A Good Week for Inflation Data
Last Friday, we received an updated labor market report that shattered expectations. Total nonfarm payrolls increased by 256,000 against an expectation of 165,000. This caused the unemployment rate to fall from 4.2% to 4.1%.We shouldn’t overreact to a single report, but it is important to note that this one reinforces labor market strength. As the market reacted, we saw a dip in interest rate cut expectations this year. Participants quickly forecasted that this strong job market may be a signal that the fight against inflation is becoming more difficult—a timely assessment moving into this week’s Producer Price Index (PPI) and Consumer Price Index (CPI) updates.
These reports were under pressure to either support or challenge the idea that the labor market was heating back up and causing inflation to get stickier. As usual, the market did not paint such a clear picture, however, the report takeaways were generally positive.
Starting with PPI, the index rose 0.2% against market expectations of a 0.4% increase. Diving into the details, the main driver was energy costs, which were up 3.5%. Core PPI, which removes the volatile food and energy categories in an attempt to account for the stickier prices, rose 0.1% in December, a welcomed result. This positive report laid the groundwork for Wednesday’s CPI data.
CPI for December met top-line expectations of a 0.4% increase. This is greater than the 0.3% increase in November. What caught the market’s attention was Core CPI, excluding the more volatile food and energy categories, coming in below expectations at 0.2%. This kicked off a nice market rally and yet another repricing of market expectations for 2025 interest rate cuts. Similar to PPI, the biggest driver of the top-line CPI was an increase in energy prices. Shelter, a typically sticky, major component of the data, increased the same amount in December that it did in November, another positive signal.
How Do We Interpret All This Data?
The critical question the market is grappling with is how many interest rate cuts to forecast for 2025. In order to support additional cuts, the Fed will not want to see the trend of a tightening labor market. Better-than-expected inflation data, however, can potentially offset that in the short term.It is important to note two things. First, the inflation and labor market data are not in sync. It’s likely that tightening in the labor market would precede increases in inflation, so when we look at December, we can’t declare that a tighter jobs report and better-than-expected inflation report simply neutralize each other. We also have yet to receive an update on the Fed’s preferred measure of inflation, Personal Consumption Expenditures (PCE).
The second note is that the Fed is always looking at trends, not singular reports. It will be important to watch the next few months of data closely to see if we are starting new trends, or if these reports are just blips on the radar.
Overall, this data gives us optimism that the economy continues to be strong and that inflation is continuing to improve. However, the risks seem to lean more towards inflation being stubborn in 2025. There will be lots to unpack over the next few weeks and months as the new administration takes over and begins to work towards their policy objectives, which will likely create some impacts on the economy. We’ll be watching this closely with an eye towards how any new policies may impact this critical data.
