· Inflation jumps more than expected

· Fastest Easing of US Financial Conditions on record

Headline CPI inflation jumped by 3.4% year-over-year in December, slightly above consensus expectations for a 3.2% rise and up from the November reading of 3.1%.

However, Core CPI continued to trend lower, rising by 3.9% year-over-year, slightly above consensus expectations of 3.8% but below the November reading of 4%.

Services (Shelter mostly) expenses re-accelerated, while energy continued to deflate.

These numbers could complicate the task facing Fed officials, who predicted three interest rate cuts in 2024 without saying when they could happen. Investors expect six cuts this year, starting in March.⁠

The key factor influencing these expectations is how the market perceives the Fed’s response to inflation.

Suppose the Fed is willing to reduce rates while inflation is still above 2% to prevent overshooting and is trying to boost the economy before the November elections. In that case, these inflation figures might not deter them from reducing rates in March.

It is also worth noting that the market probability of a cut was over 90% after Powell Dovish’s Speech at the last FOMC meeting in December.

But despite barely moving on the CPI news report, the probability of a cut has dropped to 63% for the March interest rate decision.

Financial conditions have eased.

Financial conditions in the U.S. have become more favorable.

The parts of the economy that are sensitive to interest rates, like housing, capital expenditures, and durable goods, slowed down when the Fed raised rates.

This slowdown was particularly noticeable in housing, which has around 40% weight in the CPI basket.

The rally in the stock market, credit markets, and Treasury markets since October and after the Fed pivot in December have eased financial conditions significantly .

However, if financial conditions become stricter and inflation rises again, the Fed might take a tougher stance on inflation.

In summary, while the recent inflation figures are slightly higher than expected, mainly due to housing costs, the overall economic scenario suggests a cautious approach towards claiming a smooth economic recovery.

As the money supply continues to decrease, inflation baskets like CPI, PCE, and PPI are expected to decline eventually.

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