Priceless
Our first inflation prints of 2025 hit the wires this week and they were generally better than expected. The Consumer Price Index (CPI), which usually gets the most attention, came in close to estimates for headline data (including all items), and below estimates for the core measure (excluding food and energy).
With investors’ renewed focus on inflation, this is an encouraging sign and one that took some nerves out of markets, at least for now. Treasury yields fell and stocks rallied on the news Wednesday.
Moreover, Wednesday’s CPI data came on the heels of Producer Price Index (PPI) data from Tuesday, which was cooler than expected. PPI measures inflation from the perspective of producers instead of consumers, and reports the change in prices received on a wholesale level. It is often looked at as a read on economic activity and sometimes as a leading indicator for CPI.
Although the chart below shows a recent steady rise in PPI, markets are more concerned with how the data looked relative to expectations, hence the supportive backdrop. It’s also worth noting that a healthy - but not hot - PPI can be an indication of supportive business activity.
Tracking the Warts on the Story
For months, we’ve been paying close attention not only to the broad inflation numbers, but also the components that are keeping it elevated such as shelter and car insurance. Shelter data actually cooled in December, which is a step in the right direction, but much of the driver of elevated shelter prices has been low housing turnover due to high mortgage rates. There is still more progress to be made on that front. If we put the components of CPI into buckets based on how much they’re rising, we are seeing evidence that the pieces of inflation that have caused some of the biggest problems are becoming… less of a problem. Importantly, the chart below shows the percentage of components with readings above 4% month-over-month annualized, which has come down markedly since the middle of last year. That’s good news.
It’s not lost on us that the yellow line representing the components with CPI between 2-4%, which is technically above the Federal Reserve’s inflation target, has spiked recently. However, that’s being driven primarily by components slowing from an above 4% pace rather than an acceleration from those below 2%. We certainly have not reached a “problem solved” state of affairs yet, but this data does not show any compelling signs of danger and I think we can take it as a positive.
Seasons Change
As we move into 2025 data, there’s something to keep in mind about seasonality – if for no other reason than to encourage ourselves not to overreact in coming months. Businesses often increase prices after the start of a new year, and it’s possible that some have been more aggressive in raising prices after the high inflation of recent years. However, some economists have blamed the hot inflation prints on residual seasonality. Raw data is often adjusted to account for seasonal patterns, but that process is not perfect. If consumer and business behavior has changed post-pandemic, that could mess with the seasonal adjustment process and cause CPI to look higher than it actually is. In 2024, for example, CPI reports were hotter than expectations for January, February, March, and April. By the time April rolled around, markets were unsettled, investors had drastically repriced Fed rate cut expectations, and a bumpy spring season in the S&P 500 ensued.
The good news this year is that Fed rate cut expectations are already quite low, with markets only expecting 1-2 cuts for all of 2025. The risk is that markets again seem to be incredibly data-dependent, with big swings possible after each important macro print. Moreover, Treasury yields have been a source of concern for stocks ever since the 10-year yield surpassed 4.5%; any hotter-than-expected inflation data is likely to drive more upside in yields and pressure equity markets.
We outlined three big risks in our 2025 outlook, one of which was that inflation could reignite, causing the Fed to turn hawkish and yields to spike. As of now, inflation hasn’t reignited, but yields have spiked and markets are on edge about macro data. We should do what we can to keep a cool head as the beginning of the year unfolds.
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