U.S. January CPI growth weaker than expected! Market expectations for rate cuts are heating up, but a stabilizing labor market may keep the Federal Reserve on hold

Data released on Friday showed that the U.S. January CPI increased by 2.4% year-over-year, below market expectations of 2.5% and the previous 2.7%; month-over-month rose by 0.2%, also below market expectations of 0.3% and the previous 0.3%. Excluding volatile items like food and energy, core CPI rose by 2.5% year-over-year, in line with market expectations and lower than the previous 2.6%; month-over-month increased by 0.3%, also meeting expectations and higher than the previous 0.2%.

Although overall inflation slowed more than expected, core inflation remains stubborn. Coupled with a stabilizing labor market, this may lead the Federal Reserve to keep interest rates unchanged for some time. Analysts noted that the lower-than-expected January CPI was mainly influenced by the high base effect from last year. Additionally, January core CPI data often exceeds expectations because the Labor Department’s models do not fully account for one-time price increases at the start of the year. This CPI data may also reflect both this seasonal effect and the transmission impact of broad tariffs implemented during the Trump administration. Economists expect that, due to import tariffs and last year’s dollar depreciation, inflation may see a phased rebound during the year.

Notably, service sector inflation has risen significantly. Core services inflation excluding housing increased by 0.56% month-over-month, the largest gain since January last year. However, even with this sharp monthly increase, the year-over-year growth rate of core services inflation fell to 2.67%, the lowest since March 2021. This is likely a key reason why the January core CPI year-over-year growth slowed from 2.6% to 2.5%, hitting a new low since March 2021.

Following the release of this latest inflation data, the dollar briefly plunged, spot gold surged over $20, and the three major U.S. stock index futures turned higher. U.S. Treasury yields declined— the 10-year yield fell by 3.3 basis points to 4.071%; the two-year yield, sensitive to monetary policy, dropped by 2.3 basis points to 3.443%.

Additionally, after the January CPI data was released, expectations for Fed rate cuts in 2026 increased to 61 basis points from 58 basis points previously. The market now sees a 30% chance of a rate cut before April, and over an 80% chance before June.

Analyst Adam Button noted that after the CPI release, market pricing for the Fed shifted slightly dovish, causing the dollar to weaken and the S&P 500 futures to erase earlier losses. However, it’s important to note that due to the government shutdown, October CPI data was missing, and November data collection started later than usual, covering more seasonal holiday discounts. Economists generally warn that these disruptions may have artificially suppressed the readings.

Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management, stated that since the January CPI data was not as strong as feared, the Fed’s “normalization” rate-cut path appears clearer. This will depend on whether the labor market continues to show signs of improvement, as the Federal Open Market Committee (FOMC) is highly sensitive to labor market softness. The expectation remains that the Fed will cut rates twice this year, with the next cut expected in June.