The CPI inflation rate fell faster than expected in December. However, core inflation, which strips out food and energy, only slowed in line with forecasts amid stubborn services inflation. The S&P 500 rose moderately on Thursday’s stock market action after the release of the consumer price index.
The CPI inflation rate eased to 6.5% from 7.1% the prior month vs. Wall Street expectations of 6.6%. The consumer price index fell 0.1% on the month vs. the expected flat reading.
The core CPI rose 0.3% vs. November levels, as expected. The annual core inflation rate eased to 5.7% from 6%. The core CPI inflation rate peaked at a 40-year-high of 6.6% in September.
Also on Thursday, the Labor Department also reported new claims for jobless benefits dipped 1,000 to 205,000 in the week through Jan. 7, suggesting that layoffs have yet to pick up in a broad way.
The Fed is likely to continue stepping down the pace of rate hikes to just a quarter-point with its next policy move on Feb. 1. Odds of just a 25-basis-point Fed rate hike jumped to 93% after the CPI, up from 77% the prior day.
The extent to which the Fed keeps hiking after that will depend less on the CPI than wage growth, which is key to the outlook for service-sector inflation. The good news for markets that sparked the latest S&P 500 rally attempt was that wage growth showed a surprising deceleration in December.
S&P 500 Reaction To CPI Report
Despite falling odds of another big rate hike, the S&P 500 initially oscillated between modest gains and losses, before turning modestly higher. The S&P 500 rose 0.3%, just below its 200-day line. The Dow Jones Industrial Average climbed and the Nasdaq composite climbed 0.6%.
Meanwhile, the 10-year Treasury yield tumbled 10 basis points to 3.45%, nearing its lowest level since September.
The latest S&P 500 rally off mid-October lows got a jolt of energy on Jan. 6, when wage inflation unexpectedly tame data raised hopes that the Fed could wind down rate hikes before they crashed 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 past couple of rally attempts have failed 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 all-time closing high.
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Fed’s Powell Shifts Focus From CPI To Wages
A further decline in the CPI inflation rate could allow the S&P 500 to keep moving higher, but it won’t be the catalyst.
Wage growth has become key to the Fed’s policy outlook, so investors celebrated after the December jobs report showed a sudden downshift in Q4. The average hourly wage 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, sliding a full percentage point from the March peak.
With wages growing at an annualized 4% rate in Q4, wage growth appears to be receding to close to Fed Chair Jerome Powell’s target of 3.5%. Factoring in productivity growth of about 1.5%, wage growth of 3.5% could bring inflation in line with the Fed’s 2% goal.
The most important inflation rate going forward is personal consumption expenditure (PCE) services minus energy and housing, Powell says. Core goods-price inflation is waning and the same is likely for housing inflation in 2023, given the stalling of market rents. But inflation in nonenergy services, excluding housing, is likely to stay elevated as long as wage growth remains hot.
Services Inflation Trends
The S&P 500 initially wavered after the CPI report showed that inflation in nonenergy services prices, which affected 56% of consumer budgets, still hasn’t begun to subside. Core services prices rose 0.5% on the month and 7% from a year ago vs. 6.8% in Nov.
However, that’s partly due to the way the Labor Department calculates housing inflation. While new rates for rental housing have been falling for months, it takes about a year for that to be fully reflected in renewed leases and the CPI.
Some analysts highlighted that services prices excluding shelter rose 7.4% from a year ago. However, that category includes energy services prices, which are up 15.6% from a year ago. Excluding energy and shelter, service prices are up about 6.2% from a year ago.
To get a better idea of how the CPI core services inflation data compares to Powell’s focus on PCE core services minus housing, IBD made a few alterations. Food away from home, which is part of the PCE services sector, was the only addition. Owner’s equivalent rent, rent of primary residence and health insurance, which doesn’t feed into PCE inflation data, were subtracted.
The latest data looks generally positive. While prices for this batch of core services rose 6.5% from a year ago, the annualized 3-month trend improved to 5% from 6.5% in November and 7.1% in October.
Meanwhile, inflation in goods prices, excluding food and energy, has decelerated from double-digit increases earlier in the year. That progress continued in December. Core goods prices fell 0.3% on the month. That brought year-over-year inflation to 2.1% from 3.7% in November.
CPI Inflation Report Details
Prices for used cars and trucks fell 2.5% on the month and are now 8.8% below year-ago levels. New vehicle prices were dipped 0.1% from November, while the annual price increase moderated to 5.9% from 7.2% the prior month.
Energy prices fell 4.5% on the month, while the annual increase moderated to 7.3% from 13.1% in November.
Prices for food rose 0.3% on the month, as the annual increase slowed to 10.4% from 10.6%.
Rent of one’s primary resident and owner’s equivalent rent rose 8.3% and 7.5% from a year ago, respectively. Both rose 0.8% on the month.
Prices for transportation services rose 0.2% on the month and 14.6% from a year ago.
Medical services prices rose 0.1% on the month, after falling 0.7% and 0.6% the prior two months. That left the annual increase at 4.1%.
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