Fed’s rate cuts may slow with higher inflation

The 0.5% monthly rise in US headline CPI for January was two tenths above expectations, with the core rate a tenth above at 0.4%. These may seem like small margins, but to a market that is, once again, hugely sensitive to upside inflation surprises, the miss was sufficient to crater the bond market and strip more Fed easing out of the fed funds futures market. But there are mitigating factors.

The first is that data in the early part of the year, and particularly January, can be subject to upside bias as firms make annual price increases at the start of the year. We have been through this before with the CPI data, as strong early-year data has given way to moderation. Of course, we can’t be sure that it will happen again, but some of the large increases in the January data, like car insurance, do seem to lend themselves to this explanation.

A second factor to bear in mind is that the annual revision of seasonal adjustment factors was carried out, and this showed a better trend in inflation through the second half of last year than previously thought. Admittedly, it was modest. And admittedly, the overall level of inflation is unaltered by these seasonal adjustment changes. But the Fed may be relieved that the trend in the second half of last year was a bit better than thought, provided the January surge proves a one-off.

But is it likely to be a one-off? For while there might be some reasons why January saw an elevated rise, the outlook is not necessarily much better. For a start, if prices were elevated a bit in January as firms looked to push through hefty early-year increases, it may suggest that so-called ‘price gouging’ is still alive and well. If you remember, the Biden administration was very alert to this issue, and Kamala Harris put a big focus on stopping price gouging by firms in her presidential election pitch. We have not heard the same sort of things from the Trump campaign or the Trump administration to date.

In fact, we could legitimately argue here that much of the focus has been on getting consumers to pay more because of tariffs, not less. But even if the tariff threat comes to nothing, which we doubt, there’s still a sense in our mind that the administration won’t clamp down on price hikes in the same way as we’ve seen before and as much as we would have seen under a Harris administration.

Another worrying point is that inflation expectations are creeping higher in both market pricing and, in some cases, amongst consumers. The latter could reflect the fact that consumers are resigned to higher prices and hence could be acquiescent if US firms try to push any tariff increases onto households and other businesses.

One final factor that we’d mention, which is related to tariffs, is that global supply chains could be disturbed somewhat, if not fractured by the Trump Administration’s policies, even if tariffs are not introduced. We know from the post-pandemic surge in inflation that compromised supply chains can make prices surge. But why might that happen again now?

To see this, take the USMCA, the trade deal agreed between the US, Mexico and Canada that allows free trade – or at least free trade up until the point that Trump decides to rip it up. Even if this does not result in tariffs, the fact that Trump can rip up trade deals that he himself agreed is bound to make firms question the reliability of many existing supply lines. And if these supply lines are rearranged to account for such risks there is a strong likelihood that it will come at a cost of higher inflation.

The bottom line, in the Standard Bank’s view is that the January CPI data might not be as bad as first blush, but this does not mean that the outlook is much better. It continues to believe that 10-year treasury yields will scale 5% this year and that the Fed will stay on hold for virtually all of the year.