CPI inflation fell faster than expected in December. However, core inflation, which excludes food and energy, slowed only in line with forecasts amid stubborn service inflation. The S&P 500 was higher in stock markets late Thursday morning, oscillating between modest losses and gains following the release of the CPI.
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CPI inflation eased to 6.5% from 7.1% the previous month versus Wall Street’s expectation of 6.6%. The consumer price index fell 0.1% for the month from the expected flat reading.
As expected, core CPI rose 0.3% from November levels. Annual core inflation 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 jobless claims, which fell by 1,000 to 205,000 in the week ended Jan. 7, suggesting layoffs are yet to pick up broadly.
The Fed is likely to further reduce the pace of rate hikes to just a quarter point with its next monetary policy move on February 1st. The probability of a Fed rate hike of just 25 basis points rose to 93% post-CPI, up from 77%.
The extent to which the Fed tightens further thereafter will depend less on the CPI and more on wage growth, which is crucial to the outlook for service sector inflation. The good news for the markets that fueled the S&P 500’s recent rally attempt is that wage growth showed a surprising slowdown in December.
Goods vs. expenditure on services
Inflation in commodity prices excluding food and energy has slowed from double-digit increases earlier in the year. This progress continued into December. Core commodity prices fell 0.3% for the month. As a result, annual inflation rose to 2.1% from 3.7% in November.
Non-energy service price inflation, which affects 56% of consumer budgets, has still not started to ease. Core service prices increased 0.5% mom and 7% year-on-year versus 6.8% in November. However, this is partly due to the way the Department of Labor calculates housing inflation. While new rental home prices have been falling for months, it will take about a year for this to be fully reflected in renewed leases and CPI.
Nonetheless, prices for non-accommodation services increased by 7.4% year-on-year. This includes prices for energy services, which are up 15.6% year-on-year. Excluding energy and housing, the price of services rose by about 6.2% year-on-year.
Reaction of the S&P 500 to the CPI report
The S&P 500 was up less than 0.1% as of 10:55 a.m. ET, showing little direction. The Dow Jones Industrial Average gained 0.4% while the Nasdaq Composite fell 0.1%.
Meanwhile, the 10-year government bond yield slipped 2 basis points to 3.53%.
The recent S&P 500 rally from mid-October lows received a further boost of energy on Jan. 6 as weaker-than-expected wage inflation data raised hopes that the Fed could scale back rate hikes before they crash the economy.
The rally sparked by the jobs report has pushed the S&P 500 up within 0.4% of its 200-day moving average. The last few rally attempts have stalled around this level, but this one might have some legs.
The S&P 500 on Wednesday closed 13.7% above its Oct. 13 bear market low, but remained 17.6% below its all-time closing high.
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CPI Inflation Report details
Prices for used cars and trucks fell 2.5% over the month and are now 8.8% below last year’s levels. New car prices fell 0.1% from November, while the annual inflation rate slowed to 5.9% from 7.2% in the previous month.
Energy prices fell 4.5% over the month, while the year-on-year increase eased to 7.3% from 13.1% in November.
Food prices rose 0.3% for the month, while the annual increase slowed to 10.4% from 10.6%.
The rent of the primary residence and the corresponding rent of the owner increased by 8.3% and 7.5% year-on-year. Both were up 0.8% for the month.
Prices for transportation services rose 0.2% month-on-month and 14.6% year-on-year.
Medical services prices rose 0.1% for the month after falling 0.7% and 0.6% respectively in the previous two months. The annual increase remained 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 move higher, but that won’t be the catalyst.
Wage growth has become key to the Fed’s policy outlook, which is why investors celebrated after December’s jobs report showed a sudden decline in the fourth quarter. Average hourly earnings rose 4.6% year over year, below forecasts of 5%, fueling the current S&P 500 rally. Wage growth has now fallen to its lowest level since August 2021, slipping a full percentage point from the March peak.
With wages up 4% on an annualized basis in the fourth quarter, wage growth looks closer to Fed Chair Jerome Powell’s target of 3.5%. Factoring in productivity growth of around 1.5%, 3.5% wage growth could bring inflation close to the Fed’s 2% target.
The key rate of inflation going forward is personal consumption expenditure (PCE) on services minus energy and housing, Powell says. Core inflation in goods prices is easing, and given the stalemate in market rents, so should house inflation in 2023. But inflation in non-energy services, excluding housing, is likely to remain high as long as wage growth remains strong.
Housing accounts for over 30% of CPI and 40% of core CPI, but accounts for only 15% of the broader PCE basket.
Health spending in the CPI excludes the bulk of spending: spending covered by employers and government programs. In addition, recent declines in medical service prices in the CPI reflect outdated data on insurers’ profits. In contrast, inflation in PCE health services is rising in the face of higher labor costs. Also, groceries consumed in restaurants, which continue to experience high inflation, are excluded from core CPI but are grouped into core PCE services.
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