Mixed Messages – Inflation Sparks in January While Retail Sales Slump

• January's Consumer Price Index (CPI) rose more than expected, both in overall and core measures. 

• Retail sales experienced their largest decline in nearly two years. 

• Despite inflation concerns, 10-year yields dropped below 4.50%. 

The Federal Reserve's goal of reducing inflation to 2% encountered challenges this month. January's CPI increased for the fourth consecutive month, marking the highest level since August 2023. The Federal Open Market Committee's decision to reduce interest rates by 25 basis points in December 2024, despite signs of ongoing inflation, now seems questionable. 

Last month, the headline CPI rose by 0.5%, the largest increase in 18 months, driven by household expenses such as groceries and gas. A significant rise in egg prices, due to a bird flu outbreak, contributed to the increase in grocery costs. Excluding food and energy, core CPI also exceeded forecasts, with higher costs for car insurance, airfares, and prescription drugs. Hotel prices pushed the shelter component higher, while rents remained stable. Supercore inflation also rose to nearly 0.8% month-over-month. 

Federal Reserve officials, who had previously noted a slowdown in inflation during the latter half of 2024, found some reassurance in the seasonal adjustments released with this CPI report. The Bureau of Labor Statistics' annual recalibration of seasonal factors revised the three- and six-month annualized core CPI down to 3.1%. 

The Fed chair addressed the Senate Banking Committee, emphasizing a cautious approach to interest rate changes and avoiding discussion on new policies from the Trump administration. 

In contrast, U.S. retail sales fell sharply in January, the largest drop in almost two years, indicating a reduction in consumer spending following the 2024 holiday season. Retail sales decreased by 0.9% month-over-month, and consumer sentiment declined for the second month as short-term inflation expectations rose. This combination offset much of the CPI increase, with interest-rate swap contracts now pricing in 37 basis points of cuts this year, up from 28 expected post-CPI. 

The mixed economic signals are unlikely to alter the Federal Reserve's plans for the upcoming meeting. They are expected to maintain current rates, despite the retail sales and consumer sentiment data. While the Fed remains data-driven, the impact of new policies from the Trump administration is also a factor. The next Fed meeting will occur midway through Trump's first 100 days, potentially providing insights into the Fed's stance on recent political developments. 

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