The Inflation Debate Likely Continues

Key Highlights

• Inflation data have been mixed, creating a ripe environment for investors to debate the perceived inflation trajectory.
• The Federal Reserve (Fed) will announce its rate decision later today, along with publishing a revised Summary of Economic Projections (SEP).
• We should expect the Fed to tamp down expectations for aggressive cuts in 2025 as the economy is humming.
• Both the sticky components of inflation and the flexible ones are running hotter than expected, putting upward pressure on rates. As of this morning, the 10-year Treasury yielded around 4.4%, up 80 basis points from its lows in September.

Mixed Signals

In recent days, investors have been busy dissecting the mixed signals on the inflation front. Some categories, such as rents, are continuing to decelerate as the economy moves farther away from the pandemic shock. Other categories, including medical services and insurance, are not slowing down like they were earlier this year.

More recently, producer prices were also a concern. The annual pace of producer prices in November rose roughly 3%, the fastest clip since early 2023. On an encouraging note, consumer prices excluding housing remained under 2%.

Inflation Dashboard

Source: LPL Research, AAA, Bureau of Economic Analysis, Bureau of Labor Statistics, NY Fed, 12/18/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. 

Sticky Prices

What categories are considered sticky? The categories the Atlanta Fed considers as most sticky are in the services categories, such as medical services, housing, and education. The prices for these categories change infrequently given the structure of the market. On the other hand, commodity prices often change very quickly as it is timed to real-time market pricing.

One reason prices, both sticky and flexible, are high is from steady consumer demand. Consumer spending continues to surprise to the upside. Strong income growth is giving consumers plenty of spending power as we close out 2024. Restaurant spending fell for the first time since March, but the levels are still above September figures.

Adjusting for inflation, retail sales rose 0.4%, indicating a solid consumer. Overall, November retail activity was solid as consumers had plenty of spending power from higher incomes, rising portfolio values, and stable financial footing. This report will likely add to the Fed’s debate about the policy path for 2025. Unless the labor market materially weakens, investors should expect the Fed to ease rates next year but not as much as originally hoped.

Updated Fed Projections

When the Fed meets today, the committee will publish an updated summary of its economic projections. The infamous “dot plot” will take the spotlight, and investors should expect these dots to basically shift upward – inflation is still sticky, the economy is chugging along with lots of animal spirits, and the Fed will not cut rates as aggressively as they telegraphed just a few months ago.

The various inflation-related metrics are a bit mixed, hence the debate among investors about where rates are heading but, consumer inflation outside of housing is indeed encouraging.

Yes, some inflation metrics have experienced a bit of an uptick in recent months, but if you take the various data in aggregate, many inflation categories are improving — albeit slowly. The “surprise” may be how the Fed will prepare investors for the expected policy path in the year ahead.