December CPI Reveals No Upside Surprise

STOCK INDEX FUTURES

The indexes are higher following Decembers CPI inflation data, which showed  core prices rose 0.2% during the month, below expectations. Core CPI rose 2.6% on the year in December, edging down from November’s 2.7% and also below expectations, while headline inflation held steady at 2.7%. On the corporate front, JP Morgan shares rose about 1.2% in premarket trading after the bank’s earnings and revenue exceeded estimates, while Bank of New York Mellon fell 0.5% as its results failed to impress investors. Delta Air Lines plunged nearly 6% after forecasting adjusted earnings per share of $6.50–$7.50 for the year, below analysts’ estimate of $7.25.

Markets broadly recovered from an early session sell-off stemming from news that the Trump Administration threatened Fed Chair Powell with a criminal indictment over the weekend. The news reignited concerns over central bank independence and triggered a sell-off in American assets during the Asian session. Geopolitical tensions are also in focus after Trump said the US might meet Iranian officials and was in contact with the opposition, as the administration weighed its response to the protests in Iran, including military options.

CURRENCY FUTURES

US DOLLAR: The dollar gave up earlier gains following December’s inflation print, which showed core price pressures eased in December, while headline prices remained stable. Fed Chair Powell has suggested that the impact of tariffs on inflation will peak in the first quarter and then subside. The dollar was pressured to start the week after Fed Chair Powell said the Department of Justice had served the Fed with grand jury subpoenas, threatening a criminal indictment related to his testimony before the Senate Banking Committee last June. December’s inflation report added to rate cut prospects from the Fed. A rate cut from the Fed is now fully priced in for June following December’s inflation data, whereas a July cut was previously priced in ahead of the prices data. Still, the market remains favorable to a cut over the summer. December’s report signaled a stable labor market, with employment growth remaining sluggish, while unemployment was little changed, reinforcing the narrative around a ”low-hire, low-fire” economy. Currently, markets are pricing in a 1% chance of a rate cut at the January meeting, with a rate cut not fully priced in until the June meeting.

EURO: The euro is little changed against the dollar in what is to be a relatively dry week of data for the eurozone, with Germany’s GDP data on Thursday set to take the spotlight. Recent data showed that German exports unexpectedly fell in November, while industrial output rose despite expectations for a decline. Germany’s exports fell 2.5% month-over-month in November to their lowest level since October 2024. Germany’s total exports rose 0.9% from the same period in 2024. Germany’s industrial output rose 0.8% month on month in November, easing from a revised 2.0% increase in October and beating forecasts of a 0.4% decline. The sustained growth was driven mainly by a sharp rebound in the automotive sector. On the prices front, eurozone inflation figures broadly matched expectations, supporting the view that the ECB is likely to keep policy steady for some time. Headline CPI rose 2.0% year over year in December, while core inflation edged down to 2.3%, slightly below forecasts.

BRITISH POUND: The pound held onto gains from the previous session against the dollar as the currency has benefited from political turmoil in the US. UK GDP data will be released Thursday and is expected to show an improvement in growth amid a potential recovery in manufacturing conditions following the cyberattack on Jaguar Land Rover, which slowed production. Industrial production and the RICS house price survey for December will also be out Thursday, offering a glimpse into demand for homes following the passing of Reeves’ budget. On the political front, Prime Minister Keir Starmer said he would stay the course when recently asked if there were any circumstances in which he could stand down if a poor showing in local elections in May prompts a challenge to his leadership. A possible challenge to leadership could raise concerns about a potential shift to the left, creating renewed unease over fiscal risks. Traders will continue to focus on policy outlooks between the Fed and the Bank of England, as both central banks are expected to lower rates at least once in 2026. The BoE lowered rates by 25 bps last month, although officials at the bank cautioned that the pace of easing could slow as the bank does not want to jump the gun on inflation. Money markets suggest the next rate cut could come in April or June, with the latter meeting being fully priced in for a cut.

JAPANESE YEN: The yen fell to its lowest level against the dollar since July 2024 following news that Prime Minister Sanae Takaichi had conveyed to a ruling party executive her intention to hold a snap election in a bid to capitalize on her strong public approval ratings. Takaichi’s policies, which favor big spending and a dovish Bank of Japan stance, have recently weighed on the Japanese currency and a strong electoral victory could pressure the yen further. The news has seen JGBs reach new local highs as concerns about fiscal expansion grow. Markets are favorable for a July rate hike from the Bank of Japan, though wage negotiations and updated forecasts on the economy do present opportunities for odds to shift earlier in the year. Governor Kazuo Ueda has said the BOJ would continue to raise borrowing costs if economic and price developments move in line with its forecasts.

AUSTRALIAN DOLLAR: The Aussie is little changed against  the dollar as traders await domestic data out of the continent for further clues on how central bank policy could unfold in 2026. A concern for the Reserve Bank of Australia remains persistently high inflation. The release of the November household spending indicator later in the week will also draw close attention, amid growing evidence of a broad-based economic recovery partly driven by consumer demand. If household spending shows a sharp pre-Christmas increase, the RBA might be more inclined to begin raising rates sooner than expected. Market odds are favorable to a rate hike in May, with an increase in rates not fully priced in until August. Data out last week showed that consumer prices rose 3.4% on the year in November, below forecasts for 3.6% and a drop from October’s reading of 3.8%. Trimmed mean CPI, which is a key measure of core inflation for the Reserve Bank of Australia, rose 0.3% in November and 3.2% for the year, staying well above the target 2%. Capacity utilization, housing demand, facets from GDP data, and other indicators have all recently posted hotter-than-expected readings. Still, the central bank sees the monthly inflation figures as volatile and places greater emphasis on its quarterly inflation report, which is due in late January.

INTEREST RATE MARKET FUTURES

Yields are lower at the front end and higher at the long end following the release of December’s CPI report. December CPI showed moderate but sticky inflation, with headline prices up 0.3% on the month and 2.7% year over year, while core inflation rose 0.2% on the month and 2.6% on the year. Shelter and services (rent, lodging, recreation, medical care) continued to drive inflation, while goods prices and gasoline fell, keeping overall inflation contained but still above the Fed’s target. Energy was mixed, gasoline prices fell, but natural gas costs jumped, leaving energy slightly higher overall. Beneath the surface, goods prices continued to decline (used cars, furnishings, communication), but services inflation remained sticky, with notable increases in recreation, airline fares, medical care, and lodging, highlighting why inflation progress has slowed even as headline readings stabilize. For officials at the Fed, the downward surprise in the data, or lack of an upside surprise, is likely to be welcomed. However, the data is not very likely to shape opinions on how to move on monetary policy. Several officials have recently reiterated that policy remains in a good place, while the bank waits to see how current economic conditions play out.

The Fed on Sunday night announced that Chair Powell was facing criminal prosecution over the Fed’s recent renovations. The bank released a video Sunday night, with Chair Powell accusing the administration of using the threat of criminal prosecution to pressure the central bank into lowering rates. Powell framed the move from the Justice Department as a head-on challenge to the central bank’s independence. Powell made clear by releasing the video that the situation would be well in the public spotlight. A criminal investigation of a sitting chair is without precedent. Markets largely recovered from their initial sell-off following the announcement.

December’s labor report saw the yield curve flatten, with both the 2/10 and 2/30 year spreads narrowing from recent highs. Most categories in the report saw little changes and reinforced the narrative of a cooling but stable labor market. Policymakers at the Fed are likely to question what level of hiring is required to maintain a stable unemployment rate, given that December’s unemployment figure edged back down to 4.4%. Unemployment by demographic group showed little to no change, signaling no signs of stress emerging unevenly. Some groups are more likely to feel unemployment first, which can often serve as a leading indicator on labor market weakness. The Treasury will auction $22 billion in 30-year bonds Today.

The spread between the two- and 10-year yields is 64.20 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.537%.

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