Payden & Rygel: Core inflation in the US to dip close to 2% year-over-year mid-2025

Payden & Rygel: Core inflation in the US to dip close to 2% year-over-year mid-2025

11 december 2024

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By Jeffrey Cleveland, Chief Economist, Payden & Rygel

At the moment, everyone wants to talk about Mr. Trump. However, we think that the path of inflation and unemployment will dictate the Fed's policy path, which will, in turn, matter most for markets. Let's look at each piece in turn. 
First, we expect core measures of inflation to continue to moderate in 2025. We can dissect core inflation in the U.S. into three major groups: goods, housing, and non-housing services. Goods prices have been in deflation, dragging down overall consumer prices. Meanwhile, housing costs and non-housing services remain sticky. Over the next year, though, we expect housing costs to moderate further and non-housing services (everything from haircuts to health care) to moderate as the labor market cools. By mid-2025, we expect core inflation in the U.S. to dip close to 2% year-over-year, consistent with the Fed's target. 
 
Second, we expect the labor market to continue cooling. Job growth in the U.S. slowed to 132k on average in the fall of 2024, compared to 250k in 2023. Consequently, unemployment rose from 3.4% in the spring of 2023 to 4.2% in November. While a 4.2% unemployment rate is still low by historical standards, the recent rise clearly shows a slowdown in the labor market underway. 
 
Third, with inflation near or in the Fed's "target zone," we expect policymakers to focus more on the labor market in 2025. Congress tasked the Fed with maintaining full employment, so if inflation is no longer a threat, any further deterioration in the labor market will prompt a more rapid pace of rate cuts than the market expects. We see the Fed cutting at next week's meeting and four times in 2024, but if unemployment rises above 4.2%, the Fed will move faster, meaning that the risk is more rate cuts, not fewer. 
 
Finally, you might wonder, will Trump's policies affect the path of inflation, unemployment, and the Fed funds rate? The problem, as ever, is details and timing. Much will depend on what is announced and when it takes effect. For example, a fresh round of tax cuts might be agreed to, but will policymakers act in 2025, and the changes take effect in 2026? Further, the ultimate macro impact will be more ambiguous if spending cuts accompany the tax cuts. 
 
For financial markets, a more aggressive Fed coupled with a still growing economy (i.e., no recession) bodes well for stocks and bonds--"risk" rallies when the central bank is easing outside a recession, and rate cuts mean bond yields will move lower across the curve. 
 

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