Cooling Inflation Drives US Stocks to New Highs

After months of stubborn inflation, the Consumer Price Index (CPI) report released on Wednesday, 15 January, marked a shift.

The CPI, a key gauge of inflation closely monitored by policymakers like the Federal Reserve, is a vital economic indicator that impacts both the broader economy and financial markets. 

Let’s dive into the latest CPI data to understand the factors behind this reversal in inflation rates within the world’s largest economy:

The Latest US CPI Results 

The latest CPI report revealed the following: 

• The core CPI showed a slowdown for the first time in several months, increasing by 0.2% in December and bringing the annual rate down to 3.2% (from 3.3% in September). 

• Overall, the CPI rose by 0.4% in November, driven largely by higher prices for energy (especially gas) and food. Energy prices accounted for 40% of the overall increase. 

• Prices in the volatile categories of food and energy saw significant hikes, particularly for items like meat, eggs, and gasoline, which heavily impacted household budgets, particularly for lower-income Americans. (Source: CNN)

Inflation Trends in Recent Years

Inflation has significantly decelerated since its peak of 9.1% in June 2022. However, the journey back to normal has been uneven, with inflation rates fluctuating throughout 2024. Consumer prices for everyday goods have risen by 21% since 2021, putting additional strain on family budgets, particularly for essential items such as food, energy, and housing. 

Wages vs. Inflation

Although wages have been outpacing inflation for the past 20 months, they still fall short of pre-pandemic levels. 

What Does It Mean for the US Economy?

While recent inflation data may suggest positive developments for the US economy, it's crucial to recognize that inflation remains a substantial challenge for many American households, particularly due to the high costs of essential goods. As Federal Reserve economist Claudia Sahm says, "We are making progress on inflation, it's just very slow."

How Will It Affect the Fed?

As mentioned above, the CPI is one of the Federal Reserve's key inflation indicators. Therefore, Wednesday’s report may have provided traders and analysts with valuable insights into the potential direction of the Fed's monetary policy ahead of their upcoming rate decision meeting on 28-29 January. 

Economists like EY chief economist Gregory Daco argue, “This latest inflation reading confirms a Fed rate cut skip at the January FOMC meeting.” Supporting this view, Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management, added that the reading “won’t change expectations for a pause later this month, but it should curb some of the talk about the Fed potentially raising rates.”

How Did the Markets React?

US markets experienced a rally yesterday as investors digested the latest inflation report and strong earnings results from major banks, including JPMorgan Chase, Goldman Sachs, and BlackRock. 

Wall Street indices saw impressive gains across the board, with the S&P 500, Dow Jones Industrial Average and tech-heavy Nasdaq rising 1.8%, 1.6%, and 2.5%, respectively. The Russell 2000 also climbed 2%, reflecting broader market optimism. Meanwhile, the 10-year Treasury yield dropped by more than 13 basis points after reaching its highest level in over a year. (Source: Yahoo Finance)

More US Data for the Week

In addition to today's inflation report and the major bank earnings releases from Morgan Stanley and Bank of America, traders should also keep an eye on Friday’s upcoming US retail sales and housing starts data. These reports will provide valuable information about the health of the world’s largest economy.

Conclusion

In conclusion, the latest CPI report marks a noteworthy shift in the inflation landscape, offering some relief after months of persistent price increases. While the core CPI's slowdown is encouraging, inflation remains a challenge, especially for households grappling with the high costs of essentials like food, energy, and housing. This ongoing inflationary pressure, though decelerating, continues to influence the Fed’s decision-making, with expectations of a cautious approach to interest rates in the near term. 

The market’s positive reaction to the report, coupled with strong earnings from major banks, underscores the optimism surrounding the US economy's resilience. 

As we move into the week, traders will closely monitor additional data, such as retail sales and housing starts, for further clues on the economy’s trajectory.