The S&P/ASX 200 opened 1.4% higher on Thursday after a better-than-expected US CPI report reinforced confidence that inflation continues to moderate.
US core inflation – which excludes volatile energy and food components – rose 0.2% month-on-month in December, slightly below market expectations of a 0.3% increase. On an annual basis, core inflation was up 3.2% compared to expectations of 3.3% – marking the first downside surprise since June 2024.
This data, alongside a string of strong bank earnings from names like JPMorgan, Citi, Wells Fargo and Goldman Sachs (all of which beat revenue, margin and earnings expectations) sent equity markets sharply higher.
Overnight, the S&P 500 (+1.83%), Nasdaq (+2.45%) and Russell 2000 (+2.01%) logged their best sessions since the post-election surge of November 6, 2024.
While the positive momentum has helped markets shake off early-year jitters, questions remain about the sustainability of the rally amid still-elevated inflation levels and an uncertain monetary policy outlook.
Here is a key summary of the US December inflation report.
Core inflation up 3.2% vs. market expectations of 3.3%
Headline inflation up 0.4% month-on-month vs. 0.3% consensus
Annualised headline inflation was 2.9% vs. 2.8% consensus
Energy and food contributed to the bulk of the upside, with the energy sub-index spiking 2.6% month-on-month and accounting for 40% of the headline increase
Food prices rose 0.3% month-on-month, decelerating from a 0.4% rise in the previous month
Shelter index up 0.3% month-on-month, unchanged from the previous month's increase
Used vehicles (+1.2%), car insurance (+0.4%) and airfares (+3.9%) all spiked month-on-month
Interestingly, core CPI (to four decimal points) was 3.248% and therefore rounded to 3.2%. If core CPI was 0.002% higher, it would have been 3.250% and rounded to 3.3%. Could this have caused the market to move in the opposite direction?
The inflation data sent bond yields sharply lower, with the US 10-year yield down 14 basis points to 4.65% or the largest one-day decline since August 2, 2024. Despite the pullback, the 10-year is only testing a one-week low.
Likewise, the Australian 10-year yield eased 12 basis points to 4.52% but barely scratching a one-week low.
Market expectations for 2025 monetary easing have moderated amid resilient economic data and hawkish Federal Reserve rhetoric. Following the Fed's 25-basis-point cut on December 18, Chair Powell emphasised a more measured approach ahead, noting "we moved pretty quickly to get here, and I think going forward obviously we're moving slower."
The below table shows the interest rate probabilities by December 2025. The consensus is currently one rate cut whereas a month ago, the market was expecting two rate cuts. However, yesterday's inflation print has sparked a slight repricing, with the probability of two cuts climbing to 29.8% from 24.7%.
Despite December's encouraging CPI report, multiple leading indicators suggest a challenging path toward the Fed's 2-3% inflation target band.
The US ISM services PMI prices index, which measures the prices paid for materials and services, jumped 6.2 percentage points in December to 64.4. The survey flagged that fifteen of the 18 services industries reported increases in prices paid in December. This marks the highest level in 22 months.
Oil prices have rallied strongly this year on Russian oil sanctions, cold weather boosting heating demand in Europe and ongoing geopolitical impacts. Brent crude is currently up 8.8% year-to-date to US$81.5 a barrel, the highest since August 2024.
ASX February reporting season looms as a critical test for market valuations and outlook. A few key focal points include the sustainability of tech sector growth, banking sector valuations and potential stabilisation in resource earnings and cost pressures.
Citi's latest analysis (January 14) projects muted FY25 market earnings growth of 0.5%, placing the ASX 200 at an elevated 17.9x forward P/E ratio – significantly above the long-term average of 14.6x.
Despite muted earnings expectations, the analysts maintain a constructive outlook, with a year-end S&P/ASX 200 target of 8,600. "The delivery of rate cuts this year should bode well for market sentiment, even if some of these market expectations are already priced in," the analysts said, adding that "our domestic equity market will continue to benefit from the ongoing flow of money into superannuation funds and thus continual equity market inflows." Livewire and Market Index readers agree. Nearly 50% of the 5,000 respondents in our 2025 Outlook Survey predict the ASX will close at 8,500-9,000 by year-end, with 16.8% forecasting 9,000-9,500.
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