CPI inflation is low, but services are still on the rise; S&P 500 rally paused

CPI inflation fell faster than expected in December. However, core inflation, which excludes food and energy, only slowed in line with expectations amid stubborn service inflation. The S&P 500 rose late Thursday morning The work of the stock marketFluctuating between losses and light gains after the release of the consumer price index.




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CPI inflation eased to 6.5% from 7.1% in the previous month versus Wall Street’s forecast of 6.6%. The Consumer Price Index declined by 0.1% during the month versus the flat reading expected.

Core CPI increased by 0.3% from November levels as expected. The annual core inflation rate eased to 5.7% from 6%. Core CPI inflation peaked at 6.6% in 40 years in September.

Also Thursday, the Labor Department reported that new claims for unemployment benefits fell by 1,000 to 205,000 in the week ending Jan. 7, indicating that layoffs have yet to rebound on a large scale.

The Fed is likely to continue to step back from its pace of rate hikes to just a quarter of a point with its next policy move on February 1. The odds of a rate hike of only 25 basis points. jumped to 93% after the consumer price index, up from 77%.

How far the Fed continues to rise after that will depend less on the consumer price index than wage growth, which is central to the service sector inflation outlook. The good news for the markets that sparked the S&P 500’s latest rally attempt is that wage growth showed a surprising slowdown in December.

goods vs. Spending services

Commodity price inflation, excluding food and energy, has slowed from double-digit increases earlier in the year. This progression continued into December. Commodity prices fell 0.3% during the month. This lifted the year-on-year inflation rate to 2.1% from 3.7% in November.

Price inflation for non-energy services, which affects 56% of consumer budgets, has not begun to subside. Prices for basic services rose 0.5% in the month and 7% year-on-year, compared to 6.8% in November. However, that is due in part to the way the Labor Department calculates housing inflation. While new rates for residential rents have been declining for months, it takes about a year for that to be fully reflected in renewable leases and the consumer price index.

However, prices for services excluding shelter rose 7.4% from a year ago. This includes prices for energy services, which were up 15.6% from a year ago. Excluding energy and shelter, utilities prices increased about 6.2% from a year ago.

S&P 500 reaction to the CPI report

The S&P 500 was up less than 0.1% at around 10:55 a.m. ET, showing little direction. The Dow Jones Industrial Average rose 0.4%, while the Nasdaq Composite fell 0.1%.

Meanwhile, the 10-year Treasury yield fell 2 basis points, to 3.53%.

The latest rally for the S&P 500 from its mid-October lows got another jolt of energy on Jan. 6, when unexpected wage inflation data sparked hope that the Federal Reserve might moderate its rate hikes before they implode the economy.

A rally triggered by the jobs report lifted the S&P 500 within 0.4% of its 200-day moving average. The past two attempts at the rally have stumbled around this level, but this one may have some legs.

The S&P 500 finished 13.7% above Wednesday’s October 13 bear market low, but still 17.6% below its all-time closing high.

Be sure to read IBD’s The Big Picture Every day to stay in sync with the market trend and what it means for your trading decisions.

Details of the CPI inflation report

Used car and truck prices fell 2.5% during the month and are now 8.8% lower than year-ago levels. New car prices decreased by 0.1% compared to November, while the annual price increase eased to 5.9% from 7.2% in the previous month.

Energy prices fell 4.5% month over month, while the annual increase eased to 7.3% from 13.1% in November.

Food prices rose 0.3% in the month, as the annual increase slowed to 10.4% from 10.6%.

Principal resident rent and owner’s equivalent rent were up 8.3% and 7.5% from last year, respectively. Both were up 0.8% for the month.

Prices for transportation services increased by 0.2% in the month and 14.6% from a year ago.

Prices for medical services increased by 0.1% during the month, after declining by 0.7% and 0.6% in the previous two months. That left the annual increase at 4.1%.

Powell Fed shifts focus from CPI to wages

A further drop in CPI inflation could allow the S&P 500 to continue moving higher, but it won’t be the catalyst.

Wage growth has become key to the Fed’s policy outlook, so investors have yet to celebrate December jobs report It showed a surprising downward turnaround in the fourth quarter. Average hourly earnings were up 4.6% from a year ago, below forecasts of 5%, kicking off the current S&P 500 rally. Wage growth has now fallen to the lowest level since August 2021, down a full percentage point from its March peak.

With wages growing at an annualized rate of 4% in the fourth quarter, wage growth appears to be easing to move closer to Fed Chair Jerome Powell’s target of 3.5%. Factoring in productivity growth of about 1.5%, wage growth of 3.5% could bring inflation close to the Fed’s 2% target.

The most important inflation rate in the future is Personal consumption expenditures services less energy and housingPowell says. Commodity price inflation is waning and the same is likely to happen to housing inflation in 2023, given market rents have stalled. But inflation in non-energy services, excluding housing, is likely to remain high as long as wage growth remains high.

Housing accounts for more than 30% of the CPI and 40% of the core CPI, but it only makes up 15% of the broader PCE basket.

Health care spending in the CPI excludes the bulk of the expenditure: spending covered by employers and government programs. Moreover, recent declines in medical services prices in the CPI reflect outdated data on insurance company earnings. By contrast, health care inflation in personal consumption expenditures is on the rise amid rising labor costs. Also, foods consumed in restaurants, which continue to experience high inflation rates, are excluded from the core CPI but are grouped under core PCE services.

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