CPI: The "Relief" Was Priced In, But The Expectation Gap Is Closing

The numbers are in, and the market's relief was fleeting. The December Consumer Price Index report delivered exactly what the Dow Jones consensus expected: a headline CPI rise of 0.3% monthly and a 2.7% annual rate. On the surface, that's a clean in-line print. The real story, however, is in the core data and the subtle expectation gap it reveals.

The core CPI, the metric Fed officials watch most closely, came in cooler than the whisper number. It posted a 0.2% monthly gain, which was 0.1 percentage point below expectations. The annual core rate held at 2.6%, marking the lowest since March 2021. That's a significant milestone, but the monthly print still beat the prior month's 0.3% gain. The market had priced in a slightly hotter monthly core print, so this slight miss, even against a lower baseline, created the narrow expectation gap.

This is the setup for a "sell the news" dynamic. The headline numbers met consensus, but the core data showed inflation cooling just enough to meet the low bar, not clear the high one. The result was a muted market reaction: stock market futures briefly rose before settling, and traders kept bets intact that the Fed would stand pat. The expectation gap is closing, but not decisively enough to shift the narrative.

The Market's Reaction: "Buy the Rumor, Sell the News"

The market's muted response to the data confirms the "buy the rumor, sell the news" dynamic. Despite the core CPI coming in cooler than expected, US stocks are largely unchanged after the report. The 10-year Treasury yield also held near recent highs, with the yield at 4.18%. This flatline action is the clearest signal that the relief was already priced in.

The expectation gap was narrow, and the market had already anticipated this level of cooling. The data did not shift the consensus view that the Fed would likely not consider a rate cut until June. As the evidence notes, traders kept bets intact that the Fed would stand pat and likely won't consider another cut until June. The whisper number for core CPI was 0.3%, and the print of 0.2% was just a slight miss against that low bar. In other words, the market got exactly what it expected, and that was enough to trigger a "sell the news" reaction.

The setup was clear: a core rate at its lowest since 2021, but a monthly print still above the prior month. This provided some leeway for the Fed to be dovish, but not a decisive catalyst. The knee-jerk reaction showed relief that prices didn't jump further, but that relief was quickly absorbed. The bottom line is that the data confirmed the trend was cooling, but not fast enough to reset the forward view. The expectation gap is closing, but the market's path remains unchanged.

What's Driving the Trend and What to Watch

The trend is clear: inflation is cooling, but the pace of disinflation is the key. The primary drivers of the monthly increase were shelter and food prices. The shelter index rose 0.4 percent in December, and the food index jumped 0.7 percent. These are the two largest components of the CPI basket, and their continued pressure means the Fed's path to its 2% target is not a straight line. The core services ex-housing component, a critical gauge for Fed policy, rose 2.7% annually, showing disinflation is continuing but not accelerating. This is the data point that will determine if the expectation gap closes decisively or remains a narrow one.

For now, the market consensus remains anchored to a June rate cut. The data confirmed the trend but did not reset that view. The next major catalyst is the January Personal Consumption Expenditures (PCE) price index, which will be the Fed's primary inflation gauge. The market is already looking ahead, with nowcasts suggesting the January core PCE could be around 2.45%. A print that continues to trend toward 2% would be the decisive signal the Fed needs to move sooner. Until then, the expectation gap will remain a tight squeeze.

The upcoming FOMC meeting in mid-March is the next concrete test. With the core services ex-housing rate at 2.7%, the Fed has room to be patient. But if the January PCE data shows disinflation accelerating, the March meeting could become the first real opportunity to reset the forward guidance. The market is watching for any shift in language that suggests the June cut is no longer the baseline. For now, the setup is one of contained inflation and a narrow expectation gap, but the path to a dovish pivot depends entirely on the next data point.