Inflation surged 0.5% in January, reaching an annualized rate of 3.0%, according to the Bureau of Labor Statistics. This follows gains of 0.4% in December and 0.3% in November.

The gains were driven by increases in gasoline prices (+1.8%), energy (+1.1%), commodities (+0.6%), air fare (+1.2%), and used motor vehicles (+2.2%).

Core inflation, which excludes volatile food and energy prices, came in above expectations, rising 0.4% to an annualized rate of 3.3%. Meanwhile, the three-month average core CPI inflation is running at a “hot” 3.8%, as noted by BMO’s Scott Anderson, well above the Fed’s 2.0% target.

“This report is probably the last thing the Federal Reserve and new Administration wanted to see,” wrote TD Economics’ Thomas Feltmate. “The first CPI reading for 2025 showed core inflation rising at its fastest pace in nearly a year, amid a further uptick in goods prices and ongoing stickiness in services inflation.”

Feltmate also pointed out that the surge in core inflation is the largest month-to-month increase seen since March of 2024. 

Impact on Canadian bond yields and interest rates

Rising inflation in the U.S. could lead to higher interest rates in Canada, driven by an increase in Canadian bond yields.

Bruno Valko, VP of National Sales at RMG, emphasized the importance of watching the connection between U.S. inflation and Canadian bond yields.

“Unfortunately, because the Canada 5YR is influenced by the 10YR [Treasury], which is influenced by the U.S. Inflation rate, even though Canada’s inflation is below the central bank’s mutual target of 2%, our 5YR yields are rising today on the bad inflation data from the United States,” he wrote in a note to subscribers.

Canada’s 5-year bond yield surged nearly 10 basis points to 2.88% before easing somewhat.

While rising U.S. inflation is concerning, Scotiabank’s Derek Holt views today’s release as one that “doesn’t matter” given the other factors at play. 

“Why doesn’t this CPI report matter? One reason is because the FOMC is very clearly on hold for the March 19 FOMC, and so nothing immediately hangs on this report,” he wrote.

Holt added that tariffs and a range of incoming economic data are more significant overall than a single CPI report. “That’s the bigger picture in my opinion, whereas this CPI report just doesn’t cut it.”

‘Higher-for-longer’ interest rates back in play

However, today’s inflation data did cause futures markets to push back the Fed’s next anticipated rate cut to December. Prior to the release, markets were fully priced in for a rate cut in September.

BMO’s Anderson highlighted the Fed’s growing caution regarding future rate cuts, noting that “higher-for-longer interest rates is becoming the mantra again.”

“The problem for the Fed is this isn’t just a one-month event, but looks like a real multi-month firming of inflation pressures,” he wrote.

“It will make the FOMC, which is already cautious and patient regarding future rate cuts, even more so,” he added. “This is especially true as we await new announcements on sizeable import tariffs. The risk of Fed rate hikes, while still low, is going up.”

bond yields brett Surbey CPI inflation derek holt economic fed federal reserve rate outlook Scott Anderson Thomas Feltmate trends U.S. CPI

Last modified: February 12, 2025