The December jobs report sent ripples through financial markets, triggering declines in equity and bond prices while bolstering the dollar and bond yields. While the robust job growth was a significant catalyst, the market’s reaction was more nuanced, reflecting anticipation of the impending December Consumer Price Index (CPI) inflation report. Base effects, the influence of past price changes on current inflation readings, loomed large, threatening to artificially inflate year-on-year inflation figures for both headline and core CPI. This prospect sparked concern that markets could experience further volatility should investors further downgrade their expectations for interest rate cuts in 2025.
The strong jobs report, with 256,000 net new jobs added and unemployment dipping to 4.1%, was not the only positive economic indicator during the week. The ISM Non-Manufacturing Index climbed, showcasing continued expansion in the services sector. Initial jobless claims dipped significantly, and the JOLTS report from the Bureau of Labor Statistics revealed a surprising surge in job openings. These data points, combined with a modest decline in factory orders, painted a picture of robust economic growth, with the Atlanta Fed’s GDPNow model projecting 2.7% GDP growth for Q4 2024. This backdrop of economic strength, coupled with the Federal Reserve’s previously expressed concerns about inflation in the minutes of their December meeting, contributed to market jitters.
The impending release of the December CPI report added another layer of complexity to the market’s response. While expectations were for positive growth data releases in the coming week, including retail sales and industrial production, the focus remained squarely on inflation. With November’s year-on-year inflation rates already elevated (total CPI at 2.7%, core CPI at 3.3%), forecasts suggested a potential further acceleration in December due to base effects. This possibility heightened concerns that the Federal Reserve might maintain a hawkish stance on interest rates, delaying or even eliminating anticipated rate cuts in 2025.
The potential impact of accelerating inflation on Federal Reserve policy is significant. The December FOMC projections already indicated a more conservative approach to rate cuts in 2025 than previously anticipated, suggesting only two 0.25% reductions. A further surge in inflation could push these expectations even lower, potentially eliminating all anticipated rate cuts for the year. While some analysts predict that any inflation spike in December would likely be transitory, due to the influence of base effects, the immediate market reaction could be substantial.
The interplay between inflation expectations and market reactions poses significant risks. If the December CPI report reveals accelerated inflation, the dollar and bond yields could continue their upward trajectory, further depressing equity and bond prices, and potentially impacting industrial commodity prices as well. This scenario underscores the delicate balancing act facing the Federal Reserve. While robust economic growth might typically warrant a sustained hold on interest rates or even further hikes, the potential for a transitory inflation spike adds a layer of complexity to the decision-making process.
The market’s sensitivity to the December inflation data highlights the evolving narrative surrounding economic recovery and the Federal Reserve’s policy response. While the strong jobs report and other positive economic indicators point towards continued growth, the persistent threat of inflation, even if potentially transient, keeps the Fed’s options constrained. The coming weeks will be crucial in determining the trajectory of monetary policy and its impact on financial markets. Market participants are keenly awaiting the December CPI report, recognizing its potential to significantly shift expectations for interest rate cuts in 2025 and, consequently, influence the direction of various asset classes.
