The U.S. Federal Reserve Chair is closely examining the upcoming Consumer Price Index (CPI) data, set to be released on February 13th, for signs of subdued inflation. This is seen as a potential opportunity for spring interest rate cuts. The nowcasts estimate that the headline monthly CPI will rise by 0.1%, while the core CPI is expected to increase by 0.3%, aligning with the Federal Reserve's expectation of inflation trending towards its 2% target.
However, the Federal Reserve would ideally like to see inflation reach its target more quickly and smoothly. In December 2023, the monthly CPI increase was revised to 0.2%, indicating a gradual upward movement. Recent revisions in seasonal factors for past CPI reports have slightly reduced reported inflation. Although these revisions were monitored by the Fed, their impact was limited, resulting in a favorable development for those hoping for lower U.S. inflation.
The primary focus for the Fed is to observe a low CPI increase. While a 0.3% rise would generally be acceptable, a lower result would increase the likelihood of an interest rate cut. Of particular interest within the underlying series is the expectation that shelter costs will cool in the coming months. As home prices have generally declined recently, it is anticipated that the CPI series may follow suit. In December 2023, shelter costs rose at an annual rate of 6.2%, which is comparatively high. If these costs were to decline, headline inflation could cool as a result.
Additionally, the Fed will pay close attention to services inflation. Despite inflation cooling in many categories, services costs continue to rise in several sectors, driven by increasing wage costs that lead to price hikes. The Fed hopes to see services prices cool down, allowing for greater confidence in cutting interest rates while keeping inflation subdued. The Atlanta Fed's Wage Growth Tracker indicates that wage growth is already cooling, suggesting a potential deceleration in services prices.
The January CPI data is the first of two releases that the Fed will receive prior to its March 20th interest rate decision. It is anticipated that rates will remain unchanged at that meeting. However, if inflation continues to trend lower and approach the Fed's 2% goal, the central bank has indicated that an interest rate cut may be possible at a subsequent meeting.
The Fed has generally been satisfied with the cooling of inflation but wants to ensure that the trend continues before considering its first interest rate cut of this economic cycle. However, the state of the job market poses a potential risk. The Fed remains concerned that a weakening job market could necessitate rate cuts. So far, recent reports suggest a relatively strong job market, indicating that less restrictive interest rates are not adversely affecting employment as a whole.
Market expectations point towards a potential interest rate cut by late spring or early summer. While January's CPI data is unlikely to be the deciding factor, sustained subdued inflation could act as a catalyst for interest rate cuts. This may occur at the Fed's meeting in May or later. Nonetheless, the market continues to anticipate lower interest rates as inflation data remains relatively benign. The critical question remains the timing of the first rate cut.
