Markets Brace for January CPI Report Amid Sticky Inflation Concerns

The January Consumer Price Index (CPI) report, set for release on February 12 at 8:30 AM ET, is expected to show inflation remaining stubbornly above the Federal Reserve’s 2 percent target. Consensus forecasts call for headline CPI to rise 0.3 percent month-over-month, down slightly from the 0.4 percent gain in December. On a year-over-year basis, headline inflation is projected to remain at 2.9 percent. Core CPI, which excludes volatile food and energy prices, is also expected to rise 0.3 percent month-over-month, an acceleration from December’s 0.2 percent reading. Year-over-year core CPI is forecast at 3.1 percent, down from 3.2 percent in the prior report.

Key Drivers Behind the CPI Report

Several factors will influence this month’s CPI reading, with housing, wages, and recent tariff discussions playing a central role. Shelter inflation, which makes up over 40 percent of the core CPI index, has been gradually easing but remains elevated. Wage growth, which has been resilient, continues to pose an inflationary risk, particularly in the services sector. The strong January jobs report, which showed unemployment steady at 4 percent and wage growth running above expectations, suggests consumer demand may remain firm. Additionally, recent tariff announcements on steel, aluminum, and Chinese imports could introduce cost pressures into the supply chain, potentially pushing prices higher.

Another crucial element to watch is the base effect. Since January 2024’s 0.3 percent month-over-month reading is dropping out of the year-over-year calculation, this month’s annual inflation print will be particularly sensitive to any surprises in the monthly figure. A weaker-than-expected number could see the year-over-year rate decline, which markets would interpret as a positive signal for the Fed’s inflation fight.

Market Caution Ahead of the Report

Recent economic data has set the stage for a more cautious market tone heading into the CPI release. The January jobs report showed that the labor market remains strong, which has made traders more hesitant to price in aggressive rate cuts. At the same time, PMI reports have shown a rise in input prices, suggesting inflationary pressures may not have fully abated.

The combination of resilient economic data and sticky inflation has led market participants to brace for a potentially strong CPI reading. If the report comes in hotter than expected, it could push out expectations for Federal Reserve rate cuts and lead to renewed selling pressure in rate-sensitive sectors like technology and high-growth equities. Conversely, if inflation surprises to the downside, it could provide a much-needed relief rally for risk assets.

The U.S. Dollar Index (DXY) has been rebounding off range support, suggesting that currency traders are preparing for a stronger-than-expected CPI print. A hotter inflation number could push the dollar higher toward 109.00, while a softer reading could see the greenback retreat toward 107.50. Meanwhile, bond markets will closely watch Treasury yields, which could rise if the data reinforces a “higher-for-longer” Fed stance or decline if inflation shows further easing.

Sticky Inflation and Its Policy Implications

One of the biggest concerns for the Fed remains sticky inflation, particularly in services. While goods inflation has cooled significantly, services inflation, driven by wages and housing, remains persistent. The December CPI report showed some improvement, with core inflation ex-shelter dipping below 3 percent for the first time in months, but it remains to be seen whether this trend continues.

Federal Reserve Chair Jerome Powell has repeatedly stated that the central bank wants to see inflation firmly moving toward its 2 percent goal before easing policy. The first day of Powell’s congressional testimony was largely uneventful, with the Fed Chair maintaining the same message he delivered during the January 31 FOMC press conference. However, if the CPI report shows a meaningful deviation from expectations, Powell’s tone could shift on the second day of testimony. A stronger-than-expected print might lead him to push back on the timing of rate cuts, while a weaker number could provide more flexibility for a pivot.

CPI's Impact on the Fed's Path and Market Expectations

Markets are currently pricing in rate cuts beginning in the middle of 2025, with traders largely expecting two cuts this year. However, a strong CPI report could prompt traders to further delay their rate cut expectations, reinforcing the Fed’s messaging that it is in no rush to ease policy. If inflation remains stubborn, it could even lead to speculation that the Fed may not cut at all in 2025, a scenario that would likely weigh on equity markets.

Conversely, if CPI comes in below expectations, it could fuel optimism that inflation is on a steady path lower, opening the door for the Fed to begin cutting rates sooner. This would likely trigger a rally in equities, particularly in rate-sensitive sectors, and could push bond yields lower.

The Bigger Picture

While the January CPI report will provide an important data point for the Fed’s inflation trajectory, it is only one piece of the puzzle. The Fed will also be closely watching future inflation readings, labor market data, and the broader economic backdrop before making any policy adjustments. Additionally, external risks such as trade policy, global economic conditions, and geopolitical developments could all influence inflation trends in the coming months.

For now, markets remain on edge, with traders preparing for a potentially volatile reaction depending on how the data unfolds. If inflation continues to trend lower, it could reinforce the view that the Fed’s tightening cycle has been successful, giving policymakers confidence to begin easing policy later this year. However, if inflation remains sticky or reaccelerates, it could complicate the Fed’s path, keeping markets in a state of uncertainty.

With Powell set to continue his testimony after the CPI release, all eyes will be on how he interprets the data and whether it alters the central bank’s messaging. One thing is certain—this report will have significant implications for the market’s outlook on interest rates, the economy, and the path of inflation in the months ahead.