December CPI Report Boosts Case for Fed Rate Cuts

The latest Consumer Price Index (CPI) report for December shows inflation is cooling faster than anticipated, strengthening the case for the Federal Reserve to lower interest rates.

While headline inflation rose 0.3% month-on-month, matching consensus forecasts, core inflation climbed only 0.2%, missing the 0.3% expectation. The data counters concerns of a potential 0.4% spike, which some analysts feared due to timing issues related to a government shutdown that may have distorted price discovery between November 2024 and November 2025.

Goods Prices Defy Tariff Fears

A closer look at the data reveals that prices for core goods remained remarkably stable, suggesting the inflationary impact from tariffs has been much weaker than predicted. Key categories often subject to import duties saw prices fall or stagnate:

• Appliances: -4.3% MoM

• Furniture: -0.4% MoM

• Used Vehicles: -1.1% MoM

• New Vehicles: 0.0% MoM

• Video and Audio Equipment: -0.4% MoM

This trend indicates that U.S. retailers may be absorbing tariff-related costs by squeezing their profit margins rather than passing them on to consumers.

However, some service sectors continue to experience price pressures. Primary rent and owners' equivalent rent both increased by 0.3%, while medical care services rose 0.4%. Transportation services saw a 0.5% increase, driven largely by a 5.2% jump in airline fares. Apparel and food prices also climbed, rising 0.6% and 0.7% respectively.

Fed Rate Cuts Remain on the Table

Overall, the inflation report is a positive development for policymakers. Fed Chair Jerome Powell has suggested that the impact of tariffs may peak in the current quarter. The surprisingly muted effect of these tariffs gives the central bank more room to maneuver.

With downward pressure from falling gasoline prices, slowing housing rents, and weakening wage growth, CPI is expected to continue its trend lower this year, potentially approaching the 2% target by year-end. This outlook makes two Federal Reserve rate cuts seem highly achievable, with risks skewed toward a third cut, especially given the cooling labor market.

Job Market Stagnation Clouds Economic Outlook

While inflation is easing, the jobs market presents a more concerning picture. ADP private payrolls data showed an average weekly increase of just 11,750 in the four weeks to December 20. This figure is consistent with the 50,000 monthly gain in non-farm payrolls reported by the Bureau of Labor Statistics (BLS).

Crucially, Fed Chair Powell has indicated that the Fed believes official payroll figures are being overestimated by around 60,000 per month. Factoring in this adjustment suggests the U.S. labor market is effectively stagnant.

Why Consumers Feel Left Behind

This weakness in the job market helps explain why consumer confidence remains low despite easing price pressures. Household affordability is becoming a major source of anxiety. Outside of government, leisure and hospitality, and private education and healthcare, all other sectors have lost jobs in seven of the last eight months.

This sentiment is further explained by BLS data on worker compensation. The proportion of economic growth flowing to workers through their pay has declined from 64% in the 1950s to less than 54% today. With the corporate sector capturing an increasing share of economic gains, it's clear why strong GDP growth and record-high stock markets are not translating into a sense of prosperity for many households.

Political Pressure Mounts Ahead of Mid-Terms

These underlying economic anxieties are shaping up to be a central theme in the upcoming November mid-term elections. In response, the Administration may increase efforts to generate positive economic headlines.

Potential measures could include capping credit card borrowing costs, improving mortgage availability and affordability, and removing some items from the scope of tariffs. Delivering the proposed $2,000 tariff dividend ahead of the elections will also be a key priority for the President.