(UBS)
The renewed optimism came following data suggesting the trend toward slower US inflation is back on track, which calmed worries that the Fed may struggle to justify rate cuts in 2025. Of course, investors should expect further swings ahead. Markets will be on the alert for policies from the incoming Trump administration that could make it harder for the Fed to hit its 2% inflation goal, including higher trade tariffs, fiscal easing, and tighter immigration controls.
But our view remains that further Fed rate cuts will take place later this year. Although the December consumer price index was only fractionally slower, with the monthly ex-food and energy measure down from 0.3% to 0.2%, this was the first decline in six months. Core inflation also slowed on an annual basis to 3.2% from 3.3% in December.
It is also worth noting that much of the current inflation is coming from shelter costs, which account for more than a third of headline CPI, and which we expect to slow further in the coming months. Excluding shelter, headline inflation was just 1.9%, while core inflation ex-shelter stood at 2.1%, consistent with the Fed’s 2% target. As a result, we believe that the market pricing for only around 38 basis points of Fed easing in 2025 is too cautious, and we still expect 50 basis points of cuts.
Takeaway: Although the pace of Fed easing looks set to be slower than anticipated prior to the hawkish December meeting, US rates are still coming down. That will further erode returns on deposits and money market funds, increasing the importance of putting cash to work in fixed income and equity markets.
For more, see the Weekly Global: Slowing US inflation calms market worries over the Fed , published 20 January, 2025.
