Will warmer inflation readings change the Fed’s course?

Inflation

On the inflation front, last Tuesday began with the release of U.S. productivity and costs, showing revised data for the third quarter. While economists were predicting no change, unit labor costs were revised downward to 0.8%. This was a large revision relative to the initial reading of 1.9%. Last Wednesday, the CPI report aligned with expectations, confirming that inflation continues to be stickier than the Fed’s target of 2%. However, the underlying components tell a more nuanced story. While food prices and used car prices increased more than expected at 0.4% and 2% respectively, other components showed signs of cooling. Most notably, owners’ equivalent rent increased just 0.2% on the month, its lowest reading since 2021.

Last Thursday’s PPI release mirrored CPI’s slightly warmer-than-expected results, at 0.4% on the headline number. However, PPI excluding food and energy was much more in line with expectations at 0.2%. Import and export prices were also slightly higher than expected. Given the warmer readings, the 10-year yield increased approximately 25 bps, closing the week at 4.4%.

Other key economic releases

As investors will shift focus on the Fed’s rate decision this week, three central banks announced rate cuts last week. The Bank of Canada (BOC) cut rates by 50 bps but signaled that they may slow the pace moving forward. The Swiss National Bank (SNB) surprised markets with a 50-basis-point rate cut, more than the expected 25-basis-point cut, aiming to support exporters and curb its strengthening currency. The European Central Bank (ECB) cut rates by 25 bps and signaled that more rate cuts were likely as they continue to tackle inflation and weak growth prospects. The dollar broadly strengthened last week given central bank rate decisions, uncertainty about the Fed’s path with warmer inflation readings, and overall concerns regarding the incoming administration’s tariff plans.

Jobless claims were also released last week with initial claims at 242,000. This was well above the consensus estimate of 220,000 and closer to the level that would begin to worry economists (250,000). While inflation news dominated headlines, investors should watch this data point closely, as it has historically been a reliable leading indicator for what lies ahead. Given its volatility, the coming weeks will provide a clearer picture.

The week ahead

Investors will focus on the FOMC meeting this Wednesday. While it is likely that the Fed will cut rates by 25 bps, investors should pay close attention to the updated Fed forecast. There is also a plethora of other data set to be released, including S&P flash PMIs, retail sales, housing starts, revised GDP, and PCE.