Market Wire - Generational surge in prices leaves Fed policy expectations unmoved.

Karl Schamotta, Chief Market Strategist, kschamotta@cambridgefx.com

US consumer prices climbed 7 percent in December relative to the same month last year, recording the fastest annual increase since 1982 as tight labour markets, disrupted supply chains, and rocket-fuelled consumer spending helped lift inflation to levels not seen in the median American’s lifetime. Data released by the Bureau of Labor Statistics this morning showed a 0.5 percent seasonally-adjusted month-over-month increase in the headline consumer price index in December - a number that precisely matched market expectations, but could prove politically important as hyperbolic headlines put pressure on the Federal Reserve and the Biden administration to dampen price growth.

Shelter and vehicle costs were the biggest contributors: Indexes for rent and owners’ equivalent rent both rose 0.4 percent - the same pace recorded in November - while prices for used cars and trucks climbed 3.5 percent in the month, after 2.5 percent increases in each of the prior two months. Apparel prices leapt 1.7 percent in the month.

Typically-volatile categories slumped: Food price increases weakened, rising 0.5 percent in December after jumping 0.9 and 0.7 percent in October and November. The energy index snapped a sustained series of gains, falling 0.4 percent as gasoline and natural gas prices tumbled.

Core price growth accelerated: The less-volatile core measure, which excludes food and energy costs, rose 0.6 percent in December, up 5.5 percent on a year-over-year basis - the fastest move since 1991. Markets expected a 5.4 percent increase.

But price pressures didn’t broaden: Non-energy services prices rose 0.3 percent, down from 0.4 percent recorded in the prior month, and well below levels that would indicate a more fundamental shift in long-term inflation expectations among the general public.

Implications for Fed policy are limited: At yesterday’s confirmation hearing, Federal Reserve Chair Jerome Powell acknowledged the “severe threat” posed by rising prices, but said that pressures should subside as the pandemic eases. He warned low workforce participation could “be an issue going forward for inflation, probably more so than these supply-chain issues,” while setting the stage for at least three interest rate increases over the course of the year. His comments did little to shift market-implied odds on a rate hike in March, which are currently sitting around the 80-percent threshold.

And the dollar is softening: Treasury yields and equity markets remained stable after the release, and risk-seeking behaviour continued in the currency markets, with traders piling into bets on rate-sensitive and commodity-linked currencies as the “reflation trade” enters another phase.