U.S. CPI cools down, but why is the market unresponsive? The data is distorted; the key is to watch next week’s PCE.

U.S. CPI cools down, but why is the market unresponsive? The data is distorted; the key is to watch next week’s PCE.

The US December CPI data appears mild at first glance, but is actually a “fake move” full of pitfalls. According to the latest research reports from Deutsche Bank and Morgan Stanley, this “positive” report is filled with unsustainable noise and statistical distortions. The real test is next week’s PCE data!

According to a Wallstreetcn article, data released by the US Bureau of Labor Statistics on January 13 showed that December CPI met expectations year-on-year and month-on-month. Core CPI rose 2.6% year-on-year, the lowest since March 2021 and below the expected 2.7%; month-on-month was 0.2%, also below the expected 0.3%.

Although December CPI seems to provide evidence for cooling inflation, the market reaction was muted, and investors have yet to see this as a signal for the Fed to accelerate rate cuts. On January 14, according to Chase Trading Desk, Deutsche Bank and Morgan Stanley believe the key reason is: the data may be distorted, and the core PCE inflation gauge, which truly determines the Fed’s policy path, is expected to rebound significantly.

Deutsche Bank analysts bluntly stated in the research report that the December CPI data is "filled with distortions and anomalies," and part of the cooling was due to an unusually sharp drop in information technology products and wireless phone services, which together dragged down core CPI by about 6 basis points. Excluding these outliers, Cleveland Fed’s Trimmed Mean CPI and Median CPI were 0.31% and 0.28% respectively, both stronger than core CPI, indicating that underlying inflationary pressure is actually more stubborn.

Morgan Stanley, meanwhile, warned in its report that despite core CPI being below expectations, its model suggests that the core Personal Consumption Expenditures (PCE) price index in December may reach a monthly rate of 0.46%, far higher than the CPI performance. This abnormal divergence arises from differences in category weights between the two indicators—items with higher weights in PCE saw bigger price increases. According to the Wallstreetcn calendar, the November core PCE price index report will be released next Thursday.

The market now needs to wait for next week’s PCE data to confirm the true inflation trend. Analysts believe that if PCE rebounds as expected, the Fed’s room for further rate cuts will be significantly constrained.

Deutsche Bank breakdown: CPI “inflated”, anomalies hide true inflation rigidity

The cooling in December CPI data is largely due to technical factors.

Deutsche Bank pointed out that information technology product prices dropped by 2.16%, wireless phone services by 3.33%, with both combining to drag down core CPI by about 6 basis points. These abnormal swings do not represent a persistent trend.

Indicators that better reflect underlying inflation tell a different story.

According to the report, the Cleveland Fed’s Trimmed Mean CPI rose 2.95% year-on-year after excluding outliers, and the Median CPI rose 3.08%, both significantly higher than core CPI’s 2.64% year-on-year growth. This suggests that after removing extreme fluctuations, inflationary pressure is actually more entrenched.

At the goods level, clothing prices increased by 0.59%, the second largest monthly gain since February 2025; household goods prices increased by 0.54%, third largest since November 2024.

Deutsche Bank believes this may reflect the correction of distortions caused by previous government shutdowns that delayed data collection. The November data collection was closer to the holiday sales period, artificially suppressing that month’s data, while December saw a reverse adjustment.

Deutsche Bank’s report says housing rents are showing signs of a rebound. Primary residence rent monthly rate rose 0.26%, and owners’ equivalent rent rose 0.31%, both returning to the average growth rate of the first nine months of 2025.

The bank particularly pointed out that this rebound was not due to missing data from a government shutdown (related impacts will appear in April), but was actual price increases. While the market generally expects rental deflation, this data undoubtedly throws cold water on that view.

Morgan Stanley warning: Huge “wedge”, next week’s PCE could see a stunning rebound

This may be the most overlooked risk point in the current market.

Morgan Stanley warns that a huge “wedge” is forming between CPI and PCE. Based on this seemingly mild CPI report, Morgan Stanley sharply raised its forecast for core PCE.

The bank raised its forecast for the core PCE monthly rate in December from 0.37% to 0.46%, a calculation based on detailed CPI data, but the conclusion is completely contrary to overall CPI performance. This divergence is rooted in the fundamental difference in weighting allocation in the two inflation indicators.

Categories with higher weights in PCE performed strongly in December. Video media rental prices soared by 19.5% month-on-month, contributing about 8 basis points to core PCE; software price increases contributed another 8 basis points.

Morgan Stanley says, if these two items are excluded, the core PCE monthly estimate drops to 0.30%, but both are prominent in the PCE basket.

Additionally, Morgan Stanley estimates core goods PCE month-on-month rate reached 0.46%, far higher than the flat performance of core goods in CPI. This difference comes from the weakness of new and used cars in CPI, but faster rising prices for appliances, software, electronics, etc., which carry higher weights in PCE.

Analysts point out that this divergence poses a dilemma for the Fed. CPI, the best known inflation indicator, shows cooling inflation and could strengthen expectations for rate cuts; but the PCE indicator which the Fed really watches may show inflation re-accelerating. If Morgan Stanley’s forecast is correct, December core PCE year-on-year will rise to 2.90%, far above November’s 2.67%.

Tariff effects beginning to show

Signs of tariff shocks have started to surface in inflation data. Both Deutsche Bank and Morgan Stanley have noted the continued impact of tariffs on goods prices.

Morgan Stanley’s breakdown shows that goods more sensitive to tariffs rose again in December, continuing the upward trend after brief softness in October and November.

Deutsche Bank specifically pointed out that although apparel prices have not yet clearly reflected tariff impacts, pressure is building upstream in the supply chain. Import prices and producer price index (PPI) for apparel show pipeline pressure is forming. This means price increases for consumers may be just a matter of time.

How will the Fed react?

Analysts believe the Fed is unlikely to rush into signaling further rate cuts in the face of noisy data.

Deutsche Bank made it clear that December CPI data is a blend of distorted November data corrections and genuine signs of weakness, and the Fed is “likely to want to see more data before becoming comfortable enough to signal further rate cuts.”

Morgan Stanley believes the Fed can discern the “noise” in the data and “will likely downplay the apparent strength shown in core PCE calculations.” But even so, the uncertainty in the data is enough for the Fed to remain cautious.

Risk Warning and DisclaimerThe market has risks, investment needs caution. This article does not constitute personal investment advice nor consider the special investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article fit their specific situation. You are responsible for your own investment decisions.