Inflation Comes in Soft, but Markets Remains On Edge

• Core CPI rose 0.2% monthly and 2.6% annually, both 0.1 percentage point below forecasts, giving the Fed cover to remain patient on rate policy
• CME FedWatch Tool shows 97.2% odds of no rate change in January, but 47% probability of at least one 25-basis-point cut by June 2026
• U.S. CAPE ratio ended 2025 at 40, a level historically associated with negative 10-year real returns and potential for a 'Lost Decade' similar to 2000-2009

Market Summary: Inflation Data and Fed Policy Outlook

Key Economic Data:

The latest Consumer Price Index (CPI) report met or beat expectations, with headline CPI rising 0.3% monthly and 2.7% year-over-year as forecasted. Core CPI increased 0.2% monthly and 2.6% annually—both 0.1 percentage points below expectations. Despite remaining above the Fed's 2.0% target, these figures suggest inflation is stabilizing rather than accelerating.

Federal Reserve Implications:

The January 28 FOMC meeting has a 97.2% probability of maintaining current rates, according to CME's FedWatch Tool. Market expectations point to the first potential 25-basis-point cut in June, with 47% odds of a single cut and over 20% probability of 50+ basis points in reductions. Analyst Louis Navellier predicts at least two rate cuts in 2026.

Fed Leadership Uncertainty:

The race to replace Fed Chair Jerome Powell between Kevin Hassett (currently 33% odds) and Kevin Warsh (39% odds) adds market uncertainty. Both candidates must balance Trump's preference for rate cuts against Congressional concerns about Fed independence. Senator Thom Tillis has threatened to block nominees pending resolution of a Justice Department investigation into Chair Powell.

Market Valuation Warning:

The U.S. CAPE ratio reached 40—a historically elevated level. Analysis shows countries with CAPE ratios exceeding 40 have never achieved historical 10-year real return averages, suggesting potential for a "Lost Decade" scenario of stagnant returns rather than dramatic crashes.

Investment Strategy:

Analysts recommend shifting from buy-and-hold strategies to selective, nimble approaches given elevated valuations and narrow market leadership, emphasizing stock-picking over broad index investing.