CPI growth fell faster than expected in December. However, core inflation, which strips out food and energy, eased only in line with forecasts due to stubborn services inflation. The S&P 500 rose late on Thursday morning stock market action, fluctuating between mild losses and gains following the release of the consumer price index.
CPI inflation fell to 6.5% from 7.1% the previous month, against Wall Street expectations of 6.6%. The consumer price index fell 0.1% month-on-month compared to an expected flat reading.
Core CPI rose 0.3% compared to November levels, as expected. The annual core inflation rate fell to 5.7% from 6%. Core CPI inflation hit a 40-year high of 6.6% in September.
Also on Thursday, the Labor Department also reported new claims for unemployment benefits fell 1,000 to 205,000 in the week to January 7, suggesting layoffs have yet to pick up broadly.
The Fed is likely to continue to reduce the pace of rate hikes to just a quarter point with its next move on February 1. The odds of a rate hike of just 25 basis points increased to 93% after CPI, up from 77%.
The extent to which the Fed continues to hike after that will depend less on the CPI than on wage growth, which is key to the outlook for services sector inflation. The good news for the markets that sparked the last S&P 500 rally attempt is that wage growth showed a surprising slowdown in December.
goods vs. Services Expenses
Inflation in commodity prices, excluding food and energy, has slowed from double-digit increases earlier in the year. Progress continued in December. Core commodity prices fell 0.3% in the month. That brought year-over-year inflation to 2.1 percent from 3.7 percent in November.
Inflation in the prices of non-energy services, which affects 56% of consumers’ budgets, has still not begun to abate. Prices for core services rose 0.5% on the month and 7% from a year ago, compared to 6.8% in November. However, that is partly due to the way the Ministry of Labor calculates housing inflation. While new rates for rental properties have been falling for months, it takes about a year before it is fully reflected in renewed leases and the CPI.
Nevertheless, service prices excluding shelter rose by 7.4% from a year ago. That includes the prices of energy services, which are up 15.6% from a year ago. Excluding energy and shelter, service prices are up by around 6.2% from a year ago.
S&P 500 Reaction To CPI Report
The S&P 500 was up less than 0.1% around 10:55 a.m. ET, showing little direction. The Dow Jones Industrial Average rose 0.4%, while the Nasdaq Composite fell 0.1%.
Meanwhile, the 10-year Treasury yield fell 2 basis points to 3.53%.
The latest S&P 500 rally since mid-October lows got another jolt of energy on Jan. 6, when unexpectedly tame wage inflation data raised hopes the Fed could scale back rate hikes before crashing the economy.
The rally sparked by the jobs report has lifted the S&P 500 within 0.4% of its 200-day moving average. The last couple of rally attempts have limped around that level, but this one might have some legs.
The S&P 500 finished 13.7% above its Oct. 13 bear-market intraday low on Wednesday, but remained 17.6% below its most recent close.
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CPI inflation report details
Prices for used cars and trucks fell 2.5% in the month and are now 8.8% below last year’s levels. Prices for new cars fell 0.1% from November, while the annual price increase moderated to 5.9% from 7.2% the previous month.
Energy prices fell 4.5% in the month, while the annual increase moderated to 7.3% from 13.1% in November.
Food prices rose 0.3% on the month, as the annual increase slowed to 10.4% from 10.6%.
The rent for one’s primary resident and the owner’s corresponding rent rose by 8.3% and 7.5% respectively from the previous year. Both rose 0.8 percent in the month.
Prices for transport services rose 0.2% compared to the month and 14.6% from the previous year.
Medical services rose 0.1% on the month, after falling 0.7% and 0.6% in the previous two months. That put the annual increase at 4.1%.
Fed’s Powell shifts focus from CPI to wages
A further decline in the CPI inflation rate could allow the S&P 500 to continue moving higher, but it won’t be the catalyst.
Wage growth has become key to the Fed policy outlook, so investors celebrated after the December jobs report showed a sudden slowdown in the fourth quarter. Average hourly earnings rose 4.6% from a year ago, below 5% forecasts, kick-starting the current S&P 500 rally. Wage growth has now fallen to the lowest level since August 2021, falling a full percentage point from the peak in March.
With wages growing at an annualized rate of 4% in the 4th quarter, wage growth appears to be on the way down to near Fed Chair Jerome Powell’s 3.5% target. Assuming productivity growth of around 1.5%, wage growth of 3.5% could bring inflation close to in line with the Fed’s 2% target.
The key rate of inflation going forward is personal consumption expenditures (PCE) services minus energy and housing, Powell says. Inflation in core commodity prices is slowing, and the same is likely for housing inflation in 2023, given the halt in market rents. But inflation in non-energy services, excluding housing, is likely to remain high as long as wage growth remains high.
Housing accounts for over 30% of CPI and 40% of core CPI, but it only accounts for 15% of the broader PCE curve.
Health costs in the CPI exclude the bulk of expenditure: expenditure covered by employers and government programmes. Furthermore, the recent declines in the prices of medical services in the CPI reflect outdated data on insurance companies’ profits. In contrast, inflation in PCE healthcare is on the rise due to higher labor costs. Also, food consumed in restaurants, which continues to experience high inflation, is excluded from the core CPI but is grouped among core PCE services.
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