【MACRO Alert】 US CPI report triggers market volatility: Analysis of Fed policy and economic outlook

The monthly rate of the US CPI after seasonal adjustment in December was 0.4%, the highest since March 2024, higher than market expectations and the previous value of 0.3%; the annual rate of the US CPI without seasonal adjustment in December was 2.9%, in line with expectations, and warmer than the previous value of 2.7%. The monthly rate of the US core CPI without seasonal adjustment in December was 0.2%, in line with market expectations, and cooler than the previous value of 0.3%; the annual rate of the US core CPI without seasonal adjustment in December was 3.2%, the lowest since August 2024, and the market expected it to remain unchanged at 3.3%.

After the release of the CPI data, interest rate futures traders bet on the Fed to cut interest rates in June, and expected a 50% chance of a second rate cut by the end of 2025. The US dollar index fell more than 40 points in the short term, and spot gold rose nearly $10 in the short term, once standing above the $2,690 mark. Non-US currencies rose across the board, with the pound rising more than 60 points against the US dollar in the short term, the euro rising more than 50 points against the US dollar in the short term, the US dollar falling more than 60 points against the Japanese yen in the short term, and the US dollar falling nearly 40 points against the Canadian dollar in the short term.

Prior to the December CPI report, the year-over-year core CPI growth rate had been stuck at 3.3% for the past four months. The three-month core CPI annualized rate has now fallen to 3.3%, down from 3.7% in the previous month, which, while still high, has stopped a two-month upward trend. For the overall CPI, energy appears to be the culprit, accounting for more than 40% of the month-over-month growth of all items, with gasoline prices rising 4.4% for the month.

Details of the report also showed that housing inflation also remained mild last month, increasing by 0.3% month-on-month. In addition, super core services rose only 0.21% month-on-month, the lowest level since July last year. Analysts Ira F. Jersey and Will Hoffman of Bloomberg Industry Research (BI) said that the knee-jerk rebound in the market after the CPI report that was more or less “in line with expectations” clearly showed that those who were worried about upward inflation data were relieved.

Some Fed officials welcomed the latest data showing a smaller-than-expected increase in a gauge of consumer prices in December, giving them confidence that inflation will continue to weaken. At a separate event in Annapolis, Maryland, Richmond Fed President Thomas Barkin told reporters that the newly released price data “continues the trend we've been seeing, which is that inflation is moving down toward our target.”

A relatively modest rise in U.S. consumer price index data sparked a strong rebound in stocks and bonds on Wednesday, but traders and investors warned that concerns about inflation may remain. Market participants said the future remains shrouded in uncertainty about the prospects for further interest rate cuts by the Federal Reserve and President-elect Trump's actions on issues such as taxes and tariffs.

While the headline CPI rose faster than expected in December, the market focused on the core CPI, which rose 0.2% month-on-month in December after rising 0.3% for four consecutive months. U.S. stocks surged after the CPI report was released, with the benchmark S&P 500 index rising 1.8%. The benchmark 10-year U.S. Treasury bond reversed losses caused by the release of a strong non-farm payrolls report last Friday.

Treasury yields have risen sharply in recent weeks after the Federal Reserve in December downplayed the prospect of rate cuts and predicted that inflation would be firmer in 2025 than previously forecast. Concerns about the potential negative impact that Trump's policies could have on inflation remain an issue. Fed officials on Wednesday pointed to heightened uncertainty in the coming months as they await initial glimpses of the incoming administration's policies, even as they said Wednesday's data showed inflation was continuing to ease.

Volatility could become more prevalent as markets remain data-dependent. Kevin Flanagan, head of fixed income strategy at WisdomTree, expects daily moves of 10 to 15 basis points in the 10-year Treasury note to become the new normal. After the data, interest rate futures traders still expect the Fed to wait until June for its next rate cut. But now they are roughly even-keeled about the chances of a second rate cut by the end of the year.

Market volatility and economic data releases will continue to influence investor sentiment and the Fed's policy decisions. CPI and PPI data will provide the market with important clues about inflation and economic health, while the performance of the job market will further affect the Fed's path of interest rate cuts.