The January Consumer Price Index (CPI) showed that inflation was, once again, hotter than expected, frustrating both the market and the Federal Reserve (Fed). Both headline and core monthly inflation accelerated while the Fed’s favored supercore inflation measure extended its recent upward trend. Today’s inflation report shows that it is too early for the Fed to declare victory, confirming that a March rate cut must be off the agenda and reduces the odds of a May cut.

Report details

  • Monthly headline inflation rose 0.3% in January, faster than the 0.2% December pace and above consensus expectations. As a result, annual headline inflation only slowed from 3.4% to 3.1%, rather than the 2.9% that was widely expected. Monthly core inflation rose from 0.3% to 0.4%, the highest pace since May last year. As a result, annual core inflation failed to decline, remaining unchanged at 3.9%.
  • Core goods inflation decelerated, and the annual measure is now in negative territory for the first time since July 2020.
  • The upward surprise to inflation numbers came from core services. Shelter was the largest contributor to the number, continuing to defy leading indicators which have been signaling that an easing in rental costs is on the way. Airfares and hotels also surprised to the upside but, as they are generally volatile measures and do not enter the core PCE inflation measure, the Fed will likely look past them.
  • More worryingly, the Fed’s favored supercore inflation measure (core services ex-housing inflation) rose again in January. The monthly measure is now at its fastest pace since April 2022, while the annual measure is the fastest since May 2023.

Policy outlook

The final mile towards the Fed’s 2% inflation target was always going to be slow, erratic, and frustrating. Today’s data is not what markets or the Fed would have liked to see, but it does not (yet) indicate that an inflationary resurgence is developing.

Today's report underscores the importance of a cooling labor market and economy to prevent inflation progress from stalling. While a potential rate cut in May remains on the table if economic activity finally starts to show the impact from prior Fed tightening, our policy forecast remains steady: anticipating 3 to 4 cuts this year, likely beginning in May or June.

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