U.S. inflation relief is finally happening, putting Fed pause in view

U.S. inflation data offered the strongest evidence yet that price pressures have peaked, cheering financial markets and putting a pause from the Federal Reserve’s interest-rate hikes in view.

Stocks and bonds rallied after the report as investors boosted bets that the Fed will pause its tightening cycle early next year. So-called core inflation — which excludes food and energy — rose just 0.2% in November, the smallest monthly advance since August 2021.

However, with annual headline inflation still running above 7%, it’s far too soon for the Fed to let off the gas on its rapid ascent in interest rates. Policymakers are widely expected to downshift to a 50-basis point hike Wednesday, but Chair Jerome Powell will likely communicate that rates will need to remain restrictive well into next year to further cool prices and get inflation back to target.

Assuming further moderation in inflation ahead, the November report “provides more confidence that the Fed may only need to tap the brakes lightly in the new year to cap this tightening cycle,” Sal Guatieri, senior economist at BMO Capital Markets, said in a note. “If so, it will go some ways to increasing the odds of a soft landing.”

In other words — cooling inflation without triggering a recession.

The half point move for this week was well-telegraphed before the CPI report. Traders are now leaning toward an even smaller 25-basis point increase for February’s Fed meeting. They also see a lower peak in the fed funds rate.

The report caps off a year in which inflation surged to 9.1%, the highest in 40 years, propelled by persistent mismatches in supply and demand and compounded by Russia’s war in Ukraine. Economists expect supply chains to continue to improve, while consumer spending and the labor market soften — which would ease the pressure on prices.