Investors are closely watching for the release of U.S. inflation data, which could potentially influence the Federal Reserve’s decision to cut interest rates in the coming months. The data is scheduled to be published at 8:30 a.m. Eastern Time.
Economists predict that the headline annual inflation for December will show a slight increase from November, rising to 3.2% compared to the previous month’s 3.1%. Core inflation, which excludes volatile items like energy and food, is expected to decrease to 3.8% from 4%.
On a month-on-month basis, December’s headline inflation is projected to rise by 0.2% compared to November’s 0.1%, while the core inflation is anticipated to remain unchanged at an increase of 0.3%.
The decline in annual core inflation is particularly positive news for the Federal Reserve as it strives to bring the headline rate back to its target of 2%.
In 2022, U.S. inflation reached a multi-decade high of 9.1% due to soaring energy prices and supply disruptions caused by the COVID-19 pandemic. In response, the central bank implemented a rapid series of interest rate hikes.
Bond markets have recently experienced a rally, leading to a significant drop in yields. This reflects investors’ belief that easing inflation will provide the Federal Reserve with the opportunity to lower borrowing costs in the near future.
However, some analysts caution that the market’s optimism regarding the pace of Fed rate cuts may be premature, considering the potential challenges of further reducing inflation.
Key Takeaways:
- Absent improvements on the supply side, disinflation could pose challenges to achieving a 2% target.
- The Fed is expected to keep interest rates unchanged at the next meeting, with a possibility of a rate cut in March.
- Market confidence in a Fed pivot remains high, but officials have talked about later moves.
- Economic data to watch includes CPI prints, initial jobless claims, and a 30-year bond auction.
Supply Side Challenges
According to Mohamed El-Erian, adviser to Allianz and Gramercy, achieving continued disinflation to the 2% target could become trickier due to the lack of improvements on the supply side. This is what he refers to as the ‘last mile’ challenge.
Expectations for the Fed Meeting
Early market indications suggest a high probability of the Federal Reserve keeping interest rates unchanged at the range of 5.25% to 5.50% in their next meeting on January 31st. The CME FedWatch tool puts the probability at 97.4%.
Possibility of Rate Cut
Looking ahead to the subsequent meeting in March, there is a 68.9% chance of at least a 25 basis point rate cut. This reflects the market’s expectation for the Fed to lower its Fed funds rate target to around 4% by December 2024, as indicated by 30-day Fed Funds futures.
Market Confidence and Official Statements
Markets currently remain confident in an impending pivot by the Fed. However, Jim Reid, strategist at Deutsche Bank, notes that officials have primarily been discussing future moves rather than taking immediate action. He also emphasizes that the upcoming Consumer Price Index (CPI) prints before the March meeting could still influence potential changes.
Economic Data to Watch
Important economic data scheduled for release includes weekly initial jobless claims at 8:30 a.m., and a U.S. Treasury auction of $21 billion worth of 30-year bonds at 1 p.m. Additionally, the monthly budget statement will be unveiled at 2 p.m., with the Congressional Budget Office projecting a deficit of $128 billion in December.
Key Speakers
Cleveland Fed President Loretta Mester will make an appearance on Bloomberg Television at 11:30 a.m., sharing insights on the economy. Similarly, Richmond Fed President Tom Barkin is scheduled to discuss the economic outlook at 12:40 p.m.
