Pockets of Sticky Inflation

MACRO FRAME

January’s CPI and employment data reinforce the case for an extended Federal Reserve pause, with pockets of sticky inflation persisting while signs of meaningful labor market deterioration remain limited. Equity volatility continues to reflect rapid sentiment shifts rather than broad macro stress, as investors rotate between perceived winners and losers. Currency markets remain sensitive to political developments and evolving policy expectations as rate outlooks gradually stabilize.

STOCK INDEX FUTURES

Equity indexes are lower following January’s inflation data, as attention remained on a broad rotation out of megacap stocks amid a prevailing “shoot-first, ask-questions-later” trading mentality.

January’s CPI report reinforced the disinflation trend, with headline prices rising 0.2% month-over-month and the annual rate easing to 2.4%, while core inflation held at 2.5% year-over-year. Energy and used vehicle deflation helped offset firmer services costs, particularly in transportation and medical care, leaving inflation cooling. Paired with the recent strength in labor data, the report supports a Federal Reserve stance of patience rather than urgency, keeping expectations centered on policy easing later in the summer rather than in the near term.

Markets have seen inflows into more defensively positioned or “AI-insulated” sectors, including utilities, consumer staples, mining, construction, and telecommunications. The rotation from high-growth technology leadership toward traditional value-oriented industries reflects concerns that companies will be unable to reap sufficient returns from higher capital spending. The S&P 500 software and services index was down 15% since the end of January as of Wednesday.

As fourth-quarter earnings season concludes, evidence of a broader market rotation has become increasingly apparent. Elevated concentration, with the top ten US stocks comprising roughly 39% of the S&P 500 compared with about 26% at the peak of the dot-com era, left equities vulnerable to a shift in leadership. Recent price action suggests a broadening of diversification rather than a risk-off play.

Watch point: Following January’s jobs and inflation prints, focus on sectoral job gains will gain greater scrutiny.

CURRENCY FUTURES

US DOLLAR: The USD pared early gains to be little changed following January’s inflation data, which reflected headline cooling with pockets of sticky inflation. The mixed signals limited conviction around near-term policy repricing, leaving the dollar caught between firmer wage and services components on one side and a still-intact disinflation trend on the other. With markets broadly centered on summer easing rather than an imminent move, near-term direction is likely to remain sensitive to incoming labor and inflation updates rather than a decisive shift in rate expectations.

Watch point: Signals on labor and inflation will determine whether the dollar can regain momentum or remain range-bound as rate-cut expectations evolve.

EURO: The euro slipped against the dollar. Second-estimate GDP figures were left unchanged, confirming 1.5% growth in 2025, while projections for 2026 also held steady at 1.2%. Separate data showed eurozone employment rose 0.2% in Q4 2025, above expectations for a 0.1% increase. Together, the figures reinforce a narrative of steady growth and relatively firm labor conditions across the bloc, supporting the European Central Bank’s extended pause in policy.

The single currency has drawn support from indications that the European Central Bank remains broadly comfortable with the euro’s recent appreciation, alongside reports that Bank of France Governor François Villeroy de Galhau is expected to step down in June, a development viewed as marginally hawkish given his typically dovish policy stance. Broadly, the euro continues to draw structural support from capital flows and relative equity performance despite a neutral policy backdrop.

Watch point: Sustained appreciation above $1.20 would materially raise expectations of verbal or policy intervention from ECB officials, though action from the bank is unlikely.

BRITISH POUND: Sterling inched higher against the dollar, while political turbulence and weak growth figures provide headwinds to further gains. The UK’s economy expanded by 1.3% in 2025, a modest improvement from 1.1% growth in 2024, with all major sectors contributing to the increase. Despite the uptick, the result fell short of the government’s 1.5% projection and remained subdued relative to historical averages. Activity faced several headwinds during the year, including higher tax burdens, trade-related uncertainty, and disruption from a significant cyberattack on a major domestic manufacturer.

Other data showed that industrial production unexpectedly declined 0.9% month-on-month in December, missing expectations for a flat reading and reversing an upwardly revised 1.3% gain in November, the first contraction since September. The pullback was led by softer manufacturing output, particularly in pharmaceuticals, food products, and chemicals, pointing to renewed weakness in goods-producing sectors despite prior momentum.

Paired with the Bank of England’s narrower-than-expected vote to hold rates steady last week, the prospect of a March rate cut has moved more firmly into consideration. Several policymakers have signaled growing comfort with near-term easing, and alongside softer wage growth, a gradual loosening in the labor market, and updated BoE projections showing CPI returning to target by Q3 2026, concerns over persistent price pressures have eased, though some officials are likely to seek further confirmation that recent progress is sustained. Markets are pricing a 62% chance of a 25 bps cut at the March meeting.

Watch point: Expectations for near-term easing are likely to build if upcoming data remain accommodative, leaving sterling vulnerable to further downside against the dollar should rate-cut timing shift toward March or April.

JAPANESE YEN: The yen weakened against the dollar but is on track for a weekly gain of more than 2%, supported by firm Japanese equities and rising JGB prices. Improved sentiment, reflecting market confidence in Prime Minister Takaichi’s fiscal plans after she ruled out additional debt issuance, has underpinned the currency as domestic political uncertainty has eased.

Positive sentiment that Japanese markets may be positioned for a cyclical breakout remains supportive of the yen, with equities outperforming bonds and expansionary fiscal and industrial policies reflecting a broader push to strengthen economic growth. Still, Prime Minister Takaichi’s fiscal ambitions are likely to temper the pace of further appreciation, suggesting gains may continue but are unlikely to extend unchecked.

Watch point: Improving sentiment toward Japan’s growth outlook should lend near-term support to the yen, though concerns over expanded fiscal spending may act as a headwind to further appreciation.

AUSTRALIAN DOLLAR: The Aussie is lower but continued to trade above the $.70 level as widening yield differentials provided support. Ten-year Australian government bonds now yield roughly 75 bps more than comparable US Treasurys, compared with a 60 bps disadvantage this time last year, the widest positive spread since 2016, when the currency last traded near $0.75. Three-year yields are also more than 200 bps above German bunds, the largest gap since late 2022, reflecting a rapid repricing over recent months.

The widening in spreads has been driven largely by the Reserve Bank of Australia’s hawkish shift amid persistent inflation pressures, reinforcing the currency’s relative carry appeal. The Aussie hit a three-year high at $0.7143 on Wednesday amid a rise in metals prices and hawkish commentary from a central bank official. Reserve Bank of Australia Deputy Governor Andrew Hauser reiterated that inflation remains too high and that policymakers are committed to bringing it lower. Markets currently imply roughly a 70% probability of another rate increase to 4.10% at the May meeting, with expectations reinforced by recent inflation data.

Watch point: Evidence of sustained moderation in core inflation or a clearer slowdown in household demand would likely temper tightening expectations, while continued strength in price and spending data could keep policy bias firm.

INTEREST RATE MARKET FUTURES

Treasury yields are lower following January’s CPI print, which reinforced a broader disinflation trend, but services inflation remained the stickier component, limiting potential downside in yields. The 10-year yield is 1.7 bps lower to 4.087% and finding resistance at the 4.075% level. Core prices rose 0.3% month-over-month in January, a modest pickup from December’s 0.2% pace, suggesting underlying inflation pressures remain present even as the broader year-over-year trend continues to ease. The increase was driven largely by services categories, reinforcing the view that wage-sensitive components of inflation are cooling gradually rather than decisively

Services inflation in the January CPI report remained firm despite broader disinflation in goods and energy, with transportation and medical services offsetting continued but gradual cooling in shelter costs. The persistence of wage-sensitive categories reinforces the view that domestic price pressures are easing only incrementally rather than collapsing outright. Paired with resilient labor data, the report supports a patient Fed stance, limiting the scope for near-term easing even as the broader inflation trend continues lower.

Markets remain centered on a July rate cut, with some probability assigned to a June move. Money markets are pricing around 59.6 bps of total easing by year end.

Despite the substantial revisions to 2025’s data, January’s NFP figures supported the case for hawks on the FOMC with signals pointing to a stabilization in the labor market. The unemployment rate edged down to 4.3%, even as the labor force as the labor force participation rate increased from 62.4% to 62.5%, reinforcing the narrative of a low-hire/low-fire environment. Broader labor supply dynamics remain a point of uncertainty, particularly as administration policies immigration are likely to weigh on net workforce growth in 2025.

Watch point: With labor data pointing to continued stability and January’s core inflation rising 0.3% on the month, even as the year-over-year pace eased slightly, a summer rate cut remains the base case rather than an imminent move. Attention now turns to weekly jobless claims for incremental signals on labor momentum ahead of the next monthly employment reports.

The spread between the two- and 10-year yields is 64.60 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.433%.

 

 

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