Looking ahead to 2025 and the upcoming Trump 2.0, will inflation risks return? What kind of resistance will the Fed encounter in cutting interest rates? Can the dollar remain strong?

US core inflation fell slightly

The US CPI rose 2.9% year-on-year in December, in line with expectations. The previous value was 2.7%, which was the third consecutive month of increase and the highest growth rate since July. However, the core CPI (excluding food and energy) unexpectedly fell to 3.2%, which had remained at 3.3% for the previous three months. The super core service CPI (core service CPI excluding rent) fell to the lowest level since July at 0.21% on a monthly basis.

From the perspective of the CPI composition in December, the 2.6% month-on-month increase in energy prices was the main reason for the overall CPI increase, and under the service item, the price increase of transportation services (especially air tickets) was the most obvious. However, the rent price, which accounts for one-third of the CPI weight, maintained a moderate growth, with the year-on-year growth rate falling to 4.6% (monthly rate of 0.3%), but this is still higher than the average level before the epidemic.

Trump 2.0 and inflation stickiness

In the short term, the stickiness of inflation may come from the recovery of energy prices and the high housing costs. Especially in a high interest rate environment, the low willingness to buy houses leads to strong demand for rentals, and rents may continue to remain at a high level for quite some time. In addition, the Los Angeles fire will also raise rents and housing reconstruction costs to a certain extent. It is worth noting that even if rents are reduced, there will be a lag, and it will take some time to be reflected in the CPI.

In the medium and long term, with the arrival of Trump 2.0, his policy combination of “tax cuts and expulsion of illegal immigrants at home + high tariffs abroad” has the risk of pushing up inflation again. The latest University of Michigan’s inflation expectations for the next 1 year and 5-10 years have both risen to 3.3%, the latter of which is the highest level since 2008. The expectation of rising inflation will prompt companies and individuals to rush to buy and stock up before high tariffs are implemented, which may make it difficult for inflation to fall in the short term.

The Fed’s interest rate path in 2025

Compared with other major economies, the current US job market and economic operation remain stable. Coupled with the potential inflation risk of Trump 2.0, the Fed has made corresponding adjustments. In its economic outlook in December last year, it raised the inflation rates in 2025 and 2026 to 2.5% and 2.2%, and also reduced the full-year interest rate cut expectations to two times, clearly sending a signal of “slowing down the pace of interest rate cuts.”

However, there are more hawkish voices in the market. After the release of the inflation data, the interest rate market’s bet on the Fed’s “only one interest rate cut” for the whole year has not changed, but the time point has been brought forward from September to June. It is worth noting that three of the four new members of the Fed’s voting committee this year are considered hawks.

For the Fed’s interest rate decision on January 30, it is almost certain to keep the interest rate unchanged. As the first interest rate meeting after Trump took office, the wording of the meeting statement and Powell’s speech at the press conference are unlikely to produce a major shift. The Fed may need more time to observe the advancement of various policies and the performance of economic data.

Can the strong dollar continue?

The US dollar index has risen nearly 10% since the end of September (see figure below), driven by the cooling of interest rate cut expectations, the threat of trade war and the brewing of risk aversion. If the upward trend line can be maintained, the next important target for bulls is the September 2022 high of 114.80, but the divergence in the figure cannot be ignored.

From the perspective of the central bank, the interest rate paths of global central banks may diverge this year. While the United States slows down or even suspends interest rate cuts, Europe may be forced to make a larger interest rate cut, the United Kingdom is likely to continue to promote interest rate cuts, and the People’s Bank of China will continue its moderately loose monetary policy. All these show that the United States is converting its relative economic advantages into its interest rate advantages (high interest rate differentials with other economies), which is beneficial to the US dollar. However, the Bank of Japan is a major variable. As the only major central bank with a high probability of raising interest rates this year, its hawkish interest rate hikes may reverse the strength of the US dollar.

From the perspective of the trade war, it is still uncertain at what speed and intensity the Trump administration will increase tariffs. The escalation of the trade war is obviously good for the US dollar. On the contrary, if the intensity and scope of the tariff policy are relatively mild, the US dollar may give up some of its gains.

In addition, uncertainties such as geopolitical risks and the US debt crisis will also greatly affect the trend of the US dollar. Trump may try to reduce or calm substantial geopolitical conflicts, but his strategic contraction of the US-first strategy and his remarks on social media may trigger another form of geopolitical turmoil.