Inflation risks keep the Fed on edge

The November CPI report aligned with consensus expectations, likely confirming a Fed policy cut next week. Nevertheless, with monthly core inflation hitting its strongest rate since the inflation scare of early 2024, price pressures are hardly settling at a level that the Fed can be completely at ease with. The Fed will be concerned by the very stubborn nature of inflation and will be increasingly cautious about the upside inflation risks that President-elect Trump’s policies may bring. As a result, we expect the Fed to adopt a more cautious tone beginning next year, slowing its pace of cuts to just every other meeting.

Report details

• Monthly headline inflation rose 0.3% in November, as expected, bringing the annual rate to 2.7%—from 2.6% prior. Meanwhile, core inflation, which strips out food and energy, also came in as expected, increasing 0.3% in the month, leaving the annual rate unchanged at 3.3%. The recent run-rate of monthly inflation has continued to remain firm, however, as the three-month annualized pace of core inflation rose to 3.7%—from 3.6% prior, the fourth consecutive monthly acceleration.
• Food prices rose 0.4% in the month, close to the highest level seen in the past two years, with four of the six major grocery store food group indices notching an increase. Meanwhile, energy prices rose 0.2% as fuel prices rebounded, despite a decrease in electricity prices. The rise in both food and energy prices contributed about 21% to the monthly headline rise in inflation.
• Core inflation has remained sticky, with the recent rise driven primarily by services, particularly shelter costs, which rose 0.3% and contributed about 40% of the total increase in headline inflation. While shelter inflation has been a challenge to the ongoing disinflationary process, there was some good news as owners’ equivalent rent showed signs of moderating, its monthly increase falling to the slowest pace since January 2021, rising 0.2% in the month. Other problematic categories like airfares and auto insurance also came in relatively soft, rising 0.4% and 0.1%, respectively, with the former seeing the lowest monthly increase since July. Meanwhile, medical care continues to notch increases, rising 0.4%.
• As for core goods inflation, prices rose 0.3% to the highest pace since May 2023 and after several prior months of outright deflation. A rebound in both new and used vehicle prices, rising 0.6% and 2% in the month, respectively, helped drive core goods prices higher. Prices for household furnishing and supplies also rose 0.7% in the month, the biggest increase since August 2022.
• The Fed's preferred supercore inflation measure, which excludes shelter from core services and is primarily driven by wage costs, rose 0.3% in the period, roughly matching the average three- and 12-month pace, leaving the annual rate at 4.3% in November.

Policy outlook

The November CPI report, lacking any meaningful upside surprise, likely confirms a Fed policy cut next week. The positive development with owners’ equivalent rent, its monthly pace having fallen to the slowest rate since January 2021, is also likely to be a welcome development.

However, with monthly core inflation still showing signs of stickiness, with overall monthly core inflation hitting its strongest rate since the inflation scare of early 2024 and its recent annualized run-rate notching a fourth straight monthly acceleration, price pressures are hardly settling at a level that the Fed can be completely at ease with. The Fed will be concerned by the very stubborn nature of inflation and will also be increasingly cautious about the upside inflation risks that President-elect Trump’s policies may bring. We expect the Fed to move off autopilot in January, adopting a more cautious tone, and slowing its pace of cuts to just every other meeting.