US CPI Preview: Amid Political Pressure, Fed Likely to Hold Through Q1 Unless Inflation Drops

US CPI KEY TAKEAWAYS:

• US CPI expectations: 2.7% y/y headline inflation, 2.7% y/y core inflation
• The DOJ’s subpoena of Fed Chairman Powell raises risks for Fed independence, though the central bank is still seen as likely to hold interest rates unless inflation falls dramatically in Q1.
• USD/JPY remains in a longer-term uptrend, tilting the odds of an upside breakout above 158.00 if inflation comes in above expectations.

When is the US CPI report?

The US CPI report for December will be released at 8:30ET (13:30 GMT) on Tuesday, January 13.

What are the US CPI Report Expectations?

Traders and economists are projecting both headline and core (ex-food and -energy) CPI to come in at 2.7% y/y. This reading, if seen, would match the headline price pressures seen last month and represent a 0.1% uptick from last month’s core CPI reading.

US CPI Forecast

As numerous Federal Reserve officials have noted in recent weeks, monetary policy is in a precarious position with inflation still above the central bank’s 2% target and signs that the labor market is cooling off.

Broadly speaking, US consumer inflation has seen its decline toward the Fed’s 2% target stall for well over a year now, with headline CPI readings stuck between the 2.3% and 3.0% y/y range for that period. Meanwhile, Core CPI, which filters out more volatile food and energy prices to better show the underlying trend in prices, remains stubbornly in the mid- to upper-2% range as well.

Despite this prolonged period of above-target inflation, the Fed’s concerns about the jobs market are still seen as more urgent and accordingly the Fed Funds rate is expected to fall further this year, though the implied probability of another cut by the central bank’s March meeting is only about 25% (markets are pricing in a hold with high confidence at the Fed meeting later this month):

Source: CME FedWatch

This weekend’s news that the Department of Justice has subpoenaed Fed Chairman Powell raises further risks for the Fed’s independence, raising the (low) probability that President Trump will install a new Chairman at the central bank sooner rather than later. In that (still unlikely) scenario, we could see more aggressive interest rate cuts, regardless of current inflation numbers.

As many readers know, the Fed technically focuses on a different measure of inflation, Core PCE, when setting its policy, but for traders, the CPI report is at least as significant because it’s released weeks earlier. As we noted above, CPI has generally ticked lower so far this year, but it remains stubbornly above the Fed’s 2% target:

Source: TradingView, StoneX

Looking at the chart above, the “Prices” components of the PMI reports have started to roll over in recent months, but inflation nonetheless remains below where those readings would historically imply, hinting that there may be limited potential for inflation to fall toward 2% in the immediate term.

US Dollar Technical Analysis – USD/JPY 4-Hour Chart

Source: TradingView, StoneX

USD/JPY is in focus ahead of the CPI report. The pair typically sees the “cleanest” reaction to US data, and with USD/JPY testing previous resistance near the 158.00 level, a bullish breakout is in play if inflation comes in higher than anticipated.

Technically speaking, the pair remains in a longer-term uptrend, tilting the odds of an upside breakout (though readers should be wary of the potential for Japan’s MoF to intervene directly into the market if USD/JPY approaches 159). If inflation comes in cooler-than-anticipated, a pullback is possible as traders bring forward expectations of a Fed interest rate cut; in that scenario, a dip to 157.00 or lower is possible independent of any developments in Japan itself.

-- Written by Matt Weller, Global Head of Research

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