US CPI in line with expectations, but no clear disinflationary trend

US CPI for December was in line with expectations, the headline rate expanded by 2.7% YoY, while the core rate was slightly below expectations at 2.6% YoY, both above the Fed’s target rate of 2%. The market reaction has been mild so far, Treasury yields are slightly lower across the curve, the dollar index remains at the highs of the day and US stock index futures are pointing to a positive open for US stocks.

Inflation still way off from Fed target

This is the first ‘clean’ inflation print since the US government shutdown last year. There was a lot resting on this report to give us the latest read on the trend in US inflation. Due to this, it is important to dig into the detail of the report. The monthly CPI increase for December was a relatively high 0.3%, which justifies the Fed’s caution when it comes to signaling the prospect of further rate cuts this year.

The key drivers of December’s price growth were shelter and food. Energy costs also rose by 0.3%. Interestingly, core price growth, which strips out food and energy costs, rose by a modest 0.2% last month. Recreation, airline fares, medical care, education and clothing costs increased. However, household furnishings, communication and used car and truck prices receded last month.

Used cars and truck prices increased in October and November, so declines in  this part of the index is welcome. However, the cost of food at home and out of the home rose strongly last month, partly due to seasonal factors, added to this, shelter costs, which are a key segment of the CPI index, rose by 0.4%, which suggests that inflation is still no closer to returning to the Fed’s target 2% rate.

No clear disinflation trend in US economy  

Added to this, energy prices are no longer dampening inflation and in recent months energy prices have picked up, after falling in the middle of last year. This suggests that there is no clear disinflation trend in the US economy right now. Elevated wage growth, combined with a strong economy, could keep price pressures above the target rate for the foreseeable future.

Shelter costs remain elevated as CPI report does not shift the dial for rate cut expectations

Shelter is a major outgoing for most people, so the fact that inflation remains elevated in this part of the index, could keep the Federal Reserve cautious about the future path for inflation. On the back of this report, expectations for US interest rates have barely budged. There is still only a 5% chance of  a cut later this month, and there is just under one rate cut now priced in by April this year, just before Jerome Powell steps down as chair of the Fed. We do not see anything in this inflation report to shift the dial for the Fed, and we expect them to remain mindful of price pressures, as well as institutional pressure to cut rates when the economy could be running hot.

Why the next Fed chair needs to be mindful of inflation risks

This CPI report comes at an interesting time for the Federal Reserve, as President Trump  is accused of interfering with the central bank’s decision making. This CPI report suggests that the market needs to be aware of political pressure to lower interest rates when inflation pressures remain. It also highlights the need for a Fed chair who is vigilant on the outlook for inflation. The market reaction is mild now, but there were some signs of price pressures in this report, and they need to be taken seriously.

JP Morgan’s share price faces political risk premium

Overall, the S&P 500 is expected to extend further into record breaking territory later today, even though the reaction to JP Morgan’s results have been muted. The stock price is higher by 0.13% in the pre-market, after it reported stronger than expected revenues and net income. This was driven by strength in its trading unit and higher than expected net interest income. However, the bank announced that investment banking underwriting fees were weaker than expected, and the CEO Jamie Dimon also said that if President Trump does impose a 10% cap on credit card interest rates then this could fundamentally change its business. JP Morgan is the US’s largest credit card issuer, so the company’s share price may now face a political risk premium, akin to a currency, which could keep the stock price under pressure for some time.

Overall, stocks are in a buoyant mood on Tuesday, as Fed independence fears fade into the background. Although, this CPI report suggests that investors need to be aware of that risks remain.