Inflation is expected to have declined in December

The rate of consumer inflation is expected to decline slightly in December from the previous month due to the fall in petrol and energy prices, but the annual rate will still remain high.

According to Dow Jones, economists now expect a 0.1% decline in the monthly consumer price index, but inflation is still expected to rise at a rate of 6.5% from the previous year. That compares with a 0.1% gain in November, and a 7.1% annual pace. However, the CPI is far from the peak level of 9.1% in June.

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Core CPI, excluding energy and food, is expected to rise 0.3% in December, gaining 5.7% on a year-over-year basis. Core CPI rose 0.2% in November and 6% year-on-year.

“We welcome with open arms. It’s good news,” said KPMG chief economist Diane Swonk of the expected population decline. “It’s very good and helped consumer spending in the fourth quarter. … But it’s still not enough.”

The consumer price index is due at 8:30 am ET. This is the last CPI report before the Federal Reserve’s Feb. 1 interest rate decision. For that reason, inflation numbers have become a major event for financial markets, and now some traders are betting that inflation will show slower than economists’ forecasts. They also pointed to weaker-than-expected wage growth in the December jobs report, as well as other data pointing to lower inflation expectations.

Stocks rallied on Wednesday ahead of the report. “The market is looking at it as a half-full glass. Inflation is rolling over, and the Fed is almost done raising interest rates,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “I think they remember the last two months when you have numbers that are well below expectations. They are just assuming that it will be small again.”

In the futures market, traders continue to bet the central bank will raise rates by just a quarter of a point at its next meeting. Meanwhile, some economists continue to expect policymakers to increase the target level of the food fund by half a percentage point. Market expectations are only 20% for a 50 basis point increase. A basis point is equal to 0.01 of a percentage point.

“It’s amazing the reaction and the overreaction to one data point,” said Simona Mocuta, chief economist at State Street Global Advisors. “Clearly the CPI is very important. In this particular case, it has pretty direct policy implications, which is about the size of the Fed’s next rate hike.”

Mocuta said the cooler CPI should affect the Fed. “The market has not been fully priced at 50. I think the market is right in this case,” she said. “The Fed can still argue with the market, but what the market prices is the right decision.”

Wilmington Trust chief economist Luke Tilley said a 12% drop in gasoline prices in December and other declines in energy prices – for costs like home heating – helped reduce inflation.

“Shelter is the main focus because of the lag,” he said. Rental market data shows a slowing rate, but the CPI has not reflected that. “Everyone is familiar with the lag required for data to show up in the CPI,” added Tilley. “We think there may be a sharper slowdown.” The cost of the shelter is 40% of the core CPI.

Shelters are expected to rise 0.6% month-on-month. Tilley said that with the downturn in the real estate market, he’s heard from landlords that they’re having a harder time raising rents. “We are penciling in a slow increase in January and February and March in a shorter lag,” he said.

Economists are watching closely to see how much services-related inflation rises in the CPI, as goods inflation is expected to continue to decline now that supply chains are operating normally.

“The title changes every month for two, three months overstate improvement. We will not ask for the same gasoline in the next report. I do not want to see acceleration in the shelter. I want to see some of the discretionary areas showing deceleration,” said State Street’s Mocuta. “I think right now the focus is very much on the service side.”

Markets are laser-focused on inflation as the Fed’s progress in the fight could determine how far the central bank will move down the path of rate hikes. Rate hikes are slowing the economy, and more choices could be the difference between a soft landing or a recession.

“The hope is that we are now in a position where you can imagine a soft landing. That would require the Fed not only to stop raising rates but faster and it doesn’t seem to be going anywhere,” said Swonk. “The Fed is hedging a different bet than the market. … This is where the nuances are really difficult. You are in this position that is getting better. Like the patient is getting better, but not out. in the hospital yet.”

The fed funds rate range is currently at 4.25% to 4.5%, and the central bank has forecast a final high rate of 5.1% for this year.

“The Fed is also worried about a second supply shock, whether China abandons its zero-Covid policy or something else from Russia. They don’t want to declare victory too soon,” said Swonk. “He made that very clear. He has said it over and over and no one is listening.”

Economists expect another key metric – the personal consumption expenditure deflator – to show core inflation slowing even below the Fed’s forecast of 3.5% by December 31. Some recession-proof economists predict rate cuts before the end of the year, as markets expect. But the Fed has no forecast for rate cuts until 2024.

Some strategists expect Fed officials to start sounding more dovish and less at odds with market views. Boston Fed President Susan Collins said in an interview with The New York Times on Wednesday that she is leaning towards a quarterly hike at the next meeting.

“We think one of the changes in the coming months is that the Fed will realize that it is cheaper to change the inflation narrative than to reverse the recession that caused millions of lost jobs,” Fundstrat founder Tom Lee wrote in a note Wednesday.