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Financial markets experienced a significant downturn after the release of the December jobs report. This was largely due to a surge in the dollar and bond yields, but anticipation of the upcoming Consumer Price Index (CPI) inflation report for December likely also played a role.
Base effects could cause year-on-year inflation rates to rise in the December CPI report, scheduled for release on January 15th. If this happens, financial markets could face turbulence as investor expectations for interest rate cuts in 2025 diminish.
Solid Growth, But Inflation Concerns Linger
The strong December jobs report wasn’t the only positive economic data released last week. Other indicators, such as the ISM Non-Manufacturing Index and jobless claims, also pointed to continued economic growth. However, the Federal Open Market Committee (FOMC) minutes from their December meeting revealed concerns about elevated inflation.
While the Fed minutes and positive growth data had already dampened hopes for imminent rate cuts, the December jobs report practically eliminated them. The unemployment rate falling to 4.1% and significant job gains solidified the case for the Fed maintaining current interest rates.
December Inflation Report in Focus
This week’s economic data will be dominated by inflation reports, with the December CPI and Producer Price Index (PPI) taking center stage. While modest month-on-month inflation increases are expected, there’s a risk of a sharper rise in year-on-year CPI and core CPI rates.
November’s year-on-year inflation figures were already concerning, with total CPI at 2.7% and core CPI at 3.3%. Analysts at Prestige Economics predict a further increase in December’s CPI report, reaching 3.0% for total CPI and 3.4% for core CPI.
This potential acceleration in inflation is expected to prevent the Fed from cutting rates in the near future. It could also dampen expectations for future rate cuts throughout 2025.
Potential Implications for Fed Policy and Financial Markets
The December FOMC projections anticipated only two 0.25% rate cuts by the end of 2025. However, a further rise in December’s year-on-year CPI could push these expectations even lower.
On a brighter note, Prestige Economics believes any increase in December’s CPI is likely temporary. Base effects are expected to bring down year-on-year inflation rates in Q2 2025. This means total CPI and PCE inflation rates could still reach the Fed’s target of 2% by the end of the year, even though they are currently above it. However, core inflation rates might remain elevated throughout 2025.
If year-on-year inflation falls in Q2, it could lead to a reassessment of potential rate cuts in 2025. While a cut this month or in March is unlikely, a 0.25% reduction in May remains a possibility due to the anticipated fall in year-on-year inflation.
The outlook for future rate cuts hinges on the upcoming inflation report. A significant rise in December’s CPI could lead to a revision of expectations, with markets anticipating fewer or even no rate cuts in 2025. This scenario could further strengthen the dollar and bond yields, putting downward pressure on equity prices and industrial commodity prices.
