The latest updates on the labor market and consumer prices show President-elect Donald Trump inherits an economy where inflation is poised to return to the Federal Reserve’s target later this year. Those wondering what that means for interest rate cuts should focus not on the Fed but on the next White House’s fiscal and trade policies.
Last week’s payrolls report was a big upside surprise, but it nonetheless provided further evidence that the labor market is no longer a source of inflation. Year-over-year growth in average hourly earnings for non-managerial employees came in at 3.76%, the lowest since 2021 and essentially in line with the trend through much of 2019. That’s to be expected when white collar employment growth remains tepid and the overall hiring rate is low.
Indeed, qualitative signs point to a growing sluggishness in corners of the jobs market: It’s taking longer for the unemployed to find positions, graduates from even the top business schools are struggling to land roles, and employers continue to pressure workers to return to the office, suggesting we could see softening in payrolls and wages in the months to come.
The signals from the labor market were echoed in the consumer price index report released Wednesday, which showed that the stickiest components of inflation have become unstuck.
Here, shelter has been the biggest culprit, in part because rents often reset annually, and it took time for the surge in housing costs from 2021 and 2022 to flow into the government data. Looking at owner’s equivalent rent — what a homeowner would pay if they rented their home — December registered a second consecutive annualized monthly increase below 4% for this proxy measure. There’s good reason to expect OER changes to continue to track lower as the softness we saw in market rents last year is slowly reflected in the official numbers.
Motor vehicle insurance has been another high-profile source of sticky inflation. Automobile values and maintenance costs surged in 2021 and 2022, but insurers needed time to raise premiums to account for the increases. Vehicle values and wages for workers such as mechanics stabilized last year, allowing insurers to finally catch up on pricing. As a result, in the fourth quarter of 2024, motor vehicle insurance only increased at a 1.7% annualized rate. While premiums probably won’t decline, drivers should see some stability in pricing going forward.
The pockets of inflation that have heated up a bit in recent months appear to be more like “dead cat bounces” than renewed sources of structural price pressures. Used vehicle prices fell 20% between February 2022 and August 2024 as supply chains healed and auto demand weakened and have risen back 6.3% since then. That’s more a sign of normalization than a trend likely to persist with auto supply now in better balance. The inflation we’ve seen in airfares since the summer also appears to be about carriers tweaking supply to support profitability rather than overheating demand for air travel.
As my Bloomberg Opinion colleague Jonathan Levin pointed out on Wednesday, the latest producer and consumer price reports point to gains in the core personal consumption expenditures index, the Fed’s favored gauge of underlying inflation, returning to 2% later this year if last month’s impulse is sustained. Bloomberg Intelligence estimates the core PCE index, due out Jan. 31, rose 0.17% in December from the previous month.
The risk is that the current outlook for the labor market, shelter inflation and supply chains is thrown out of whack by the incoming administration. Trump’s economic team is discussing raising tariffs gradually, perhaps by 2% to 5% a month, Bloomberg News reported recently. That may be a way to avoid a price shock, but moderate, persistent increases could end up embedding inflation more sustainably into the economy and unnerve both businesses and consumers. Despite a razor-thin Republican majority in the House of Representatives, Speaker Mike Johnson has said that a big tax bill will pass the House by the end of April, providing a form of fiscal forward guidance that raises growth expectations and inflation fears.
Ultimately, we’re not going to know for at least a few months what the administration will do on trade and fiscal policy, and its impact on inflation. Until then, traders trying to game out the next Fed rate cut will focus more on headlines and tweets from the White House than the economic data. The current trajectory should allow for Fed cuts later in the year, but only if the White House cooperates.
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