U.S. inflation cools down, falling to lowest level in almost a year

U.S. inflation slowed for its sixth consecutive months in December and fell to its lowest level in more than a year. This is a further sign that price pressures may have peaked and would justify a slowdown in rate hikes by the Federal Reserve. 

The Bureau of Labor Statistics showed that the consumer price index registered an annual increase of 6.5%. As a result, annual U.S. inflation fell in December to its lowest level in more than a year. 

While the annualized rate is still well above the Fed’s 2% goal, this was the lowest level since October 2021 and represents a notable decline from the 9.1% reached in June. Compared to the previous month, prices dropped by 0.1%.

“Core inflation” – which removes the effects of volatile food and energy prices – remains the Fed’s preferred inflation indicator. It rose 0.3% from the previous month, which amounted to an annual rate of 5.7%.

Commentators have noticed that Fed officials may feel justified in slowing down its rate hikes. Last months, Fed officials had already stepped down to a half-point rate rise, down from four consecutive 0.75% increases. 

I remain skeptical. Even if Fed officials are hinting to a 0.25% rise at their future meeting, it is still a rate rise. While Goods inflation tumbled to its lowest level since February 2021, Services inflation soared to its highest since September 1982. 

Also, Energy was the biggest driver of the decline in the YoY print. Energy prices are volatile and don’t necessarily translate a long term trend. The decline will help with input costs for manufacturing however. 

Shelter also rose on a month-to-month basis. 

And shelter was also the biggest contributor to Core CPI 0.3% gain. The increase in the shelter index in December at 0.8% marks one of the biggest increases since 1990s. 

After an initial kneejerk reaction, SPY is currently up 0.56% pre-market. 

In short, inflation (both headline and core) printed as expected (which might be a slight disappointment to markets). Goods inflation slowed but services continue to soar. Shelter costs are also playing catch up and are soaring with a lag.

There is nothing in this report that would suggest a Fed pivot. Fed officials will hike further. Even if it’s a 0.25bps hike, a terminal rate well above 5% is most definitely in the cards. There will be a small sense of relief and markets will trend up a little bit. But, as we mentioned here, Fed officials won’t like this unexpected easing of conditions and expect some tough talks from Fed officials should financial easing continue.