December CPI Preview: Inflation Data Expected to Show the Challenging Last Mile of Disinflationary Path

The US December CPI data, due to be released by the Bureau of Labor Statistics at 8:30 ET on Thursday, is expected to show a reversal of the cooling trend in headline inflation. Economists polled by Bloomberg expect headline CPI to increase 0.2% in December, boosting the annual pace to 3.3% (vs. 3.1% prior). The monthly pace of core inflation likely held steady at 0.3%, with the year-over-year change falling to 3.8% (vs. 4.0% prior).

Gasoline prices rose modestly on a seasonally adjusted basis, halting the primary source of headline disinflation since September. Deflation in core-goods prices continues weighing on headline and core, but if firms are successful in destocking inventory, that source of disinflation will abate in months ahead. Ultimately, core CPI inflation will likely prove sticky above the Fed's 2% average inflation target through 2024, even as the pace of housing inflation slows.

1. Energy prices: Barclays expected energy prices to have modestly added to inflation in December on a seasonally adjusted basis. Retail gasoline prices' seasonal factor for December implies that prices likely increased by about 0.4%. It was partly offset by lower natural gas prices, as weak weather-driven demand due to milder temperatures persisted into early December. Taken together, Barclays estimated energy to have added 5bp to December CPI % m/m, versus a 15bp drag in November.

2. Food prices: The FAO Food Price Index stood at 118.5 points in December 2023, down 1.8 points (1.5 percent) from its November level, as decreases in the price indices for sugar, vegetable oils and meat more than offset increases in dairy products and cereals. The index stood 10.1% below its corresponding level one year ago. Sugar prices plunged, mainly driven by the strong pace of production in Brazil, bolstered by conducive weather conditions.

3. Auto prices: Considering Manheim's Used Vehicle Value Index and CarGurus's index, used car prices are expected to decline by 1.1%. According to Goldman Sachs, new car prices are likely to fall 0.2%, as promotional dealer incentives continued to rise in December. Looking ahead, GS expected new and used car prices to decline by 1.3% and 7.0% respectively this year, reflecting normalizing auto production, higher inventories, and higher new vehicle incentives.

4. Rent: Goldman Sachs forecasted both rent and OER to increase by 0.45%, as the gap between rents for new and continuing leases continues to close.Rent growth for new tenants has slowed from 5.7% in 2022 to only 0.6% in November, and it may translate into a slower pace of shelter inflation in 2024. GS expected shelter inflation to run at a monthly pace of 0.25-0.30% by 2024H2.

However, we need to be wary that the number of cities with falling rents is decreasing; this, combined with previous record high prices for existing and new homes, poses a risk of reflation.

5. Traffic services: Firm inflation in categories like motor vehicle insurance and a rebound in airfares may boost continued strength in transportation services. Airfares havetypically declined only 2-3% NSA in December in the pre-pandemic era. However, travel website Hopper suggests that December fares are likely to have risen 3% m/m NSA, amid the rush for last-minute bookings.

■ The CPI is likely to see a smaller increase in January despite the temporary rise in December.

A solid decrease in the used vehicle CPI in January shown by JD Power, as well as another decline in gasoline prices, will likely lead to predictions of smaller increases in the January CPI. UBS projects the headline CPI to rise 12bp in January (seasonally adjusted) and the core CPI to rise 18bp. These monthly increases imply that 12-month headline CPI inflation would drop to 2.9% in January while the core CPI would edge down to 3.7% — both the lowest they have been since the spring of 2021.

■ Still, could medium-term CPI be sticky after January?

Although for the United States, which is highly dependent on import products, the Import Price Index has been negative for 10 consecutive months, the decline has gradually narrowed to the lowest level since February. This reflects that the destocking process of many products may be nearing its end, and there could be less room for core inflation (except cars) to continue to decline.

The ISM Services PMI Prices Index registered 57.4 percent in December. Eleven services industries reported an increase in prices paid during the month of December, including Retail Trade, Health Care & Social Assistance, Construction, and Educational Services. This could feed into core services inflation and keep it elevated.

■ Will the December CPI change the Fed's trajectory?

UBS's analyst Alan Detmeister noted that even if the December CPI surprises to the upside of consensus, it won't alter the tone of the FOMC. Inflation has slowed notably faster than the FOMC was thinking over the summer, and it will take far more than one strong CPI print to change that. More importantly, he expected the 12-month change in the Fed's preferred core PCE inflation measure would step down roughly 13bp, which would see it decline from 3.2% to about 3.0% when the December data is brought in. The larger step down in core PCE inflation compared to core CPI inflation is a result of different base effects and the smaller weight of rents in PCE prices.

However, if inflation is sticky in 2024, the debate about whether the Fed could be forced to raise its inflation target is likely to be brought up again. Goldman Sachs and UBS both forecast that the headline CPI at the end of the year may still be 2.9%; the current inflation level is no longer far from the year-end target.

CME FedWatch showed that the probability of the Fed cutting interest rates is 62.7% in March and 93.64% in May, whereas Barclays expects the first rate cut to start in June, so the market may have priced in a rate cut too early. If inflation falls at a slower pace, it may force the Fed to keep interest rates at the current level for longer, and it will also cause investors to adjust the target price of treasury yields in the short term. Therefore, even if the December CPI data does not change the general direction of the Fed for now, it will likely give a warning to the unusually optimistic investors.