, according to the CME FedWatch Tool.
The odds of a May 7 Fed interest rate cut fell to 11.8% on February 12 at 8:46 a.m. ET, immediately after the release of the CPI report. The odds of a May rate cut were 21.3% the night before the report’s release on February 11 at 9:00 p.m. ET, according to the CME FedWatch Tool.
The odds of a June 18 Fed interest rate cut fell to 34.8% on February 12 at 8:46 a.m. ET, immediately after the release of the CPI report. The odds of a June rate cut were 50.8% the night before the report’s release on February 11 at 9:00 p.m. ET, according to the CME FedWatch Tool.
Because jobs data and the economic growth outlook are solid, the Fed is unlikely to cut rates in March 2025 or May 2025. Plus, if year-on-year and month-on-month CPI consumer inflation rates continue to run this hot or heat up further, markets could begin to price in a Fed rate hike for this year.
Future Inflation Report Implications And Risks For Financial Markets
A Fed interest rate cut now seems unlikely before June, but some interest rate cuts are still possible in 2025 and 2026. In the immediate term, financial markets are most likely to move on the fact that the January CPI report showed an acceleration in total and core CPI and is indicative of fewer rate cuts in 2025 by market participants.
Bond yields and the dollar are likely to find support on the back of this report due to relatively low expectations for Fed rate cuts against a backdrop of solid U.S. jobs and growth data.
Equities, bond prices, and industrial commodities prices are likely to come under pressure in the wake of this report due to the risk of higher interest rates.
What do you think of the January CPI report and the future prospects for inflation and Fed interest rate cuts?
Let me know what you think in the comments below.
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