Next CPI Inflation Report Could Improve 2025 Fed Rate Cut Expectations

January Jobs Report and Tariff Fears Impacted Financial Markets Ahead of Inflation Reports

The financial markets experienced a significant shake-up following the release of the January jobs report and growing concerns over potential U.S. tariffs. While the jobs report showcased a robust labor market, with 143,000 new jobs added and a drop in the unemployment rate to 4%, the broader economic context pointed to a week of strong data. The January ISM Manufacturing Index rose to 50.9, its highest level since September 2022, signaling renewed strength in the manufacturing sector. Similarly, the ISM Non-Manufacturing Index indicated continued growth in the services sector, albeit at a slightly slower pace. Weekly jobless claims remained low, and the JOLTS report highlighted 7.6 million open jobs in December, further underscoring the health of the labor market.

However, the positive economic data had an unexpected impact on financial markets. Equity and bond prices fell as investors began bracing for potential U.S. tariffs, which could disrupt global trade flows and economic growth. The dollar and bond yields rose, reflecting heightened uncertainty and risk aversion. Despite the strong jobs report and solid economic growth data, market participants seemed more focused on the potential risks ahead, including the possibility of new tariffs and the upcoming Consumer Price Index (CPI) inflation report. This report, scheduled for release on February 12, is expected to show easing year-on-year inflationary pressures, which could provide some relief to financial markets and influence Federal Reserve policy.

Waiting for This Week’s January Inflation Reports

The coming week’s economic calendar is packed with key growth and inflation reports, but all eyes are on the January Consumer Price Index (CPI) and Producer Price Index (PPI) inflation reports. These reports are expected to be more critical for markets and Fed policy expectations than the growth data. The CPI report, in particular, is anticipated to show a modest easing of year-on-year inflation rates due to base effects, which could alter investor sentiment and Fed policy outlook.

Inflation remains the Federal Reserve’s primary concern, with December’s year-on-year consumer inflation rates still elevated. The total CPI stood at 2.9%, while the core CPI, which excludes volatile food and energy prices, was at 3.2%. Similarly, the Personal Consumption Expenditures (PCE) inflation rates, the Fed’s preferred measure, were at 2.6% for the total PCE and 2.8% for the core PCE. Despite these elevated levels, Prestige Economics forecasts that the January CPI report could show a deceleration in year-on-year total CPI to 2.5% and core CPI to 3.0%. If this forecast holds, it could mark the beginning of a trend toward easing inflationary pressures in the first half of 2025.

Potential Consumer Inflation Impacts on Fed Policy

The Federal Reserve’s policy decisions are heavily influenced by inflation data, and the upcoming CPI report could play a pivotal role in shaping expectations for future interest rate cuts. The December Federal Open Market Committee (FOMC) projections indicated that Fed officials expect only two 0.25% rate cuts by the end of 2025. However, this outlook was influenced by the acceleration in year-on-year consumer inflation rates through November and December, which pushed market expectations for rate cuts even lower.

If the January CPI report shows easing year-on-year inflation rates, it could strengthen the case for more aggressive rate cuts in 2025. Prestige Economics believes that year-on-year total CPI and core CPI inflation rates could fall to the Fed’s 2% target by the end of 2025 due to base effects. If inflation continues to decelerate in the second quarter, market participants may be underestimating the potential for two or more rate cuts in 2025. However, it’s important to note that the Fed is not under immediate pressure to cut rates, given the solid economic growth outlook. The latest Atlanta Fed GDPNow forecast suggests that Q1 2025 GDP growth could be 2.9%, supported by strong job growth, manufacturing rebound, and solid economic data.

Future Inflation Report Implications and Risks for Financial Markets

Market expectations currently reflect a very low probability of an interest rate cut at the March Federal Reserve meeting. However, the odds of a rate cut in May or June could rise significantly if inflationary pressures ease in the coming months. This shift in expectations could have a positive impact on financial markets, with a weaker dollar and lower bond yields potentially supporting equity and bond prices.

Trade and tariff risks remain a significant source of uncertainty for markets in the near term. The potential imposition of across-the-board U.S. tariffs could disrupt global trade and create volatility in financial markets. However, if the January CPI report shows a meaningful deceleration in year-on-year inflation rates, it could offset some of these risks by creating a more favorable environment for risky assets. A decline in inflation could also reduce the upward pressure on bond yields, providing relief to bond markets.

Market Expectations and Interest Rate Outlook

The Federal Reserve’s policy path in 2025 remains highly uncertain, with much depending on the trajectory of inflation and economic growth. While the December FOMC projections pointed to only two 0.25% rate cuts by the end of 2025, there is a possibility that the Fed could cut rates more aggressively if inflation declines significantly. Prestige Economics suggests that the January CPI report could pave the way for three 0.25% rate cuts in 2025, especially if year-on-year inflation rates continue to ease in the second quarter due to base effects.

However, it’s important to remember that Fed forecasts often differ from reality, and the central bank’s policy decisions will be data-dependent. The solid economic growth outlook, coupled with the strong labor market, suggests that the Fed is not under immediate pressure to cut rates. Nevertheless, a 0.25% rate cut in May or June remains plausible, especially if inflation trends downward in the coming months. Investors will be closely watching the January CPI report for clues about the Fed’s next move, as well as any potential risks that could arise from trade and tariff uncertainties.

Conclusion: What’s Next for the Economy and Financial Markets?

The upcoming week’s economic data, particularly the January CPI report, will be a critical driver of market sentiment and Fed policy expectations. While the January jobs report and solid economic growth data have diminished the likelihood of a March interest rate cut, the potential for easing inflationary pressures in the first half of 2025 keeps the possibility of rate cuts alive. Investors will need to stay vigilant, as trade and tariff risks continue to loom large, creating uncertainty for financial markets.

In the near term, the January CPI report could provide much-needed clarity on the inflation trajectory and its implications for Fed policy. If the report shows a meaningful deceleration in year-on-year inflation rates, it could revive hopes for multiple rate cuts in 2025, providing a boost to equity and bond markets. However, if inflation remains elevated, market expectations for rate cuts could be dashed, leading to further volatility in financial markets. As the economic and policy landscape continues to evolve, staying informed and up-to-date on the latest data and analysis will be crucial for navigating these uncertain times.

What are your expectations for the January CPI report? Share your thoughts in the comments below. For more insights into the economy, financial markets, inflation, and Fed policy, be sure to subscribe to this channel and visit Prestige Economics and The Futurist Institute for additional content.