The latest consumer price data, set for release on Wednesday, will reaffirm what Federal Reserve officials have been signaling for months: inflation in the US is still too high for comfort. While progress has been made, it remains short of the Fed’s 2% target, keeping interest rate cuts on hold for now.

What Economists Expect

A recent poll of economists predicts that headline inflation in January remained steady at 2.9% year-over-year (y/y), unchanged from the previous month. However, the core inflation rate—which excludes volatile food and energy prices—is expected to decline slightly to 3.1% y/y.

On a month-over-month basis, headline inflation is expected to slow to 0.3% from 0.4%, while core inflation is projected to tick up slightly to 0.3% from 0.2%.

The January report will also include revisions to previous seasonal adjustment factors, which could impact how past inflation trends are interpreted. Analysts believe that core services prices may see some seasonal strength in the data.

What’s Driving Inflation?

According to Barclays economist Marc Giannoni, January’s inflation numbers are likely to be influenced by a few key factors:

• Energy prices contributed to an expected 0.38% month-over-month increase in headline inflation.
• Food prices also played a role, though to a lesser extent.
• Core inflation (0.30% m/m) is expected to be driven by higher used car prices and a modest uptick in core services prices after a weaker-than-expected December reading.

The Fed’s Take on Inflation

Speaking before Congress on Tuesday, Federal Reserve Chairman Jerome Powell acknowledged that inflation has come down closer to the Fed’s 2% target, but he made it clear that it remains elevated.

“As the economy evolves, we will adjust our policy stance in a manner that best promotes our maximum-employment and price-stability goals,” Powell said.

This cautious stance suggests that the Fed will not rush into cutting interest rates unless it sees sustained progress toward its inflation target.

Challenges to Inflation Control

A year ago, markets widely expected that the Fed would be cutting rates aggressively in 2024, anticipating a cooling economy and declining consumer prices. That hasn’t happened. Instead, inflation has proven more persistent, and new challenges are emerging, including trade tensions.

The most immediate concern? A potential trade war.

• The US narrowly avoided disruptions with Canada and Mexico after former President Donald Trump delayed 25% tariffs on both countries for 30 days in exchange for small concessions.
• However, the US has imposed a 10% tariff on China, prompting Chinese retaliation.
• As a result, Barclays has revised its inflation forecast higher to account for potential price pressures from increased import costs.

What’s Next for Inflation?

Despite near-term challenges, many economists remain optimistic that inflation is on a downward path.

• Citi analysts expect inflation to continue slowing, and they predict the Fed may cut rates more than the 40 basis points currently priced in for 2024.
• Cleveland Fed President Beth Hammack noted that a cooling labor market has helped bring down inflation, though not yet to the Fed’s desired level.

The Fed’s preferred inflation gauge, the PCE price index, stood at 2.6% y/y in December, with core PCE at 2.4%—both still above target but showing progress.

Bottom Line

While inflation is moving in the right direction, it’s not yet low enough for the Fed to confidently declare victory. With a resilient economy and a strong labor market, the central bank has the luxury of patience before making any rate cuts.

As Cleveland Fed President Hammack put it:

“We have made good progress, but 2% inflation is not in sight just yet.”

For now, markets and consumers alike should prepare for interest rates to remain higher for longer—at least until the Fed gets clearer signals that inflation is truly under control.