An opportunity for the markets? The inflation report boosts expectations of rate cuts by the Fed.

The recent Consumer Price Index (CPI) report has sparked intense discussions about the future of the Federal Reserve’s (Fed) monetary policy in the United States.

The economy faces a complex situation: on the one hand, the data shows inflation that remains contained in some key aspects, but, on the other, certain signals generate uncertainty about how the Fed will manage inflationary risks and its full employment mandate in the coming months.

Recent figures from the CPI report

The Department of Commerce reported that the overall CPI rose 2.7% annually in November 2024, a slight increase from 2.6% in October and the highest level since July.

On a monthly basis, prices rose 0.3%, exceeding the 0.2% increase in the previous month. This increase occurred despite a 2.63% drop in gasoline prices, underlining that other sectors contribute to inflationary pressures.

As per core inflation, which excludes volatile components such as food and energy, it remained at 3.3% annually, matching Wall Street forecasts and marking its lowest level in three years. The monthly increase was also 0.3%, in line with forecasts and with the October figure.

Market reactions and expectations

The publication of the report generated immediate movements in financial markets. Futures linked to the S&P 500 recorded a gain of 25 points at the opening, while the Nasdaq gained 125 points. On the other hand, the yields on two-year and ten-year Treasury bonds fell slightly, standing at 4.126% and 4.232%, respectively. These movements reflect renewed confidence in a rate cut during the Fed meeting scheduled for next week.

The CME FedWatch Index, which measures market expectations for Fed decisions, showed an increase in the probability of a 25 basis point interest rate cut, from 86% before the report to 97.9% after its release. This contrasts sharply with the 65.3% seen in early November, reflecting a significant shift in investor sentiment.

Economic implications and risk factors

Seema Shah, global strategist at Principal Asset Management, noted that while the CPI report supports a rate cut, the persistence of certain inflationary pressures, such as housing prices, could lead the Fed to adopt a more cautious stance in 2025. According to Shah, the combination of a robust labor market and inflationary risks arising from policies of the next administration, such as trade tariffs proposed by President-elect Donald Trump, could force the Fed to reevaluate its approach.

In addition, the November jobs report reflected 227,000 new hires and 4% annual wage growth, beating Wall Street expectations. However, the unemployment rate rose to 4.2% and labor force participation declined slightly to 62.5%, signs that could temper the Fed’s urgency to act against inflation.

In essence, the November CPI report reaffirms the tension inherent in the Fed’s dual responsibility: ensuring price stability and maximizing employment. Although the data suggest that inflation is moderating, structural and political risks remain that could alter the economic outlook. Caution will be key for the Fed, which faces the challenge of balancing rate cuts with the possibility of an inflationary surge in an uncertain geopolitical and economic environment.

Next week’s decision could be crucial for markets, but also for overall confidence in the economy.

The central question is whether a more aggressive or prudent approach will be able to stabilize the economic system without sacrificing growth.

At this time of uncertainty, the onus is on monetary policymakers to make decisions that balance the short and long term.