Investors fear that inflation may have bottomed out in June 2023 and are bracing for a potential second wave of fast-rising prices in 2024 that could upend the Federal Reserve's plans for rate cuts and boost the likelihood of another recession.
The consumer price index — the market's preferred inflation measure — increased 3.3% from December 2022 to December 2023, the US Bureau of Labor Statistics reported Jan. 11. Year-over-year inflation growth peaked at nearly 9% in June 2022 and fell to just under 3.1% in June 2023, but inflation has been higher than that June low every month since, trending sideways for the second half of the year.
The decline in goods prices has stalled, rent and housing prices remain well above pre-pandemic levels, and ongoing strength in the labor market has kept wages elevated, keeping inflation growth from significantly moving toward the Fed's 2% goal. The lack of progress in getting substantial declines in progress may not trigger additional interest rate hikes from the Fed, but it will likely delay rate cuts later into the year, said Matthew Bush, a US economist at Guggenheim Investments.
"Right now, there's this belief by the Fed, by the market, that you can have this immaculate disinflation where the economy holds up just fine and inflation will get back to target," Bush said. "If we go a couple more months with inflation readings not showing continued progress, I think you're going to see a more aggressive Fed."
Heating up
The market odds of a rate cut from the Fed at its March meeting were just over 60% as of Jan. 11, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market.
While inflation is unlikely to skyrocket as it did in 2021 and 2022 on a combination of supply and demand shocks, it could heat up as wages rise and housing costs fail to tumble.
"I think there's a chance that inflation could re-ignite," said Patrick Horan, a macroeconomist with the Mercatus Center at George Mason University.
In December 2023, energy prices fell 2% from a year earlier, including fuel oil, which dropped 14.7%. Services, excluding those related to energy, increased 5.3%. Transportation services rose 9.7% from December 2022 to December 2023, including a 20.3% jump in motor vehicle insurance.
Shelter costs grew 6.2% year over year in December 2023, down from the peak of 8.2% in March 2023 but well above the 3.2% pre-pandemic growth in December 2019.
Inflation may remain relatively elevated in the coming months, potentially delaying any loosening of monetary policy from the Fed.
"The final yards were always likely to be the hard yards when it came to returning inflation to target," said Michael Hewson, chief market analyst with CMC Markets. "The idea that the Fed would look to cut rates in March was always an optimistic one, and it could be that markets will need to be patient when it comes to inflation edging closer to its 2% target."