December CPI offers some relief on rates

The December Consumer Price Index (CPI) report revealed a mixed picture of inflation, with headline CPI rising 0.4% month-over-month (MoM), slightly above the consensus estimate of 0.3%, while year-over-year (YoY) headline inflation came in at 2.9%, in line with expectations but up from 2.7% in November. Core CPI, which excludes volatile food and energy prices, rose by 0.2% MoM, matching forecasts and marking a decline from 0.3% in November. On a YoY basis, core CPI increased by 3.2%, slightly cooler than the expected 3.3% and marking a deceleration for the first time since July.

The key drivers of inflation in December were energy and food prices, with the energy index rising 2.6% MoM and gasoline prices jumping 4.4%. Food prices increased by 0.3% MoM, reflecting continued stickiness in grocery costs and higher prices for cereals, bakery products, and eggs. Shelter costs, which have been a persistent driver of core inflation, rose by 0.3% MoM and 4.6% YoY, the smallest annual gain since January 2022. Used car prices also saw an increase of 1.2% for the third consecutive month, contributing to the inflationary pressures.

"Sticky inflation" remained evident in several categories, particularly services like medical care and motor vehicle insurance, as well as food. Shelter costs, despite moderating slightly, continue to exert upward pressure on core inflation. The persistence of higher prices in essential categories underscores the uneven progress in bringing inflation closer to the Federal Reserve’s 2% target.

Markets responded positively to the report, as the cooler-than-expected core CPI print alleviated some fears of runaway inflation. The S&P 500 rallied 1.35% to 5,960, while the 10-year Treasury yield dropped 8 basis points to 4.7%. Gold prices surged 1.15% to $2,713 per ounce. The market’s reaction indicates optimism that inflation is on a more sustainable path, though uncertainties remain.

The trends in the CPI data suggest that inflation is moderating, but unevenly. While energy prices remain volatile, core inflation is showing signs of easing, particularly in shelter costs. However, the stickiness in food and services inflation signals that the fight against rising prices is far from over. The December print breaks a streak of four months where core CPI had been stuck at a 3.3% annual increase, providing some relief to policymakers and markets.

The Federal Reserve will closely analyze the CPI report ahead of its next interest rate decision. While the deceleration in core inflation may provide room for the Fed to pause or slow rate hikes, the persistence of sticky inflation in critical categories will likely keep policymakers cautious. Fed Chair Jerome Powell has repeatedly emphasized the importance of sustainable progress in core inflation before any significant policy shifts.

Real earnings data, showing a 0.1% decline in December for all private workers, highlights the ongoing challenge for households coping with rising prices. The decrease in purchasing power underscores the importance of addressing inflation comprehensively to support consumer spending, which remains a vital driver of economic growth.

Overall, the December CPI report reflects incremental progress in taming inflation but leaves room for continued vigilance. The mixed results in headline and core inflation, combined with persistent stickiness in specific categories, suggest that while inflation may have peaked, the journey back to the Fed’s 2% target will likely be gradual. Markets have embraced the cooler core CPI data, but the underlying trends highlight the complexities of the inflationary environment and the challenges facing policymakers.