SAN FRANCISCO (S&P Global Ratings) Jan. 13, 2025--At the beginning of 2025, the U.S. economy continues to be resilient, as indicated by a stronger-than-anticipated jobs market in December and running estimates of consumer spending for the same month. The three-month average of job gains rose to 170,000 in December (versus 113,000 in August when the Federal Reserve showed a strong preference to ease). Service sector price inflation remained elevated in December, as indicated by Institute for Supply Management (ISM's) price paid component for the services sector. Consumer price index (CPI) inflation likely rose 0.4% and 0.3% (headline and core, respectively) in December, resulting in the 2.9% (up from November's 2.7%) and 3.3% (unchanged from November) changes for the 12-month period. (The Federal Reserve's preferred inflation metric, the personal consumption expenditures deflator, also remains above target at 2.4%.)

Inflation and uncertainty about inflation forecasts were also front and center in the minutes from the December Federal Open Market Committee (FOMC) meeting, which suggested a "closer call" regarding the 25-basis-point (bp) interest-rate cut in the same month. FOMC members expressed concerns that the risks to the inflation outlook have significantly increased. The Fed policymakers' GDP growth, unemployment rate, and inflation outlooks were associated with an unusually elevated degree of uncertainty. Several members also observed that circumstances might warrant keeping the target range at its current value for longer than they currently anticipated. It is possible that the economy could evolve in a manner that would make further increases in the target range appropriate. On the other hand, several policymakers remarked that policy easing could take place more rapidly if labor market conditions deteriorated.

We anticipate no change to policy rate coming out of the next FOMC meeting at the end of January. As 2025 gets underway, if economic data keep surprising on the upside, our 75 bp rate cut penciled in for the year (in our November forecast update) will likely not materialize. The Fed may not have much more to do this year in such a scenario.

Additionally, the repairs and reconstruction efforts after the wildfires in the Los Angeles County are expected to add to inflation in the near term, while incurring substantial "balance sheet" costs for firefighting, property damage, and resident displacement. Reconstruction will add to economic activity, but opportunity costs in the form of money that would have been spent somewhere else (disruptions in other tangential sectors such as tourism and agriculture, for example) will hurt growth potential. The spillover effects to inflation would be directly through higher costs of material and labor to rebuild, higher rents in the local area, and the increased cost of property insurance over time. Situation remains fluid, still, with spillovers to the financial market are unpredictable at the moment. The estimated "balance sheet" costs continue to rise, and the fear is that there could be panicky moves based on (perceived or actual) bigger-than-expected loss in one corner of the market.

S&P Global Ratings today is publishing key upcoming data highlights for the U.S. and Canada while breaking down last week's releases.

What's Happening This Week

U.S.

Wednesday: December CPI; Thursday: December retail sales; Friday: December housing starts and building permits

• We expect December inflation to rise 0.4% month over month, up from the 0.3% gain in November, which would elevate year-over-year inflation to 2.9%, the highest level in five months. We expect core CPI to remain steady, advancing 0.3% month over month, resulting in a consistent year-over-year rate of 3.3%. This persistency in core CPI at the current level since last August is reflective of ongoing underlying excess inflationary impulse in the economy.
• Notably, the ISM services Purchasers Managing Index (PMI) price index surged to a 22-month high in December, while the manufacturing PMI price index saw a slight increase. Additionally, the decline in gasoline prices slowed further in December, contributing to a higher year-over-year headline inflation rate than in the previous month.
• According to the University of Michigan's consumer survey, one-year inflation expectations rose to 3.3% in January from 2.8% in December, exceeding the pre-pandemic range of 2.3%-3.0%. Long-term inflation expectations also increased to 3.3% from 3.0%.
• We anticipate a 0.5% month-over-month rise in December retail sales, following a 0.7% increase in November, driven primarily by higher auto sales. This trend indicates that U.S. consumers continued to spend during the holiday season, with particularly strong online spending.
• The National Retail Federation (NRF) reported that approximately 157.2 million consumers planned to shop on the last Saturday before Christmas, marking a 10.8% increase over the 2023 Super Saturday sales. The NRF also anticipates record levels of holiday spending in 2024.
• We expect housing starts to rebound to 1.32 million annualized units in December, following a decline to 1.29 million units in November. Conversely, building permits are anticipated to slip to 1.45 million units from 1.49 million in November. The U.S. housing sector remains sluggish due to rising mortgage rates, which have increased by more than 85 bps since September 19.

Why it matters

• Inflation has once again become a focal point in the Fed's policy adjustments. The recent increase in inflationary pressures, coupled with growing uncertainty surrounding tariffs and immigration policies, signifies a notable shift in the central bank's approach to monetary policy. This evolving landscape suggests that the Fed may need to reassess its strategies to effectively manage inflation while navigating the rising policy uncertainties.

Looking ahead

• Recent economic data shows enough growth momentum, which affords the Fed to slow down policy easing in the near term. The prospect of a rate cut has drifted by a wayside in recent weeks, given the strength of the labor market and rising upside risks to inflation. The balance of risks around our assumption for a quarterly 25-bp cut in the first three quarters (the first cut in March) has shifted towards less cuts than more. The futures market reflects this sentiment, pricing in a 41.4% chance of a 25-bp cut in September.

Last Week's Data Highlights

• The December U.S. jobs report exceeded expectations, with total nonfarm payrolls increasing by 256,000 jobs, following a gain of 212,000 in November. This brings the three-month average to 170,000 jobs. For the full year, employment rose by 2.23 million, which is 780,000 lower than the gains recorded in 2023.
• Employment growth in the second half of 2024 moderated to an average of 164,000 jobs per month from 207,000 in the first half. This trend indicates a gradual slowdown in the U.S. labor market, although employment levels remain comparable to pre-pandemic figures.
• In December, the manufacturing sector experienced a loss of 13,000 jobs after adding 25,000 in November. Over the course of 2024, the sector shed 87,000 jobs, contrasting with a gain of 26,000 jobs in the previous year. This decline reflects challenges faced by the manufacturing sector, particularly due to strikes at Boeing and the impact of hurricanes, which significantly affected employment, particularly in the fourth quarter.
• The unemployment rate unexpectedly decreased to 4.1% in December, remaining within the 4.1%-4.2% range throughout the second half of the year. The labor force participation rate held steady in 2024, fluctuating between 6.5% and 6.6%, which is 50 bps lower than pre-pandemic levels in 2019.
• In Canada, labor market data surpassed expectations, with employment rising by 91,000 in December after an increase of 51,000 in November, marking the largest monthly job gains in two years. This brings the total employment increase for the fourth quarter to 156,000, the highest since the first quarter of 2023.
• The goods-producing industries in Canada added 23,000 jobs in December, recovering from a loss of 21,000 jobs in November, particularly in the manufacturing sector. In contrast, the services sector has consistently outperformed the goods sector in the past five months, contributing a cumulative 210,000 jobs since August. This suggests that larger rate cuts by the central bank may have boosted employment in the services sector.
• The unemployment rate in Canada edged down to 6.7% in December, following a rise to 6.8% in November, though it remains over a percentage point higher than a year ago. Job openings are also significantly below levels from a year ago but are in line with pre-pandemic figures.
• Average hourly earnings growth in Canada slowed to 3.8% year over year in December from 4.1% in November.