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Core Inflation Eases in December, Here’s Where the Fed Rate-Cut Odds Stand

Favorable inflation data, renewed rate cut hopes, and strong Q4 earnings from the big banks saw Wall Street surge on Wednesday.

Core inflation in the US cooled more than expected in December, sparking optimism about the Federal Reserve’s path for interest rates in 2025. The Consumer Price Index (CPI), excluding the volatile food and energy categories, rose by just 0.2% for the month, bringing the year-over-year core inflation rate down to 3.2%, slightly below forecasts of 3.3%. This marks a notable deceleration from the previous month and offers hope that inflationary pressures are gradually subsiding.

Stock markets cheered the news, with major indexes surging on the back of the data. The S&P 500 Index (SPX) climbed 1.83%, the Dow Jones Industrial Average (DJI) rose 1.65%, and the NASDAQ Composite (IXIC) led the rally with a 2.45% gain. The small-cap-focused Russell 2000 Index (RUT) also posted a strong 1.99% increase, reflecting widespread optimism among investors.


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Decoding the Inflation Data

The Bureau of Labor Statistics (BLS) reported that overall CPI rose 0.4% in December, matching expectations and lifting the annual headline inflation rate to 2.9%. Energy prices, driven by a 4.4% surge in gasoline costs, were a significant contributor, accounting for nearly 40% of the monthly increase. Meanwhile, food prices rose by 0.3% for the month, contributing to a 2.5% year-over-year gain in the category.

Shelter costs, which comprise a significant portion of the CPI, increased 0.3% monthly and 4.6% annually—the smallest annual rise since January 2022. This moderation in shelter inflation, a persistent driver of core inflation, is a positive signal. Transportation services and used vehicle prices saw notable monthly increases, offset by declines in other categories, such as lodging away from home, which fell 1%.

Consumer Price Index core inflation chart.
12-month percentage change, Consumer Price Index chart. (Source: US Bureau of Labor Statistics)

Ellen Zentner, chief economic strategist at Morgan Stanley (NYSE: MS) Wealth Management, stated:

“Today’s CPI may help the Fed feel a little more dovish. It won’t change expectations for a pause later this month, but it should curb some of the talk about the Fed potentially raising rates. And judging by the market’s initial response, investors appeared to feel a sense of relief after a few months of stickier inflation readings.”

Markets Surge on Big Bank Earnings

The favorable inflation report, coupled with robust fourth-quarter earnings from major financial institutions like JPMorgan Chase (NYSE: JPM), Wells Fargo (NYSE: WFC), and Goldman Sachs (NYSE: GS), further boosted market sentiment. Wells Fargo surged 6.69% after exceeding profit expectations, and Goldman Sachs jumped 6.02% following its best quarterly profit since 2021. JPMorgan also saw a 2% rise, buoyed by record annual profits as market activity rebounded.

Treasury yields reacted sharply, with the 10-year yield falling to 4.65% after peaking at a 14-month high earlier this week. Lower yields typically enhance the appeal of equities, particularly growth-focused sectors like technology, which benefited from the Nasdaq’s outsized gains.


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Fed’s Next Move and Rate Cut Odds

The Federal Reserve, which uses the Personal Consumption Expenditures (PCE) Price Index as its preferred inflation gauge, will closely scrutinize the December CPI report alongside other economic indicators. According to Pantheon Macroeconomics, the core PCE index, projected to show a 0.2% monthly rise in December, is expected to remain steady at an annual rate of 2.8%.

Market participants are now pricing in a near-certain pause in rate changes at the Fed’s January meeting, with the CME FedWatch Tool indicating a 68% probability of a rate cut by June. Odds for two cuts by year-end have also risen to nearly 50%, reflecting growing confidence in the Fed’s ability to navigate a soft landing for the economy.

According to the CME FedWatch Tool, here’s how the current rate cut odds sit:

  • January: 2.7%
  • March: 28.2%
  • May: 38.6%
  • June: 44.6%

Sal Guatieri, a senior economist at BMO Capital Markets, noted:

“There’s still more inflation-fighting work for the Fed to do.”

Guatieri added that the softer-than-expected core inflation data would provide the Fed with breathing room as it awaits further details on President-elect Trump’s economic policies, writing:

“[The Fed] may not resume cutting rates until it gets some clarity on the inflation pass-through of the tariffs that could begin rolling out next week.”

Broader Economic Outlook

Despite the positive inflation trajectory, challenges remain. Wage growth has lagged, with inflation-adjusted hourly earnings declining 0.2% in December and posting a modest 1% annual increase. Additionally, concerns about incoming policies from the Trump administration, including potential tariffs and stricter immigration measures, could pose inflationary risks.

Nonetheless, analysts are encouraged by the overall direction of the data.

Stephen Massocca, senior VP at Wedbush Securities, commented:

“The CPI number and the PPI number – they’re not super cool, but they’re certainly not hot – and certainly it leads one to believe that the embers of inflation are dying.”

The December CPI report has provided much-needed relief as Wall Street eyes the Fed’s next moves and the broader economic landscape. With core inflation moderating and market sentiment improving, investors remain cautiously optimistic about the year ahead.


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Disclaimer: Wealthy VC does not hold a position in any of the stocks, ETFs or cryptocurrencies mentioned in this article.

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