Tariff transmission and the "January effect" may push up the U.S. CPI in January?

Wall Street is closely watching the upcoming release of the US Consumer Price Index (CPI) for January this Friday. Several investment banks predict a rebound in the monthly growth rate of core inflation, influenced by the “January effect” of price resets at the start of the year and the transmission of tariff costs. However, a potential slowdown in service sector inflation could be seen as an encouraging sign by the Federal Reserve.

According to Chase Wind Trading Desk, research reports from several major investment banks show that market forecasts for the monthly growth rate of core CPI in January are centered around 0.3%. Both Bank of America and Citi forecast a 0.3% monthly increase in January’s core CPI. Bank of America notes this figure reflects an acceleration in inflation at the start of the year, while Citi sees this data as on the “moderate side” of market expectations. In contrast, UBS provides a more aggressive forecast, predicting the monthly increase in core CPI could reach 0.38%, far exceeding the market consensus of 0.32%.

The focus is on the divergence between goods prices and service sector inflation. On one hand, the pass-through of tariff costs is pushing up goods prices; on the other, the seasonal strength of service sector prices is key to assessing inflation persistence. Bank of America believes that tariff transmission combined with the “January effect” will support a higher inflation reading. However, Citi points out that if the seasonal increase in service sector prices is weaker than in previous years, this would provide hawkish Fed officials with strong evidence that inflationary pressures are easing.

It’s worth noting that, due to subsequent impacts of government shutdowns, there is some uncertainty in recent data measurement and collection. Analysts warn that annual updates of seasonal factors and delayed data collection for November’s CPI could add lag effects, exacerbating volatility in January’s data and complicating market judgement of the inflation trend.

The “January effect” in core inflation and the shadow of tariffs

In previews for the January CPI, strengthening goods prices is a consensus among institutions, mainly driven by retailers' price resets at the start of the year ("January effect") and the pass-through of tariff costs.

According to Bank of America’s report, January is usually a “hot” month for inflation data. Core goods prices are expected to rise 0.40% month-over-month (0.35% excluding used cars), clearly accelerating from December. The bank notes this reflects increased tariff transmission and typical trends of price adjustments at the start of the year. Citi shares a similar view, expecting core goods prices to rise 0.31%, the strongest increase since 2023. Citi analysts note that items like furniture (+0.35%), auto parts (+0.75%), and medical goods (+0.8%) will show sellers using the annual price reset window to pass through tariff costs.

UBS’s warning on inflation risk is the most pronounced. According to their report, Adobe Digital Price Index (DPI) and Harvard Pricing Lab data show significant jumps in January online goods prices. UBS also highlights disruptions in data measurement, pointing out that late November CPI data collection caused sampling issues that will reverse in January, potentially adding roughly 5 basis points of upward impact for core goods and airline ticket prices. UBS’s current model predicts a monthly increase for core CPI anywhere between 0.28% and 0.56%.

However, Citi notes not all goods are seeing price increases, predicting apparel prices will fall 0.25% month-over-month in January, partly due to falling import prices, suggesting foreign producers are helping offset some tariff costs.

Service sector inflation: The game of seasonal factors

Although goods inflation faces upward pressure, the trajectory of service sector inflation is more divided, which will determine the January data's ultimate impact on Fed policy expectations.

Citi believes the key for January data lies in the sustained strength of service sector prices. It expects core services (excluding housing) to rise 0.39% month-over-month—a not-insignificant rise but markedly below January’s roughly 0.7% figure for each of the past two years. Citi highlights that if the residual seasonal increase in service prices is weaker than previous years, this would show underlying inflationary pressures have eased.

On housing inflation, opinions among institutions are relatively consistent. Citi expects housing prices to rise moderately by 0.23%, arguing the core trend of housing inflation slowdown hasn’t changed. UBS forecasts Owners’ Equivalent Rent (OER) will rise 0.26%, roughly in line with pre-pandemic averages, indicating long-term rent growth is slowing.

Bank of America expects service sector inflation will slightly cool compared to December, mainly thanks to lodging and airline ticket prices retreating after a strong rise in December. However, UBS reminds investors to watch for “noise” in the service sector, noting December’s abnormal volatility in components (such as moving and storage services plummeting, video rental services surging) due to data collection problems, which may see corrective rebounds in January, raising readings.

Policy path and market impact

For how the upcoming data will impact the Fed's policy path, investment banks offer differing interpretations.

Bank of America believes the current inflation situation is “not too hot, not too cold.” Although inflation has been above the Fed’s 2% target for the past five years, unless demand-driven inflation significantly re-accelerates or inflation expectations become unanchored, the Fed’s stance will remain primarily driven by labor market data. Based on CPI forecasts, it projects January’s core PCE to rise 0.29% month-over-month, with year-over-year growth around 3.0%.

Citi is more optimistic, believing January and February data are key to changing market views on inflation stickiness. It says if inflation data continues to come in lower than expected during a period when seasonal factors are usually strong (the start of the year), it will help convince hawkish officials that sticky inflation is no longer a major concern. Citi maintains its expectation that the Fed will cut rates by at least 75 basis points this year.

UBS, though predicting higher short-term data, looks ahead and believes inflation will peak this spring, then gradually decline over the next few years. It expects January headline CPI year-over-year growth to drop to 2.41%. Though core CPI’s year-over-year growth may slip slightly to 2.57%, this is still the lowest since March 2021.

~~~~~~~~~~~~~~~~~~~~~~~~

The above highlights are from Chase Wind Trading Desk.

For more detailed interpretation, including real-time commentary and frontline research, please join Chase Wind Trading Desk Annual Membership

Risk warning and disclaimerThe market carries risk, and investment requires caution. This article does not constitute personal investment advice and does not take into account the special investment objectives, financial status, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific situation. Invest accordingly at your own risk.