Inflation Is Cooling — January US Inflation Update
Impact on interest rate expectations and S&P 500’s risk‑reward dynamics
Executive Summary
Release Summary: January CPI slowed to 2.4% YoY, below expectations, led by energy declines and continued shelter deceleration—signaling disinflation without demand damage and easing equity discount-rate pressure.
Regime Analysis: Inflation remains in the Q2 moderate-inflation regime, historically associated with ~13% 1Y S&P 500 TR returns and a ~90% hit rate, favoring earnings-driven compounding rather than valuation compression.
Forward-Looking Signals: Investor focus centers on energy prices, shelter momentum, and labor costs. Absent renewed pressure, a low but persistent inflation backdrop supports equity duration and valuation stability.
Release Summary
Headline
January 2026 headline CPI (NSA, YoY): 2.4%.
Inflation fell from December’s 2.7% and came in below consensus (2.5%), marking the lowest YoY reading since May 2025 and a third consecutive downside surprise. For investors, the key signal is not just lower inflation, but disinflation without evidence of demand impairment, which preserves earnings durability while easing valuation pressure from rates.
Key Drivers
Energy: Prices declined 1.5% m/m, led by gasoline, providing the bulk of the downside surprise. This channel remains volatile but is currently a net tailwind to headline inflation.
Shelter: CPI shelter rose only 0.2% m/m, pushing YoY shelter inflation toward ~3%. Given shelter’s >⅓ CPI weight, this deceleration meaningfully lowers inflation persistence and reduces the probability of renewed policy tightening.
Food: Modest at +0.2% m/m, neutral for the broader inflation narrative.
Market-Relevant Second-Order Effects
Growth: Lower energy costs and easing shelter inflation support real disposable income, helping consumption normalize rather than contract. This reduces downside risk to cyclically exposed earnings.
Rates and policy: The downside surprise increased confidence in earlier Fed easing, compressing inflation risk premia and pulling yields lower on release. For equities, this improves discount-rate dynamics without sending a recessionary signal, a favorable combination for risk assets.
Regime Analysis
Regime definition. Inflation regimes are defined by quartiles of US headline CPI (NSA, YoY). Q1 represents the lowest inflation outcomes, Q4 the highest. The current environment sits in Q2, consistent with mid-cycle disinflation rather than deflationary stress.
Q1 – Low inflation / disinflation.
Historically the strongest equity regime. Mean 1Y return ~16.2% with a ~89% probability of positive returns, driven primarily by falling discount rates and multiple expansion. This regime underperforms only when low inflation coincides with collapsing demand.
Q2 – Moderate inflation (current regime).
Equity outcomes remain attractive but normalize: mean 1Y return ~13.1% with a ~90% hit rate. Returns are earnings-led rather than valuation-driven, as growth holds up while policy risk premia compress gradually. This regime deteriorates if inflation re-accelerates and forces a hawkish policy reversal.
Q3 – Elevated but not extreme inflation.
Near-term performance is volatile, but longer-term outcomes are strong (mean 3Y ~50.9%). Pricing power and nominal growth support revenues, though higher rates cap multiples. Investor payoff requires patience rather than tactical timing.
Q4 – High inflation stress.
The weakest equity regime. Mean 1Y return ~4.2% and ~64% probability of positive returns reflect rapid multiple compression as policy credibility and discount rates dominate earnings growth. Durable equity recovery typically begins only after inflation clearly peaks.
Equities are not linearly harmed by inflation; they are harmed by policy-forcing inflation. The current Q2 regime historically supports steady compounding via earnings growth, with materially better risk-adjusted outcomes than high-inflation environments.
Forward-Looking Signals to Monitor
Energy prices: Front-month crude and retail gasoline remain the fastest transmission channel into headline CPI. Sustained stability or declines extend disinflation; a sharp rebound would quickly revive headline volatility and policy sensitivity.
Shelter momentum: Market-based rents and new-lease data continue to lead CPI shelter lower. With shelter at ~⅓ of the CPI basket, continued deceleration is the key anchor preventing inflation persistence.
Labor costs: Unit labor costs and services wages are cooling gradually. This is the most constructive outcome for equities—services inflation moderates without an unemployment spike that would undermine earnings.
Bottom line. Inflation risk has shifted from upside re-acceleration to persistence at a lower plateau. This backdrop supports equity duration and multiple stability, with downside risk concentrated in an energy or wage-driven inflation re-ignition that forces renewed policy tightening.
This report has been written entirely by our AI macro research analyst.
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