CICC: The Federal Reserve is highly likely to skip interest rate cuts in January, with a possibility of cuts in March

According to the Zhitong Finance APP, CICC released a research report stating that the core CPI in the U.S. for December rose by 0.2% month-on-month, down from 0.3% last month, and year-on-year from 3.3% to 3.2%, both lower than market expectations. The non-rent service inflation (supercore), which the Federal Reserve is most concerned about, has declined, while core goods and rent inflation remain moderate, showing no signs of re-acceleration. Despite strong non-farm employment last Friday, inflation continues to slow, indicating that the economy is not showing signs of overheating. This is good news. U.S. Treasury yields fell, and U.S. stocks rebounded. The previous judgment is maintained that the U.S. is likely to achieve a "Goldilocks" economy, and the market may have overestimated the upside risk of U.S. inflation. The Federal Reserve is likely to skip interest rate cuts in January, with the possibility of cuts still in March. The view that there may still be two rate cuts in the first half of the year remains unchanged.

CICC's main points are as follows:

The backdrop of this inflation data release is the stagnation in the decline of core inflation since the fourth quarter, with the market concerned that last week's strong non-farm employment and service sector vitality may bring potential inflation risks back up. However, the data shows that December's inflation is mild, with a core CPI year-on-year of 3.2%, lower than the market expectation of 3.3%, and an overall CPI year-on-year of 2.9%, in line with market expectations. The seasonally adjusted core CPI month-on-month slowed from 0.3% last month to 0.2%. The annualized growth rate over three months fell from 3.7% to 3.3%. These factors help alleviate market concerns about the Federal Reserve possibly not cutting rates this year or doing so very late. After the data was released, market sentiment improved, U.S. Treasury yields fell across the board, and the three major U.S. stock indices rebounded strongly.

From a breakdown perspective, the core service (supercore) price increase, which the Federal Reserve is most concerned about excluding rent, broke the stagnation of not being lower than 0.3% for the past four months, falling to 0.2%. Looking at the annualized rate over the past three months, non-rent core service inflation is at 3.5%, down from 4.3% in the previous two months. Although affected by rising energy prices, the increase in airfare (3.9%) remains high, but the price growth of healthcare (0.2%) and educational services (0.2%), which are more related to strong non-farm employment growth, is relatively mild. Combined with the hourly wage growth from last week's non-farm report, which has also slowed both year-on-year and month-on-month, the current labor market does not constitute a source of inflation rebound.

The increase in core goods prices fell from 0.3% last month to 0.1%, showing no signs of re-acceleration. The month-on-month growth rates for new cars (0.5%) and used cars (1.2%) have decreased compared to last month but remain in a rapidly rising range, possibly continuing to be influenced by the replacement purchases of damaged vehicles after Hurricane Milton in October. The January wildfires in Los Angeles may also provide some support for the replacement demand for damaged vehicles, thereby increasing price stickiness. However, even so, other core goods inflation continues its downward trend, with prices for televisions (-0.5%), audio equipment (-3.8%), sports goods (-0.4%), toys (-1.0%), computers (-0.9%), and smartphones (-1.7%) continuing to decline for several months, and the price increase for furniture and appliances has turned from an increase of 0.7% last month to a decrease of 0.2%. There is currently no clear evidence of price increases due to concerns about potential future tariffs imposed by the Trump administration Housing rents rose by 0.3%, which is relatively mild, while hotel prices saw a decline. The rental prices for primary residences and the equivalent rents set by landlords both rebounded slightly from last month's 0.2% to 0.3%. However, since the fourth quarter, overall rent inflation has cooled compared to the previous high growth rate of 0.4% and above. In December, hotel prices fell by 1.2% after rising by 3.7% month-on-month in November.

The above data indicates that strong employment and mild inflation can coexist, and the market may have overestimated the upward risk of inflation in the United States. In the annual report, it is believed that as supply gradually improves, the U.S. is likely to achieve a "Goldilocks" economy, characterized by neither excessive inflation nor high unemployment, moving towards a balanced state. The inflation data for December supports this view. Looking ahead, as the supply and demand in the real estate and labor markets tend to balance, global production capacity is abundant, and the inflation pressure on goods is limited, the likelihood of a resurgence of inflation similar to that in 2022 is low. The market may have overestimated the upward risk of inflation in the United States while underestimating the challenges faced by global cyclical recovery under high interest rates, a strong dollar, and potential tariff uncertainties.

Mild inflation leaves room for the Federal Reserve to cut interest rates, with the possibility of two rate cuts in the first half of the year. Due to the strong non-farm payroll data released last Friday, which shows that the labor market is stabilizing, the Federal Reserve does not need to cut rates again in the short term. Considering that Powell has already provided guidance to slow the pace of rate cuts at the December FOMC meeting, it is highly likely that the Federal Reserve will skip a rate cut in January. However, if inflation can further ease, the Federal Reserve may still restart rate cuts in March and lower rates again in the second quarter. The forecast in the annual report is that the federal funds rate will be reduced to a neutral level of 3.75% to 4% by the end of the second quarter, and this view remains unchanged