Hawkish Fed Loop

Last week we got the very important Consumer Price Index (CPI) inflation data for December, from which we learned that inflation continues to trend lower, declining to 6.5% from 7.1% the month prior. In looking at the components of inflation, goods inflation continues to decline but services inflation remains elevated. Inflation related to shelter moved higher. Overall, this is good news for markets, but we need to see all of the components come down—especially housing. Regardless of the progress made, 6.5% is still far from the Federal Reserve’s 2% target, and we can expect the Fed to remain hawkish over the next few months to continue to move things in the right direction. But as inflation continues to decline, markets may become more bullish—having the opposite effect on the economy that the central bank is working to achieve. In this scenario, the Fed may have to be even more hawkish to get to 2%. This loop will continue as long as inflation is elevated.

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