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 inched higher in late Thursday morning stock market action, oscillating between mild losses and gains after 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 was 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 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 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 is that wage growth showed a surprising deceleration in December.
Goods Vs. Services Spending
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.
Inflation in nonenergy services prices, which affects 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 November. 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.
Still, services prices excluding shelter rose 7.4% from a year ago. That includes energy services prices, which are up 15.6% from a year ago. Excluding energy and shelter, service prices are up about 6.8% from a year ago.
S&P 500 Reaction To CPI Report
The S&P 500 rose less than 0.1% around 10:55 a.m. ET, showing little direction. The Dow Jones Industrial Average gained 0.4%, while the Nasdaq composite dipped 0.1%.
Meanwhile, the 10-year Treasury yield slipped 2 basis points to 3.53%.
The latest S&P 500 rally off mid-October lows got another jolt of energy on Jan. 6, when unexpectedly tame wage inflation data raised hope 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 faltered 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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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 climbed 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%.
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 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 close to in line with the Fed’s 2% goal.
The most important inflation rate going forward is personal consumption expenditures (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.
Housing accounts for over 30% of the CPI and 40% of the core CPI, but it only makes up 15% of the broader PCE basket.
Health care spending in the CPI excludes the bulk of outlays: spending covered by employers and government programs. Further, the recent declines in medical services prices in the CPI reflects stale data on insurer profits. By contrast, PCE health care services inflation is on the rise amid higher labor costs. Also, food consumed at restaurants, which continues to see high inflation, is excluded from the core CPI but is grouped among core PCE services.
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