The CPI inflation rate fell faster than expected in December. However, core inflation, which excludes food and energy, only slowed as expected amid persistent services inflation. The S&P 500 rose slightly on Thursday Action on the stock exchange after the publication of the consumer price index.
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The CPI inflation rate fell to 6.5% from 7.1% the previous month compared to Wall Street expectations of 6.6%. The consumer price index fell 0.1% over the month vs. the expected flat reading.
Core CPI rose 0.3% from November levels, as expected. The underlying annual inflation rate fell from 6% to 5.7%. The core CPI inflation rate peaked at 6.6%, its highest level in 40 years, in September.
Also on Thursday, the Labor Department also reported that new jobless claims fell by 1,000 to 205,000 in the week ending Jan. 1. 7, suggesting that layoffs have not yet been resumed generally.
The Fed is expected to continue to slow the pace of rate hikes to just a quarter point in its next policy move on February 1. 1. Likelihood of a Fed rate hike of just 25 basis points jumped to 93% after the CPI, against 77% the previous day.
The extent to which the Fed continues to hike after that will depend less on the CPI and more on wage growth, which is critical for the inflation outlook for the service sector. The good news for the markets that sparked the S&P 500’s latest rally attempt is that wage growth showed a surprising deceleration in December.
S&P 500 reaction to CPI report
Despite dwindling odds of another big rate hike, the S&P 500 initially oscillated between modest gains and losses, before recovering slightly. 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 fell 10 basis points to 3.45%, nearing its lowest level since September.
The S&P 500’s latest rally from mid-October lows received a jolt of energy on January 1. On the 6th, when data on wage inflation unexpectedly raised hopes that the Fed could halt rate hikes before they collapsed on the economy.
The rally sparked by the jobs report lifted the S&P 500 to within 0.4% of its 200-day moving average. The last two rally attempts have failed around this level, but this one might have some legs.
The S&P 500 ended 13.7% above its October level. The intraday low of the 13 Wednesday bear market, but remained 17.6% below its all-time closing high.
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Fed’s Powell moves from CPI to wages
A further drop in the CPI inflation rate could keep the S&P 500 moving higher, but it won’t be the catalyst.
Wage growth became key to the Fed’s policy outlook, so investors celebrated after the December jobs report showed a sudden slowdown in the fourth quarter. Average hourly earnings rose 4.6% from a year ago, below expectations of 5%, triggering the current rally in the S&P 500. Wage growth has now fallen to its lowest level since August 2021, slipping one percentage point from the March high.
With wages growing at a 4% annualized rate in the fourth quarter, wage growth appears to be receding toward Fed Chairman Jerome Powell’s 3.5% target. Assuming productivity growth of around 1.5%, wage growth of 3.5% could bring inflation back in line with the Fed’s 2% target.
The most important inflation rate in the future is personal consumption expenditure (PCE) services less energy and housing, says Powell. Underlying property price inflation is declining and so is likely housing inflation in 2023, given stagnant market rents. But inflation in non-energy services, excluding housing, should remain high as long as wage growth remains high.
Services inflation trend
The S&P 500 initially faltered after the CPI report showed that price inflation for non-energy services, which affects 56% of consumer budgets, still hasn’t started to subside. Prices for basic services were up 0.5% on the month and 7% from a year ago compared to 2020. 6.8% in November.
However, this is partly due to the way the Department of Labor calculates housing inflation. While new rental housing rates have been falling for months, it takes about a year for this to be fully reflected in renewed leases and the CPI.
Some analysts pointed out that prices for non-housing services were up 7.4% from a year ago. However, this category includes prices for energy services, which are up 15.6% from a year ago. Excluding energy and housing, prices for services rose about 6.2% from a year ago.
To get a better idea of how the CPI’s core services inflation data compares to Powell’s focus on PCE core services minus housing, IBD has made some changes. Out-of-home catering, which is part of the PCE services segment, was the only addition. The owner’s equivalent rent, the rent of the principal residence and health insurance, which do not feed the PCE inflation data, have been subtracted.
The latest data looks generally positive. While prices for this basic service bundle were up 6.5% from a year ago, the 3-month annualized trend improved to 5% from 6.5% in November and 7 .1% in October.
Meanwhile, commodity price inflation, excluding food and energy, has slowed from double-digit increases at the start of the year. This increase continued in December. Basic commodity prices fell 0.3% over the month. This brought year-on-year inflation to 2.1% from 3.7% in November.
CPI Inflation Report Details
Used car and truck prices fell 2.5% in the month and are now 8.8% below levels a year ago. New vehicle prices fell 0.1% from November, while the annual price rose moderately to 5.9% from 7.2% the previous month.
Energy prices fell 4.5% over the month, while the annual rise moderated to 7.3% from 13.1% in November.
Food prices rose 0.3% during the month, as the yearly increase slowed to 10.4% from 10.6%.
The principal resident’s rent and the owner’s equivalent rent increased by 8.3% and 7.5% respectively compared to a year ago. Both were up 0.8% on the month.
Prices for transport services increased by 0.2% over the month and by 14.6% compared to a year ago.
Prices for medical services rose 0.1% per month, after falling 0.7% and 0.6% in the previous two months. This left the annual increase at 4.1%.
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