In December, the U.SConsumer Price Index (CPI) revealed inflation rates that fell short of market expectations, somewhat stifling the “inflation trade” momentum that had been gaining traction previouslyAt the heart of this development lies a noticeable weakening in durable goods inflationAs observers look to the future, a pressing question emerges: will the U.S. continue its slow march toward “de-inflation” beyond 2025, and how will the impacts of Tariff 2.0 play out?

To begin with, December’s CPI results showed a slight dip compared to market predictions, highlighting a decline in both the breadth and stickiness of inflationThe year-on-year CPI for December stood at 2.9% and a month-on-month increase of 0.4%, both figures aligning with expectationsHowever, the core CPI, which excludes volatile food and energy prices, registered a year-on-year increase of 3.2% with a monthly uptick of merely 0.2%, hinting at a slight underperformance against market forecastsFollowing the release of this data, market expectations regarding a potential interest rate cut by the Federal Reserve were gently amplified, reflecting a burgeoning dovish sentiment within the central bank’s ranks.

Meanwhile, a notable retreat in U.STreasury bond yields has been observed, leading to a cooling of “re-inflation” trading activities, although persistent policy uncertainties may still keep interest rates fluctuating at elevated levelsThis past week alone, the yield on 10-year U.STreasury bonds saw a significant drop, with TIPS (Treasury Inflation-Protected Securities) yields decreasing by approximately 14 basis points, while inflation expectations remained relatively stableHowever, in the short term, the unusual combination of a nascent administration with multiple uncertainties around its policy directions and resilient economic indicators may continue to exert upward pressure on bond rates.

Diving deeper, one might wonder why the core inflation numbers in December fell below market expectations

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The primary culprit appears to be a downturn in durable goods inflation, followed closely by rental inflationA global escalation in oil prices during December caused a significant spike in energy-related CPI figuresDelving into the specifics of retraction in inflation, it becomes clear that the core inflation slowdown is mainly driven by the underperformance of durable goods, which dragged CPI growth rates down by approximately 4 basis points compared to November, with rental costs contributing negatively as well.

The cooling inflation in durable goods can be attributed largely to a temporary softening in consumer spendingThe crucial determinants for durable goods consumption hinge on income levels and interest ratesRecently, with rising yields on U.STreasury bonds and a slight deceleration in wage growth for American workers, a noticeable dip in durable goods consumption has been felt, signaling declines in specific sectors such as automobile sales during DecemberConversely, indicators like the Manheim used vehicle price index suggest that auto inflation may see a short-term rebound in the coming months.

In terms of rental inflation, the indicators for December hint at slight cooling, with trends toward “de-inflation” potentially continuingFollowing a specific path from real estate prices to new lease agreements and eventually to rental inflation as reflected in CPI, even though housing prices might suggest a rebound in rental inflation, the prolonged contraction in the growth rate of new lease index published by the Bureau of Labor Statistics (BLS) impedes rental costs from reversing the overall “de-inflation” process.

Moving forward, the persistent narrative of “re-inflation” remains unshakable, and it warrants attention on the labor market's ongoing “relaxation” process and the implications of Tariff 2.0. Currently, the U.S. labor market's relaxation process faces challenges, which could potentially reinforce the stickiness of service inflation

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