Inflation's Sticky Core: Assessing the Fed's Next Move After December's 2.7% Print

The latest inflation data presents a picture of stubborn persistence. The headline Consumer Price Index rose 0.3 percent on a seasonally adjusted basis in December, pushing the annual rate to 2.7 percent. That pace matched November's increase exactly, holding steady at a level that remains well above the Federal Reserve's 2% target. The core CPI, which strips out the volatile food and energy components, showed a slightly more encouraging but still elevated trend, climbing 0.2 percent for the month and 2.6 percent over the past year. This core figure came in below the median forecast, offering a sliver of relief.

Yet the broader narrative is one of plateauing pressure, not a decisive turn. The key tension lies in the data's mixed signals. On one hand, the headline and core annual rates are flat, suggesting inflation is not accelerating. On the other, the underlying mechanisms show little sign of cooling. Shelter costs, a major driver of the headline, rose 0.4% for the month, while food prices jumped 0.7%, the largest monthly gain in over three years. This divergence between a stable headline and persistent underlying pressures is the central puzzle.

The Atlanta Fed's sticky-price CPI, a critical gauge for the Fed's forward-looking policy, underscores this persistent heat. The index for goods and services that change price infrequently rose 3.1 percent on a year-over-year basis in December. This measure, which filters out the noise of frequent price changes, highlights that underlying inflationary momentum remains elevated. It suggests that even as some prices stabilize, the core cost pressures embedded in contracts and long-term agreements are not easing.

The central question for policymakers is whether this represents a new, higher baseline or a temporary plateau. The data shows inflation is not running hot, but it is also not cooling decisively. The slight moderation in the core CPI and the flat headline provide a rationale for caution. For now, the Fed faces a stalemate: inflation is stubbornly above target, but the latest numbers do not scream for immediate action. This setup makes a pause in the policy path appear prudent, allowing more time to assess whether the recent stability is the start of a sustained decline or merely a pause in a longer trend.

Decoding the Drivers: Where Inflation is Sticking

The plateau in headline inflation masks a more complex reality of where price pressures are actually rooted. The data reveals a clear hierarchy of contributors, with some sources showing signs of temporary volatility while others point to more persistent, structural strains.

Shelter costs remain the single largest monthly driver, rising 0.4 percent in December. This category, which accounts for a massive share of the CPI basket, continues to exert upward pressure. Its recent climb is a lagging indicator, reflecting higher rents set months ago, and suggests that the housing cost component of inflation will likely persist even as other prices stabilize. This is a classic example of a structural pressure that takes time to unwind.

Food prices are another significant and volatile source of pressure. The overall food index jumped 0.7 percent for the month, with the category of food away from home showing particularly sharp gains, up 4.1 percent annually. This surge in dining costs, alongside a 0.7% monthly increase for groceries, highlights affordability concerns for basic necessities. While some food subcategories like eggs saw price declines, the broad-based strength in food costs indicates underlying supply and demand imbalances that are not easily resolved.

Energy prices, while less volatile, also contribute. The energy index rose 0.3 percent in December, with utility gas service climbing 4.4% and electricity up 6.7% over the year. These are more immediate, commodity-driven swings that can be influenced by seasonal factors and global markets.

A critical, policy-driven factor is the impact of tariffs. Economists note that these levies have acted as a direct tax on imported goods, pushing up inflation a little over half a percentage point. While businesses have partially absorbed this cost to avoid alienating consumers, the pressure remains embedded in the price system. The potential for a Supreme Court ruling to invalidate the legal basis for these tariffs introduces a layer of uncertainty, but for now, they represent a tangible, man-made headwind.

The interaction of these pressures creates a sticky inflation profile. Shelter and food provide a persistent floor, while energy and tariffs add volatility. The key question is which pressures are temporary. The recent moderation in the core CPI suggests some of the more volatile components may be peaking. Yet the continued strength in shelter and food away from home points to underlying demand and cost pressures that are not easily dispelled. This mix explains why inflation is stuck in a range above target-neither accelerating nor decisively cooling.

The Fed's Dilemma: Pause or Prudence?

The inflation data has crystallized the Federal Reserve's immediate path. After three consecutive rate cuts last year, the central bank has signaled it likely won't lower rates again soon. The latest economic reports, including the December jobs data, have cemented this stance. Markets now price in no cuts until June, a shift from earlier expectations of cuts in January and April. This pause is a direct response to the Fed's dual mandate being pulled in opposing directions, with both price stability and maximum employment under strain.

The core trade-off is stark. On one side, the labor market shows tentative signs of stabilizing, with the unemployment rate ticking down. This provides a rationale for holding steady, as cutting rates now would be an acknowledgment of significant deterioration. Yet on the other side, inflation remains stubbornly above target. The slight moderation in the core CPI offers some relief, but it is overshadowed by the Atlanta Fed's sticky-price index, which remains elevated at 3.1 percent on a year-over-year basis. This measure, which captures the persistent, underlying inflationary momentum, suggests that cost pressures are not yet subdued. The Fed must therefore balance the need to support economic growth against the risk of reigniting inflation, especially if structural pressures like shelter and food costs persist.

A critical, policy-driven variable adds to the uncertainty: tariffs. Economists estimate these levies have pushed up inflation a little over half a percentage point. While businesses have partially absorbed this cost to avoid alienating consumers, the pressure remains embedded. The potential for a Supreme Court ruling to invalidate the legal basis for these tariffs introduces a layer of volatility. For now, the Fed is watching to see if this man-made headwind is complete before committing to further easing.

The bottom line is one of prudence. The Fed's current stance-holding rates steady for months-is a deliberate pause to gather more evidence. Officials will likely begin to take cues from inflation data to lower rates further, but only as it becomes clear that the tariff pass-through is complete and inflation is decelerating toward the 2% target. In the meantime, the plateau in headline inflation offers no easy exit. The Fed is waiting for the underlying pressures to cool decisively, not just for a temporary reprieve.

Catalysts and Risks: What to Watch in 2026

The plateau in headline inflation is a fragile equilibrium, one that hinges on the trajectory of several key forward-looking factors. For the Fed and markets, the coming months will be defined by a handful of critical catalysts and risks that could either confirm a disinflationary path or force a reassessment of the entire outlook.

The most important test will be the lagged effect of earlier rate hikes on housing costs. Shelter, which rose 0.4 percent in December and is a major driver of the CPI, is a notoriously slow-moving component. The full impact of the Fed's tightening cycle is expected to work through the rental market with a delay. If housing costs begin to moderate in the first half of 2026, it would be a powerful signal that the disinflationary forces are gaining ground. Conversely, if shelter inflation holds steady or accelerates, it would reinforce the view that underlying pressures are deeply entrenched.

A second major risk is the potential for a re-acceleration of the sticky-price index. This measure, which captures persistent underlying inflation, remains elevated at 3.1 percent on a year-over-year basis. Any escalation in tariff policy or a new supply chain disruption could easily re-ignite this gauge. The Atlanta Fed's sticky-price index is particularly sensitive to such shocks, as it reflects the cost pressures embedded in long-term contracts and agreements. The Supreme Court's pending ruling on the legal basis for tariffs adds a layer of policy uncertainty that could influence business pricing decisions and feed directly into this index.

Finally, a significant source of data noise will persist through the spring. The Bureau of Labor Statistics did not release CPI data for October 2025 due to a government shutdown. To fill the gap, the BLS interpolated data, which likely introduced a downward bias in the CPI through April. This means that the official inflation rate for the first quarter of 2026 may be artificially suppressed, creating a period of uncertainty. When the "real" data from October and November eventually gets properly incorporated, it could temporarily lift the headline number, complicating the interpretation of the disinflation trend.

The bottom line is that the path from here is not a straight line. The Fed's pause gives it time to watch these catalysts unfold. The lagged housing effect and the sticky-price index are the primary levers for disinflation, while tariff policy and the data lapse are the key risks. The coming quarters will test whether the current plateau is a stable resting point or merely a pause before the next move.