January CPI will delay Fed cuts

The January CPI inflation report for the US came in faster than expected and pushed back on market expectations of imminent rate cuts from the Federal Reserve. The headline CPI index dropped to 3.1%, down from the 3.4% recorded from January but ahead of market expectations of a dip to below 3.0%. On a monthly basis the CPI index rose by 0.3%, the fastest pace since September 2023.

Core inflation was steady at 3.9% y/y but was up 0.4% m/m, actually its fastest print since May last year, while super-core inflation, which strips out energy and housing costs rose to 4.3% y/y. To be clear, PCE inflation has been running at a lower pace—the headline index held steady at 2.6% for December while on some measures the core PCE deflator is already running below the Fed’s 2% target level.

Inflation off peak but struggling to move lower

Source: Bloomberg, Emirates NBD Research.  

Paired with a strong labour market report for January, the CPI print will in our view quash all expectations that the Fed would think of cutting rates in March—market pricing now is less than 10%—and it should also dampen the prospects of a May cut as well with markets assigning it close to a 30% likelihood. The adjustment in market expectation has been substantial in the last several months as it has become clearer that the US economy is withstanding the effects of high interest rates and is not flashing signs of needing rate cuts. A month ago markets were pricing in as many as six cuts; that has now come down to three and a half.

We hold our forecast of three rate cuts in 2024, starting from the June FOMC meeting and then proceeding on a once-per-quarter basis until the end of the year. Activity and labour market data may start to weaken by then but our view remains that lowering real rates will be the Fed’s motivation for rate cuts, rather than providing stimulus to the economy.

Market expectation for Fed Funds in 2024

Source: Bloomberg, Emirates NBD Research.

Treasury yields have bounced on the release of the stronger than expected January inflation print—the 2yr UST yield jumped 18bps to 4.6578% overnight. We expect that Q1 will mark the peak for UST yields this year before they start to move lower as the Fed does eventually carry out a slow but determined cutting cycle.