Finance
December Inflation clouds Fed’s outlook on interest rate cuts
Gas prices majorly contributed to higher inflation in December. (iStock)
Annual inflation increased to 2.9% in December, rising modestly above the 2.7% annual inflation rate of the previous month, according to the Consumer Price Index (CPI) released by the Bureau of Labor Statistics (BLS).
Inflation increased 0.4% monthly in December, slightly exceeding expectations. Core CPI, which excludes food and energy, rose by 0.2% in December, coming in below estimates after four consecutive months of 0.3% increases. This brought the year-over-year rate to 3.2%.
The cost of energy rose 2.6% and was the most significant contributor to the monthly increase in December, accounting for nearly 40% of the monthly increase in all items. Gas was up 4.4% over the month. Food prices continued to rise, increasing 0.3% last month after a 0.4% surge in November.
“December’s CPI report brings a mix of news, including a glimmer of optimism,” First American Senior Economist Sam Williamson said in a statement. “While Headline CPI increased and exceeded expectations, the monthly increase in the less volatile and more closely watched Core CPI slowed and was below expectations.
“This downside surprise in Core CPI is encouraging, but one month does not make a trend,” Williamson continued. “The Federal Reserve will likely need to see sustained progress before considering any rate cuts.”
The Federal Reserve cut interest rates by a quarter of a percentage point in December, dropping rates from 4.25% to 4.5%, but the minutes from the Federal Open Market Committee meeting showed that there is growing concern about higher inflation and a clear division among the Fed’s members on whether to continue dialing rates back. Some expressed support for keeping the central bank’s key rate unchanged, and most officials said the decision to cut rates was a close call, the minutes said. The Fed’s next meeting will be on Jan. 28 and 29.
“The December CPI numbers indicate that inflation is not cooling at the rate that satisfies the Fed’s target,” Voxtur Analytics CEO Ryan Marshall said. “As a result, those who were optimistic that the Fed would cut interest rates more in 2025 are now realigning forecasts to expect fewer rate cuts this year.”
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Shelter costs remain elevated
Shelter costs rose by 0.3% monthly, at the same pace as the previous month, which helped bring the annual inflation rate down to 4.6% from 4.7% last month, according to Realtor.com Chief Economist Danielle Hale.
Despite the slight progress, shelter costs remain above their pre-pandemic range, which averages 3.3%, according to Hale. Elevated costs are likely to stall further rate cuts, which impacts the level of longer-term rates like mortgage rates, which remain just below 7%.
“Right now, the market does not place high odds on a cut before June,” Hale said in a statement. “The labor market ended 2024 with a bang, as hiring ticked up and the unemployment rate slipped back to 4.1% in December. With the full-employment half of the Fed’s dual mandate on more solid footing than seemed the case three to six months ago, the Fed is likely to be patient, especially if inflation continues to hover just above target.”
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The housing outlook is shaky
Elevated mortgage rates will further stall the housing market despite willing buyers, according to Hale. Homeownership remains a central goal for roughly 75% of Americans surveyed by Realtor.com, but affordability remains a top concern for many.
“Existing home sales improved in recent months following fall’s lower mortgage rates, but as rates have climbed back up, our expectations for home sales have been diminished,” Hale said.
What’s ahead for housing is more of the same in terms of mortgage rates, and home prices are expected to continue rising. One bright spot is that the incoming President Donald Trump administration could spur more substantial economic growth and, therefore, higher incomes, giving Americans more buying power. Moreover, lower household tax rates are anticipated to boost disposable household income even if incomes don’t rise, according to the Realtor.com Housing Forecast.
“For 2025, the Realtor.com Housing Forecast anticipates a modest decline in mortgage rates to power a modest uptick in home sales,” Hale said. “Every drop in the inflation rate will help bring that expectation closer to reality.”
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U.S. Federal Reserve Chair Jerome Powell testifies before a Senate Banking, Housing and Urban Affairs Committee hearing on “The Semiannual Monetary Policy Report to the Congress,” at Capitol Hill in Washington, U.S., Feb. 11, 2025.
Craig Hudson | Reuters
The popular narrative among Federal Reserve policymakers these days is that policy is “well-positioned” to adjust to any upside or downside risks ahead. However, it might be more accurate to say that policy is stuck in position.
With an abundance of unknowns swirling through the economy and the halls of Washington, the only gear the central bank really can be in these days is neutral as it begins what could be a long wait for certainty on what’s actually ahead.
“In recent weeks, we’ve heard not only enthusiasm — particularly from banks, about possible shifts in tax and regulatory policies — but also widespread apprehension about future trade and immigration policy,” Atlanta Fed President Raphael Bostic said in a blog post. “These crosscurrents inject still more complexity into policymaking.”
Bostic’s comments came during an active week for what is known on Wall Street as “Fedspeak,” or the chatter that happens between policy meetings from Chair Jerome Powell, central bank governors and regional presidents.
Officials who have spoken frequently described policy as “well-positioned” — the language is now a staple of post-meeting statements. But increasingly, they are expressing caution about the volatility coming from President Donald Trump’s aggressive trade and economic agenda, as well as other factors that could influence policy.
“Uncertainty” is an increasingly common theme. In fact, Bostic titled his Thursday blog post “Uncertainty Calls for Caution, Humility in Policymaking.” A day earlier, the rate-setting Federal Open Market Committee released minutes from the Jan. 28-29 meeting, with a dozen references to the uncertain climate in the document.
The minutes specifically cited “elevated uncertainty regarding the scope, timing, and potential economic effects of possible changes to trade, immigration, fiscal, and regulatory policies.”
Uncertainty factors into the Fed’s decision making in two ways: the impact that it has on the employment picture, which has been relatively stable, and inflation, which has been easing but could rise again as consumers and business leaders get spooked about the impact tariffs could have on prices.
Missing the target
The Fed targets inflation at 2%, a goal that has remained elusive for going on four years.
“Right now, I see the risks of inflation staying above target as skewed to the upside,” St. Louis Fed President Alberto Musalem told reporters Thursday. “My baseline scenario is one where inflation continues to converge towards 2%, providing monetary policy remains modestly restrictive, and that will take time. I think there is a potential for inflation to remain high and activity to slow. … That’s an alternative scenario, not a baseline scenario, but I’m attentive to it.”
The operative in Musalem’s comment is that policy holds at “modestly restrictive,” which is where he considers the current level of the fed funds rate between 4.25%-4.5%. Bostic was a little less explicit on feeling the need to keep rates on hold, but emphasized that “this is no time for complacency” and noted that “additional threats to price stability may emerge.”
Chicago Federal Reserve President Austan Goolsbee, thought to be among the least hawkish FOMC members when it comes to inflation, was more measured in his assessment of tariffs and did not offer commentary in separate appearances, including one on CNBC, on where he thinks rates should go.
“If you’re just thinking about tariffs, it depends how many countries are they going to apply to, and how big are they going to be, and the more it looks like a Covid-sized shock, the more nervous you should be,” Goolsbee said.
Many risks ahead
More broadly, though, the January minutes indicated a Fed highly attuned to potential shocks and not interested in testing the waters with any further interest rate moves. The meeting summary pointedly noted that committee members want “further progress on inflation before making additional adjustments to the target range for the federal funds rate.”
There’s also more than just tariffs and inflation to worry about.
The minutes characterized the risks to financial stability as “notable,” specifically in the area of leverage and the level of long-duration debt that banks are holding.
Prominent economist Mark Zandi — not normally an alarmist — said in a panel discussion presented by the Peter G. Peterson Foundation that he worries about dangers to the $46.2 trillion U.S. bond market.
“In my view, the biggest risk is that we see a major sell off in the bond market,” said Zandi, the chief economist at Moody’s Analytics. “The bond market feels incredibly fragile to me. The plumbing is broken. The primary dealers aren’t keeping up with the amount of debt outstanding.”
“There’s just so many things coming together that I think there’s a very significant threat that at some point over the next 12 months, we see a major sell-off in the bond market,” he added.
In this climate, he said, there’s scant chance for the Fed to cut rates — though markets are pricing in the potential for a half percentage point in reductions by the end of the year.
That’s wishful thinking considering tariffs and other intangibles hanging over the Fed’s head, Zandi said.
“I just don’t see the Fed cutting interest rates here until you get a better feel about inflation coming back to target,” he said. “The economy came into 2025 in a pretty good spot. Feels like it’s performing well. Should be able to weather a lot of storms. But it feels like there’s a lot of storms coming.”
Walmart stock may be a steal.
Former Walmart U.S. CEO Bill Simon contends the retailer’s stock sell-off tied to a slowing profit growth forecast and tariff fears is creating a major opportunity for investors.
“I absolutely thought their guidance was pretty strong given the fact that… nobody knows what’s going to happen with tariffs,” he told CNBC’s “Fast Money” on Thursday, the day Walmart reported fiscal fourth-quarter results.
But even if U.S. tariffs against Canada and Mexico move forward, Simon predicts “nothing” should happen to Walmart.
“Ultimately, the consumer decides whether there’s a tariff or not,” said Simon. “There’s a tariff on avocados from Mexico. Do you have guacamole with your chips or do you have salsa and queso where there is no tariff?”
Plus, Simon, who’s now on the Darden Restaurants board and is the chairman at Hanesbrands, sees Walmart as a nimble retailer.
“The big guys, Walmart, Costco, Target, Amazon… have the supply and the sourcing capability to mitigate tariffs by redirecting the product – bringing it in from different places [and] developing their own private labels,” said Simon. “Those guys will figure out tariffs.”
Walmart shares just saw their worst weekly performance since May 2022 — tumbling almost 9%. The stock price fell more than 6% on its earnings day alone. It was the stock’s worst daily performance since November 2023.
Simon thinks the sell-off is bizarre.
“I thought if you hit your numbers and did well and beat your earnings, things would usually go well for you in the market. But little do we know. You got to have some magic dust,” he said. “I don’t know how you could have done much better for the quarter.”
It’s a departure from his stance last May on “Fast Money” when he warned affluent consumers were creating a “bubble” at Walmart. It came with Walmart shares hitting record highs. He noted historical trends pointed to an eventual shift back to service from convenience and price.
But now Simon thinks the economic and geopolitical backdrop is so unprecedented, higher-income consumers may shop at Walmart permanently.
“If you liked that story yesterday before the earnings release, you should love it today because it’s… cheaper,” said Simon.
Walmart stock is now down 10% from its all-time high hit on Feb. 14. However, it’s still up about 64% over the past 52 weeks.
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