The December Consumer Price Index report showed an acceleration in year-on-year total CPI inflation to 2.9%, the highest rate since July 2024. Meanwhile, core CPI remained sticky and elevated but decelerated slightly from 3.3% to 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 January 29. A change in Fed policy in March also seems unlikely. However, if consumer inflation rates ease in Q2 2025, it could pave the pathway to a Fed rate cut in May or June 2025.
Total CPI Consumer Inflation Accelerated In December
The December Consumer Price Index release on January 15 showed an acceleration in December year-on-year total CPI to 2.9% from 2.7%. In fact, total CPI inflation rates have accelerated for the three consecutive months through December to the highest year-on-year rate since July 2024, moving further away from the Fed’s 2% inflation target. Meanwhile, core CPI was higher but decelerated slightly to 3.2% from 3.3%.
The report also showed a modest rise in monthly total CPI by 0.2% and a more significant rise in monthly core CPI, which excludes food and energy by 0.4%.
Despite already elevated inflation rates, Prestige Economics cautioned that the December CPI report would likely show an acceleration in year-on-year total CPI consumer inflation rate, which is what the CPI report revealed. Fortunately, the year-on-year total CPI remained below 3%.
Total Producer Inflation Accelerated In December
The December CPI was just one of two major U.S. 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 month-on-month cost pressures, year-on-year total CPI and total PPI inflation rates accelerated.
The January 14 release of the December PPI report showed a modest rise in monthly producer prices with total PPI rising 0.2% and core PPI, which excludes food, energy, and trade, rising by 0.1%.
As with the December CPI report, the PPI report showed an acceleration in year-on-year total PPI and an elevated year-on-year core PPI inflation rate. Year-on-year total PPI accelerated to 3.3% from 3.0%, while core PPI decelerated modestly to 3.3% from 3.5%.
Year-on-year goods PPI inflation rates accelerated in December from 1.1% to 1.8%, which is still a relatively modest inflation rate.
Consumer Inflation Impacts 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. While these forecasts were informed by the acceleration in year-on-year consumer inflation reports through November, the further acceleration in year-on-year December CPI consumer inflation could keep 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. 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-term probabilities of a January rate cut, which are effectively zero. The odds of a January 2025 Fed rate cut were only 2.7% the night before the report’s release on January 14 at 9:46 p.m. ET, according to the CME FedWatch Tool. The probability of a January 20 Fed rate cut was unchanged on January 15 at 8:31 a.m. ET, immediately after the release of the December CPI report.
The further acceleration in December year-on-year total CPI inflation could dampen expectations for future rate cuts beyond January—and throughout 2025. However, Prestige Economics expects the recent acceleration in the year-on-year total CPI inflation rate is likely to be transitory, with lower year-on-year inflation rates in Q2 2025 due to base effects. In fact, total year-on-year CPI and PCE consumer inflation rates could still fall to the Fed’s 2% target in 2025, even though they are currently well above 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% not occurring until 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 slowing in year-on-year consumer inflation in Q2 2025 due to base effects. Moreover, if there is no rate cut by May, a 0.25% Fed rate cut in June would be highly likely.
Future Inflation Report Implications And Risks For Financial Markets
While a near-term Fed rate cut is unlikely, more interest rate cuts are still likely in 2025 and 2026. Plus, FOMC projections often differ greatly from reality and if year-on-year consumer inflation rates fall significantly in Q2 2025, there could be cause for the Fed to cut interest rates by more than 0.5% in 2025. This would also significantly impact financial markets.
If year-on-year consumer inflation rates fall in the second quarter due to base effects, market participants may be underestimating 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 Fed rate cuts than are currently priced into expectations, supporting bond, equity, and industrial commodity prices in the second quarter, while weighing on bond yields and the greenback.
Of course, Q2 2025 is still several months’ worth of data in the future, and another Fed rate cut seems unlikely for some time in the wake of the December CPI report.
With rate cuts deferred, equities will likely depend more on earnings reports for strength than on the hopes for dovish Fed monetary policy. Meanwhile, the dollar and bond yields may continue to find support due to relatively low expectations for Fed rate cuts against a backdrop of solid U.S. jobs and growth data.
What do you think of the December CPI report and the future prospects for inflation and Fed interest rate cuts?
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