Shortly after his inauguration on Monday, Donald Trump will move to the Oval Office to sign a series of executive orders, offering a glimpse into the priorities he may set. The positive news is that he inherits a robust economy, bolstered by a healthy labour market.
The sharp rise in bond yields in recent weeks was halted, at least temporarily, following the release of the December CPI report, with core inflation coming in below expectations. Nevertheless, most underlying inflation measures suggest that inflation will struggle to meet the Fed’s 2% target as long as growth remains above potential, and the output gap stays positive. The Fed is all but certain to keep rates steady at its meeting at the end of the month, with March likely to follow suit.
Inflation – no free lunch
Bonds and equities rose on Wednesday after core CPI data came in better than expected, easing fears of a renewed inflation surge. Headline CPI still climbed 0.4% month-on-month, driven by a 2.6% jump in energy prices. Recent data releases had heightened worries that the Fed might forgo rate cuts this year—or even raise rates further. Indeed, oil prices have risen by around 15% since the end of last year, while the University of Michigan and the New York Fed inflation expectations surveys revealed that consumers raised their long-term inflation forecasts in December. Although core producer price inflation (PPI) was unchanged last month, airline fares—feeding directly into the Fed’s preferred inflation gauge, the PCE deflator—leapt by 6.8%, the largest December increase since records began in 1990.
So, what does it all mean for the path ahead? Most measures of underlying inflation suggest that while progress has been made, there is residual stickiness. A return to the 2% target is possible but will take time. Core CPI inflation has risen at an annualised rate of around 3.25% over the past three, six, and twelve months. Rent inflation has been falling only gradually, and inflation of core services excluding rents has remained stubborn at around 4% over the past year, showing only modest signs of disinflation. This is largely due to robust consumer spending on services. Although wage inflation is easing, nominal labour income is still growing at about 5%, slightly above its trend rate.
Other measures, such as the Atlanta Fed’s sticky CPI, the Cleveland Fed’s trimmed mean CPI, the San Francisco Fed’s cyclical core PCE, and our proprietary cyclical measures of inflation, tell a similar story. Underlying inflation has fallen significantly from its 2022 peak but remains roughly one percentage point above its 2000–2007 average—the last period when core PCE inflation aligned with the Fed’s 2% target.
Looking ahead, the outlook for inflation remains challenging. The ISM services survey implies that core services inflation is unlikely to decline meaningfully in the near term. Instead, risks are skewed to the upside. While the positive output gap is narrowing, it remains positive—a factor typically associated with above-target inflation. To bring inflation back to 2%, the economy will need to cool further. Both the Fed’s and our forecasts suggest this will happen gradually, with the target not being reached until 2027.
The trajectory of inflation will also depend on the incoming administration’s policies. Tax cuts, tariffs, and stricter immigration enforcement will add to inflationary pressures, while reduced government spending and deregulation may offset them. On balance, the policy mix is likely to be somewhat inflationary. However, as we have argued before, the scale, timing, and sequencing of these measures will matter as much as the policies themselves.
Given the latest data on inflation and the labour market, the Federal Reserve is almost certain to pause in January. Markets currently price in one rate cut by midyear, which seems reasonable. We expect an additional cut in the fourth quarter, though investors remain divided on the likelihood of a second reduction.
President Trump is set to sign several executive orders on Monday after his inauguration, but it is unlikely these will provide much clarity on his broader policy direction. For now, markets and policymakers alike must contend with an economy that continues to show resilience but also persistent inflationary pressures.
By Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management
