Fed: Too Soon to Breathe Easy

Headline CPI Inflation Continues to Rise

Markets got overly excited by last week’s publication of inflation numbers relating to the Producer Price Index and Consumer Price Index. Core PPI (which excludes food and energy) was unchanged on a month-on-month basis in December compared with a 0.2% rise in November. Even more exciting for investors was the 0.2% monthly increase in the core CPI, slowing from 0.3% in each month, August through November.

In their excitement, investors avoided a déjà vu stance that would have been educational, providing a better thought-out market reaction. Core PPI actually declined, by 0.1%, last July before surging by 0.4% each in August and September. In the same vein, core CPI rose by only 0.1% in June before surging by 0.3% in each of the following four months. Becoming ecstatic about short-term price movements has not been productive in the long-run!

Just as important, headline monthly CPI inflation rate accelerated to 0.4% in the latest calculation from 0.2 - 0.3% in the preceding five months. As Federal Reserve Chairman Jerome Powell has conceded in the past, consumers’ buying power depends on the headline inflation rate rather than a constructed core index. And the headline rate still appears to be on its way up.

The latest inflation data led to a rally in equities and Treasurys. Starting the week at 4.79%, 10-year Treasurys declined in yield by 13 basis points on Wednesday alone, and ended last night at 4.62%. The exuberance came from the expectation that the latest inflation numbers would encourage the Federal Reserve to cut the Federal Funds rate several times during 2025. Following the data releases, Fed Governor Christopher Waller told CNBC that if the improvement in inflation continued, he could see rate cuts arriving sooner than when investors have priced them.

Since markets had been led to believe after the Federal Open Market Committee meeting in December that the central bank would pause on further easing, Waller’s views were especially comforting for some investors. It signaled that Uncle Jay may not become stingy with his rate reductions after all. Instead, he may continue cheerleading equity and bond markets as he has done through most of his tenure since 2018!

How will Powell and the FOMC he leads react to the latest developments? Policymakers will meet on January 28 - 29, a few days after Donald Trump assumes the presidency on Monday. By then, we will have a better idea of the extent of tariff increases that may actually be implemented, and how serious the new administration will be in its threat to deport undocumented workers.

Inflationary impact of the two moves would depend on the extent of levies, the sectors that would be affected, and the countries that would face the bulk of the new tariffs. Initial steps of the Trump administration would only indicate how serious the new President would be in implementing his measures. It would behoove the Fed to understand the full impact of the measures — which may not become clear before, say, mid-year — prior to deciding to ease policy further.

All this means that the rally in financial assets last week was probably premature. Any Forward Guidance that Powell may provide at his press conference on January 29 may create more confusion and market volatility rather than an accurate indication of future Fed policy.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

January 18, 2025

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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