News & Analysis

If the prospect of a March cut wasn’t yet dead, January’s inflation data has just provided the final bullet. Headline consumer prices rose from 0.233% to 0.305% MoM on an unrounded basis at the start of the year, while more concerningly for the Federal Reserve, core inflation accelerated by more than 0.1pp to 0.392% MoM.

While we believe that transitory factors such as start-of-the year price increases and more inflationary methodological tweaks helped boost the pace of core inflation in January, the Fed will be hard pressed in justifying a rate cut just a month after underlying inflation was seen rising at its fastest pace since April 2023 – back then, the Fed was still in full swing of its hiking cycle. Policymakers can’t point to the “supercore” measure of inflation to justify any earlier easing either, seeing as the core services ex-shelter measure jumped from 0.34% in December to 0.85% in January, lifting the 3-month annualised rate from 4% to 6.7%.

The Fed’s going to need a new inflation measure if it wants to become confident in the disinflation trend

In terms of the distribution of inflation, the story was relatively unchanged from 23Q4. Shelter continued to be the most inflationary component, rising 0.63% on the month and contributing over two thirds of the all-items monthly increase (+0.217pp). The sources of shelter inflation are beginning to diverge, however, with rent of primary residence inflation cooling for the third successive month, dropping from 0.47% MoM in October to 0.36% last month. This is very much in line with the decline in the pace of new resident rent increases as captured by alternative rent measures. By contrast, the imputed owners’ equivalent rent (OER) measure has merely accelerated in this time period, rising from 0.41% to a nine-month peak of 0.56%. Unfortunately for the Fed, the new 2024 weightings have only supported this becoming more inflationary, with OER’s relative importance rising by 0.751pp while rents have declined by -0.043pp. Outside of shelter, transportation services (+1% MoM, +0.06pp contribution to headline) and medical care services (+0.70% MoM, +0.046bps to headline) provided the largest upwards contributions, with the former reflecting a reset higher motor insurance (+1.4% MoM) and maintenance costs (+1.4% MoM), while the latter reflecting hospital services inflation jumping to levels not seen since late-2015 (+1.6% MoM).

Out of the sub-components, the most interesting development came in food away from home. Granted, overall food inflation was elevated last month at 0.4%, but with the eating out measure primarily reflecting labour costs in the industry, the 0.5% increase in the measure partially confirms the strong labour market data received at the beginning of the month. On the flip side, the largest disinflationary drags came from gasoline (-3.28% MoM, –0.0011pp to headline) and used cars (-3.37% MoM, -0.0007pp to headline). Once again, these readings were widely expected given auction prices continue to decline while oil benchmarks also softened on global growth concerns.

While today’s inflation data definitely puts an end to speculation over a Q1 rate cut from the Fed, we would caution against extrapolating the signals from today’s release onto Fed decisions from Q2 onwards.

After all, the January jobs and inflation data have proven incredibly noisy of late, while methodological adjustments have also made the inflation data look more concerning on a relative basis to Q4. Furthermore, the pace of core inflation should mean revert in February as the pace of core inflation outside of shelter components should drop considerably as firms delay further increases following start-of-year price adjustments. Markets haven’t shared today’s view, however, as pricing of a May cut is slashed to just 37.5% and a full rate cut is now delayed until the June 12th meeting. The more hawkish price action in short-term rate expectations has resulted in the 2-year Treasury yield climbing 11.8bps on the day, enabling a considerable rally in the dollar against rate sensitive currencies (SEK -1.36%, NZD -1%, JPY -0.77%).

While this has seen the DXY extend its rally beyond its post-payrolls peak, we think the dollar will struggle to compound this move in the coming days given the light data calendar and the reluctance by rates traders to widen rate differentials in the absence of weak data outside of the US in recent weeks.

The dollar DXY index surges past last week’s highs as markets price in less than 100bps of rate cuts from the Fed this year for the first time


Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst


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