Are US Data Pointing to a Downshift in Fed Rate Hikes?

The stock market should continue to move up ahead of the January 31-February 1 FOMC Meeting, as the latest (as well as expectations of upcoming) data keep open the door for a further downshifting in Fed rate hikes to 25 BPs from 50 BPs. 

The December CPI had a number of favorable elements from the Fed's perspective, even though the 0.3% m/m Core was above the Fed's inflation target.   A decline in motor vehicle prices and car rental prices provided more evidence that easing supply constraints will unwind earlier shortage-induced price hikes.  Most other prices posted subdued increases.  Food prices, both in the grocery store and restaurants,  slowed -- a positive factor for lowering inflation expectations and suggestive of a moderation in labor costs.  And, while Housing Rent remained high, it should catch up to the declines seen in recent surveys as the year progresses.  The Core CPI Less Housing, which Fed Chair Powell likes to cite, fell 0.1% m/m for the 3rd consecutive month.  Note, however, that some of the weakness in this measure reflects the pass-through of lower fuel costs to airline fares and a technical issue with how health insurance costs are measured -- not, as Powell suggests, because of slower wage increases.

Besides the favorable elements of the December CPI, inflation expectations appear to be contained, according to the University of Michigan Consumer Sentiment Survey.  The Fed's favorite measure, 5-Year Inflation Expectations, was  3.0% in mid-January, remaining within its recent range.

The increase in the overall Michigan Sentiment Index should help allay fears of recession, as it suggests the consumer is in decent shape.  Similarly, the Unemployment Claims data suggest some improvement in labor market conditions, although these data have to be viewed with caution because of holidays in the reported weeks.  If seasonal factors did not adequately offset holiday-related declines in Claims (both Initial and Continuing), they could overly boost them in next week's report.  As they stand, the Claims data raise the risk of a speedup in December Payrolls.

In contrast to the Claims data, data due this week are expected to show a soft ending in 2022.  December Retail Sales are seen falling, both Total and Ex Auto.  Price declines likely play a role in these estimates.  An unwinding of some of October's strength could play a role, as well, since a pause after a strong month could last for a couple of months.  December Industrial Production is expected to fall.  A decline in Manufacturing Output would be consistent with Total Hour Worked in the sector.  December Housing data also are expected to weaken in this week's reports.  All these weaker reports would be consistent with the Fed's desire for an economic slowdown, but they could help persuade the Fed to downshift.