U.S. inflation rose more than expected in December, pushing the annual inflation rate to 3.4% and complicating the Federal Reserve’s plans to cut interest rates. The consumer price index (CPI) increased 0.3% last month, fueled by rising food, energy and housing prices.
Key Details from the December Inflation Report
- The CPI rose 0.3% in December, higher than the 0.2% forecast
- Inflation rose 3.4% over the last 12 months, up from 3.2% in November
- Food prices increased 0.5% in December, the largest monthly gain since August
- Energy prices rose 1.6%, driven higher by gasoline, natural gas and electricity costs
- Shelter costs, which make up one-third of the CPI, were up 0.7%
“Inflation edged up due to categories that are sensitive to interest rates, such as shelter costs,” said Mark Zandi, chief economist at Moody’s Analytics. “This will make Fed officials reluctant to cut rates in the first half of 2023.”
Annual Inflation Hits 3.4%, Defying Expectations
Economists predicted inflation would continue cooling in December after plunging from a 40-year high of 9.1% in June to just 1.3% in October. But the latest data shows inflation may be more persistent than anticipated.
“We expected inflation was behind us, but this report suggests otherwise,” said Diane Swonk, chief economist at KPMG. “Stubbornly high shelter and energy costs point to stickier inflation than hoped.”
The persistently high shelter costs are especially worrying for Fed officials. Rent and housing prices tend to lag other inflation measures, meaning they could continue pushing up the CPI in coming months.
“The housing market threatens to make all American’s lives more expensive,” said Newsweek. “As interest rates decline in 2023 and 2024, conditions will once again favor the housing market and a resurgence of inflation.”
Fed Rate Cut Hopes Fade After Report
Markets were betting the Fed would start cutting interest rates as soon as March after signs that inflation was cooling faster than expected. But hopes of rate cuts anytime soon faded after the hotter-than-expected CPI report.
“March is probably too early for a rate cut,” said Cleveland Fed President Loretta Mester following the inflation data.
Other Fed officials also pushed back on imminent rate cuts. “I think we should hold at the 5-5.25% fed funds rate for the full year in order to get inflation down near our 2% target,” San Francisco Fed President Mary Daly told reporters.
Futures markets are now pricing in just a 28% chance of a rate cut by March, down from 75% odds last week. Most economists now expect the Fed to leave rates unchanged for at least the next six months.
“This inflation report pours cold water on market expectations for rate cuts this spring,” said Sarah House, Senior Economist at Wells Fargo. “We’ll be on hold at these restrictive levels for some time yet.”
Biden Administration Braces For Political Fallout
The higher inflation reading threatens to undo political gains Democrats made in the 2022 midterms by touting the cooling price growth under President Biden.
“This inflation spike coming in an election year could not come at a worse time politically for President Biden,” said Republican Senator John Thune.
Biden officials cautioned that the December report reflects conditions from last month and does not necessarily signal a resurgence of inflation.
“This report is from mid-December, before the full impacts of cooling gas prices and supply chain improvements were felt by families,” said President Biden in a tweet following the report. “There’s more work to do, but we’re moving in the right direction.”
Outlook for 2023: Sticking Near 3%?
Economists now expect inflation to stick near 3% for much of 2023 instead of the 2-2.5% range anticipated last month.
“Our forecast is for inflation to drift around 3% this year, ending 2023 at 2.7%,” said Ryan Sweet, chief economist at Oxford Economics. “It’ll be a gradual descent, unlike the plunge we saw earlier.”
Several factors could put upward pressure on prices over the next year:
- Rebounding demand: As COVID restrictions ease in China, stimulus measures take effect and gas prices potentially rise, this could reignite demand and push prices higher across sectors.
- Persistent wage growth: Wages grew 4.6% annually in December, low compared to inflation but still hot enough to pass higher labor costs to consumers.
- Rebuilding inventories: Businesses depleted inventories in 2022 amid slowing demand. As they rebuild stockpiles, this inventory restocking could fuel production, spending and inflationary pressures.
“There’s likely still some residual pandemic-era imbalances that will take time to fully resolve,” Oxford Economics said in an inflation outlook. “Risks remain tilted to the upside.”
Overall economists emphasized patience will be needed through what could be a bumpy descent from 40-year high inflation.
“It’s too soon to say inflation is reaccelerating until we see where things stand over the next 3-6 months,” said Wells Fargo’s Sarah House. “But risks abound, and inflation often proves stickier than expected.”
Market Reactions: Stocks Swing Wildly, Yields Spike
Markets swung wildly following the hotter-than-expected inflation data, with stocks giving up early gains and bond yields spiking.
- The S&P 500 fell 1.1% after rising over 1% earlier
- The tech-heavy Nasdaq plunged 1.7%
- The 10-year Treasury yield shot up 9 basis points to 3.54%, retracing much of last week’s decline
- The 2-year yield surged 13 basis points to 4.2%, hitting its highest since November
- The dollar index jumped over 1%
“It’s clear markets were not adequately positioned for the possibility of a hot CPI print,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “The reversal in both stocks and bonds reflects that.”
Many Wall Street analysts said the intense market reaction suggests investors remain sensitive to inflation surprises even after last year’s steep selloff.
“The market is like a wounds soldier, easily spooked by loud noises like inflation,” said Ryan Detrick, chief market strategist at Carson Group. “Given the PTSD suffered in 2022, this reaction shouldn’t be a huge surprise.”
Conclusion: Long Battle With Inflation Continues
The December inflation report showed the Fed’s battle with rising prices still has some way to go. While inflation has fallen sharply from its peak last summer, stubbornly high shelter, food and energy costs show sticky inflation could persist for longer than hoped across key parts of the economy.
The data will likely keep the Fed from cutting interest rates in the first half of 2023. More economic data will indicate whether December’s hot reading was a temporary blip or the start of reaccelerating inflation. But for now, the long war to conquer four-decade high price growth continues, with risks still tilted to the upside.
“Inflation has plainly stopped its precipitous plunge, and risks are plainly increasing that it regains altitude in the coming year,” said the Wall Street Journal. “The Fed wants to avoid recession if it can, but it may have no choice if it wants to get inflation back down near its 2% target.”
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