US headline consumer inflation rises to three-month highs in December

US dollar ends flat, bond yields fall, and equities end mixed on Thursday

Consumer prices rose 0.3% month-on-month in December from 0.2% the previous month and from 3.1% to 3.4% at an annual rate, the most in three months, data published by the US Bureau of Labor Statistics showed. Economists polled by Dow Jones expected headline inflation to rise to 3.2% over 12 months in December. Meanwhile, core inflation, a gauge that excludes food and energy prices, climbed 0.3% month-on-month and ticked lower to 3.9% annually, falling below 4% for the first time since mid-2021. While the month-on-month core rate aligned with Street estimates, economists expected the annual inflation rate to decrease to 3.8%.

The surge in the core inflation rate was primarily from rising shelter costs, which increased 0.5% month-on-month and 6.2% annually, contributing about two-thirds to the inflation figure. In addition, the cost of car insurance jumped to nearly five-decade highs, adding further pressure on inflation. Although US Central Bank officials anticipate shelter costs to drop through the year as new leases pointed to lower rentals, economists believe the high cost of automobile insurance will not fade away anytime soon.

CPI for all urban consumers- Month-on-month

Source: bls.gov

While the latest CPI report won’t push Fed officials to change their minds about inflation returning to 2.5% in 2024 and their 2.0% target in 2025, Fed Funds futures traders continue to stick to their stand of a rate cut in March. According to the CME FedWatch Tool, 63.3% of traders anticipate a 25-basis point rate cut in March. That number is slightly down from the previous day’s reading of 64.7%.

Source: cmegroup website

However, despite market expectations of an interest rate pivot in March and six rate cuts this year, projections by the Federal Reserve indicate only three. The projections come in the backdrop of the unemployment rate holding below 4% and solid consumer spending.

Key highlights of the December consumer price index report

The seasonally-adjusted consumer price index for all urban consumers rose 0.3% in December from 0.1% the previous month, with the index for shelter up from 0.4% in November to 0.5%, contributing over 50% to the headline index in December, the US Bureau of Labor Statistics reported.

The other major contributor to the all-items index was the motor vehicles insurance index, which increased by 1.5% in December from 1.0% the preceding month. Meanwhile, the medical care index surged 0.6% in December, unchanged from a month earlier.

The food index rose 0.2% in December, unchanged from the month earlier and 2.7% year-on-year. On the other hand, energy prices increased 0.4% on the month, with the gasoline index up 0.2%, while the natural gas and fuel indexes slid 0.4% and 5.5% in December, respectively. Over 12 months, the energy index declined by 2.0%, led by a 13.8% and 14.7% plunge in the natural gas and fuel oil indexes, while the gasoline index fell 1.9%.

Source: bls.gov

Economists’ review of the December CPI data

Seema Shah, the chief global strategist at Principal Asset Management, thinks the December consumer inflation numbers are alright, although the pace of disinflation remains slow. She believes the Fed will not pivot to lower interest rates if shelter costs are high. She, however, expects them to align by mid-year, which is when policymakers might start lowering interest rates.

Brian Coulton, the chief economist at Fitch Ratings, London, believes that the small increase in the headline CPI figures was from higher energy prices. However, he is concerned about core inflation, dropping very slowly over the past few months, and services inflation still hovering around 5.0% year-on-year, which is inconsistent with broader inflation returning to the 2.0% mark over a sustained basis. He expects the Fed to remain cautious and not hurry in cutting rates as quickly as markets anticipate.

According to Adam Turnquist, markets are convinced about the delayed effect in the shelter component of the consumer price index and anticipate it will drop over time. He believes Thursday’s reaction to the hotter-than-expected CPI report indicates a certain level of market complacency regarding the broader inflation trend.

Market reaction to the December consumer inflation report

US stock markets ended mixed on Thursday in a volatile session that saw prices swing both ways as investors tried to make sense of the hotter-than-expected consumer inflation report and its impact on the Fed’s monetary policy path. The Dow Jones Industrial Average rose 15.49 points or 0.04% to 37,711.02, the Nasdaq 100 climbed 27.86 points or 0.17% to 16820.90, while the S&P 500 closed at 16820.90, down 3.21 points or 0.07%.

With market participants hoping that the Federal Reserve will start lowering rates later this quarter, the higher-than-expected inflation will only prolong the Fed’s decision to cut rates, damping the recent stock market gains.

Investors also remained cautious ahead of the quarterly earnings season from corporate America, with some of the biggest banks in the country reporting on Friday. Bank of America, Wells Fargo, JP Morgan, and Citibank will kick off the earnings season, with markets expecting profits to slow from higher reserves to cover potential loan defaults.

The next major inflation report is the Producer Price Index (PPI), due Friday morning. Traders anticipate the headline figure to rise by 0.1% in December, with core PPI expected to increase by 0.2%. Any upward surprise could lead to a selloff in equities as traders look to adjust their interest rate expectations to align with those of Fed officials.

Treasury yields ended lower on Thursday as investors ignored the latest inflation report and looked ahead to easing price pressures. The yield on the 2-year Treasury note fell 11.1 basis points to 4.258, the lowest since December 29th, while the yield on the 10-year T-note slid 5.5 basis points to 3.974, and the 30-year bond yield declined 2.0 basis points to 4.18%.

Meanwhile, the spread between the 2-year and 10-year, considered by analysts as a recession predictor, narrowed further to -28.5 points, with the shorter dater yield falling more than the longer-dated security, signaling that rate cuts could be around the corner.

In an interview on Bloomberg TV on Thursday, Cleveland Fed President Loretta Mester said central bank officials require more evidence that inflation is slowing down before reducing rates, diminishing hopes of a rate cut in March.

In the currency markets, the greenback rose against its key counterparts in the US dollar index on the back of a higher CPI number before pulling back later in the session to close flat at 102.29 on Thursday.

However, the US currency regained some of its losses on Friday amid concerns that markets are pricing more than what the US central bank will likely cut in 2024 and on news that the US and the UK launched air strikes on Houthi rebels in Yemen.

Fed officials have made it abundantly clear in their recent public interactions that there is insufficient progress on inflation to start cutting rates in March. But despite this, a majority of traders believe the US central bank will trim rates by 25 basis points.

Bank of America forecasts a weak dollar in 2024. According to their currency strategists, if the US economy has a soft landing and growth slows in line with the other countries, the US currency should fall from its overvalued levels, particularly against the Australian dollar, Canadian dollar, and the Scandinavian currencies (NOK, SEK, DKK, ISK).

Technical View

Spot USDJPY

The Japanese yen closed at 145.26 to the dollar on Thursday, up 0.34% for the session. The pair has fallen about 7.5% after failing to break the October 2022 peak last November, although there was some rebound in late December. But despite the drop, USD/JPY is in a long-term uptrend until a close is established below 141.00.

The pair is currently holding around the near-term support zone at 144.70-145.00, and a close below this level will lead to further losses for the US dollar, with the pair likely to target the long-term bullish trendline support at 141.00. On the upside, the near-term resistance is at the key Fibonacci levels of 146.00 and 147.45, with the medium-term resistance at 151.90 (November 2023 highs).

Strategy

Go long on USD/JPY in the 144.70-145.00 zone with a stop and reverse at 144.30 for a profit target of 146.10. If the pair closes below 144.70 or breaches 144.30, reverse the long trades with a stop loss at 145.60 and exit as prices approach 141.50.

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Amazon Inc. (AMZN)

Shares of Amazon Inc. closed at $155.18 on Thursday, higher by 0.94% for the session. The long-term trend is bullish, with shares closing above the key near-term resistance zone of $152.00-$155.00. Although the gains will likely continue higher toward the long-term bullish channel resistance at $176.00, to be on the safer side, it is advisable to wait for prices to break $160.00 before initiating long trades. On the downside, if prices break below $152.00, the decline could extend to the next support zone of $143.00-$148.00.