U.S. Inflation Surprises Investors

By Davide Barbuscia and Saqib Iqbal Ahmed

NEW YORK (Reuters) – Surprisingly strong U.S. inflation in January stoked investor fears that a heating economy and looming tariffs could corner the Federal Reserve, undercutting interest rate-cut hopes and even raising the threat of a hike.

U.S. consumer prices increased more than expected in January, reinforcing expectations the central bank will be in no rush to resume cutting interest rates, particularly as economic uncertainty is exacerbated by the expected inflationary impact of U.S. President Donald Trump’s tariffs on key U.S. trade partners.

Fed Chair Jerome Powell said in congressional testimony this week that the Fed was prepared to keep rates unchanged until inflation resumes its decline. However, the hot inflation reading will likely complicate investors’ efforts to predict when it may cut rates again, with some even starting to voice concerns that the next move might be a hike to contain price pressures, a shift that would rattle markets.

> “We have to get comfortable with this idea that inflation is sticky at a higher level than what we were used to in the past,” said Erik Aarts, senior fixed income strategist at Touchstone Investments.

Aarts mentioned plans to maintain a slight “underweight” position on Treasuries, which rise in value when interest rates are set to decline. He remained bullish on corporate bonds, expecting continued economic strength.

Interest rate future traders were now betting on only one 25 basis point rate cut by the Fed later this year after the inflation data, down from about 36 basis points expected easing in 2025 ahead of the release. Benchmark 10-year U.S. Treasury yields surged over 10 basis points and were last at 4.65%, their highest in almost three weeks.

The benchmark S&P 500 stock index fell on Wednesday, as the inflation data upended expectations of broad support for equities from less restrictive monetary policy.

> “Our base case was slowing growth, slowing inflation,” said Jack Ablin, chief investment officer at Cresset Capital.

The possibility of rates staying high longer than expected means large companies with strong cash flows could become more attractive, while it could stall shifts away from the so-called Magnificent Seven technology stocks into the broader market.

> “I’d love to see that broadening, but I think this is really a setback to that trend,” Ablin stated.

TARIFFS BACKDROP

Trump’s protectionist policies intensified market fears of a sustained inflation rebound, imposing a 10% additional tariff on Chinese goods while suspending 25% levies on goods from Canada and Mexico until March.

> “Inflation acceleration is more concerning than usual right now,” Jason Pride, chief of investment strategy and research at Glenmede, noted. “The prospect of new trade barriers has the potential to further fuel inflationary pressures by increasing costs for businesses and consumers.”

U.S. consumer sentiment dropped in February to a seven-month low, with inflation expectations rising as households feared it might be too late to avoid negative effects on purchasing power from Trump’s threatened tariffs, as shown by the University of Michigan Surveys of Consumers last week.

> “The rise in inflation expectations that we’ve seen with consumers recently, combined with this hotter-than-expected January CPI report, certainly shifts some of the risks over to the inflation outlook,” said Sam Millette, director of fixed income at Commonwealth Financial Network.

“Forecasting when the next rate change will be is extremely difficult due to the volatility stemming from Washington’s policy front.”

While he wasn’t planning to tweak his portfolio based on the latest inflation reading, Millette noted an uptick in interest from advisors in securities expected to perform well in a rising rate environment.

Many in the market cautioned that seasonal effects could have worsened the January inflation reading, as companies typically raise prices at the beginning of the year. However, even considering temporary factors, disinflation has largely stalled over the past few quarters, according to Josh Jamner, investment strategy analyst at ClearBridge.

> “Should this month’s hotter and broader reading indicate a resurgence in inflation in the coming months, the Fed may need to raise interest rates in the second half of 2025,” he said.