Slowing inflation eases upward pressure on borrowing costs, benchmark interest rate indicators retreat
The slowdown in U.S. core inflation growth in December led to a significant single-day drop in the 10-year Treasury yield, and market expectations for the number of rate cuts by the Federal Reserve this year have been revised upward. Although energy prices pushed up the overall CPI, the easing of core price pressures provided relief to investors. Federal Reserve officials stated that the process of fighting inflation is ongoing, but achieving the 2% target will still take time.
Key Points
- Data released by the U.S. Bureau of Labor Statistics on Wednesday showed that inflation slowed in December, easing market concerns about a rebound in price pressures and halting a more than three-month rise in borrowing costs.
- Excluding volatile food and energy prices, the core Consumer Price Index (CPI) rose 0.2% month-over-month in December, down from 0.3% in the previous month. As a result, the yield on the 10-year U.S. Treasury note, which had been climbing since late September due to heightened inflation concerns, fell 0.138 percentage points on Wednesday to 4.655%.
- Mohamed El-Erian, chief economic adviser at Allianz, said in a post on platform X: "The slowdown in core inflation will bring relief to many, which will push down U.S. Treasury yields and, unlike in recent months, exert downward pressure on global yields."
In-Depth Analysis
The Federal Reserve began its current rate-cutting cycle in September and has cut rates three times so far, lowering the target range for the federal funds rate by a full percentage point to between 4.25% and 4.5%. However, since the easing cycle began, the 10-year Treasury yield has risen by a percentage point, contrary to historical norms, as policymakers have faced resistance in pushing inflation back to the 2% target.
The inflation slowdown report released on Wednesday not only pushed yields lower but also prompted rate futures traders to raise their expectations for the number of rate cuts by the Fed this year. According to the CME Group's FedWatch tool, traders now see a 50% probability of at least one more rate cut this year, up from 35% previously.
New York Fed President John Williams said in a speech on Wednesday: "The disinflation process is still ongoing." But he cautiously added: "We have not yet reached the 2% target, and it will take more time to sustainably achieve it."
According to the Labor Bureau's data, energy prices rose 2.6% month-over-month in December, contributing more than 40% of the 0.4% monthly increase in the overall CPI (including energy). In addition, shelter costs, airline fares, used car and truck prices, and new car prices also rose.
Shelter costs, which are partly related to slowly changing rents, rose 4.6% in the 12 months through December. In contrast, prices for a few categories such as personal care, communications, and alcoholic beverages fell in December.
Another set of data released by the Labor Bureau on Tuesday showed that the Producer Price Index (PPI) rose 0.2% month-over-month in December, down from 0.4% in November and slower than market expectations. The PPI measures the prices businesses charge for their goods and services.
Chicago Fed President Austan Goolsbee said in a webcast interview on Wednesday: "I still see continued progress in (the Fed's fight against inflation)." He added: "It's important to take a long-term view of inflation. This is a noisy data series, so single-month data should be treated with caution, while multi-month data reflect trends, and the current trend is still improving."