On Tuesday, investors will digest one of the most important data points the Federal Reserve will consider in its next interest rate decision: January’s Consumer Price Index (CPI).
The inflation report, set for release at 8:30 a.m. ET, is expected to show headline inflation of 2.9%, a significant deceleration from December’s 3.4% annual gain, according to estimates from Bloomberg.
If those estimates hold true, it will be the lowest annual inflation rate in about three years and the first time that number will come in below 3% since March 2021.
Over the prior month, consumer prices are expected to rise 0.2%, matching December’s recently revised monthly increase.
On a “core” basis, which strips out the more volatile costs of food and gas, prices in January are expected to have risen 3.7% over last year — a slowdown from the 3.9% annual increase seen in December, according to Bloomberg data.
Monthly core prices are expected to have climbed 0.3%, unchanged from the prior month.
According to Bank of America (BofA), core inflation has remained especially sticky due to high shelter prices, along with “volatile” categories like used cars, transportation services, and lodging away from home.
“The good news is that we expect shelter inflation to moderate over the course of the year given the disinflation seen in asking rent inflation,” BofA economists Stephen Juneau and Michael Gapen wrote in a note to clients on Monday.
Within core, BofA expects services to be boosted by larger price increases in transportation services and lodging away from home as demand for travel “started the year on a strong note.” Used car prices, meanwhile, should tick down by about 1.8% on a month-over-month basis, the bank noted.
To hike or not to hike?
Annual inflation has remained above the Federal Reserve’s 2% target. But the Fed’s preferred inflation gauge, the core PCE price index, has come in below that rate on a six-month annualized basis, boosting hopes the central bank could begin to cut interest rates.
Fed Chair Jerome Powell, however, has tempered those expectations. He shut down the possibility of a March rate cut at the central bank’s meeting last month, saying that’s “probably not the most likely case.”
Read more: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards
As of Monday afternoon, markets were pricing in a nearly 85% chance the Federal Reserve keeps rates unchanged in March, according to data from the CME Group.
The market largely expects the central bank to begin cutting rates at its May meeting, pricing in a roughly 60% chance of a cut.
Bank of America does not expect the first Fed rate cut to come until June.
“A report in line with our expectations would continue to build the Fed’s confidence and support our expectation for the first cut to be in June,” BofA economists said.
Fed officials have echoed Powell’s cautious rhetoric.
“It would be a mistake to move rates down too soon or too quickly without sufficient evidence that inflation was on a sustainable and timely path back to 2%,” Cleveland Fed President Loretta Mester said in a speech last week.
Minneapolis Fed President Neel Kashkari added the Federal Reserve is “not all the way there yet” when it comes to tackling inflation, while Boston Fed President Susan Collins said she’ll “need to see more evidence” that inflation is heading back toward the Fed’s 2% goal.
Both Mester and Collins said interest rate cuts could arrive “later this year.”
“The longer the FOMC waits to lower rates the more credibility their inflation-fighting determination likely gains,” UBS lead economist Jonathan Pingle wrote in a preview note on Friday. “Of course that strategy carries risks, too, with inflation expectations already falling below levels seen when inflation averaged 2%, and with a reliance on backward looking activity data.”
“Overall, inflation looks to be falling faster than the FOMC expects,” the economist continued, referring to falling inflation as the “macro theme” of the first half of this year.
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