This week’s inflation data had a little something for everyone.
The headline PPI (Producer Price Index) was softer than expected, coming in at 3.3% y/y vs. an expectation of 3.5%. The headline CPI (Consumer Price Index) was lukewarm, matching the consensus forecast of 2.9% y/y.
Looking at the rate of change, inflation accelerated versus November, with PPI rising from 3.0% to 3.3% and CPI rising from 2.7% to 2.9%. Regarding macro data, RiskBridge believes the rate of change matters more than the level.
Roughly 36% of CPI is attributed to shelter/rent, which peaked at 7.7% in April 2023 and was 4.6% in December. Based on our national rental market data analysis, this inflation component could decelerate at an even faster clip starting in March or April.
Still, the consensus forecast for full-year 2025 CPI is 2.5%, down from 3.0% in 2024. Again, the rate of change matters more than the level.
Investment Implications
Coming into 2025, there is no more hotly debated question than what is going on with the bond market. Yields bottomed on the day the Fed began cutting (September 18), and the 10-year Treasury yield spiked 100-bps in a straight line from mid-September to yesterday (January 14).
One camp argues that the Fed made a mistake by cutting 50 bps in September, citing a rise in inflation breakeven yields as a signal that inflation risks are back. The December PPI and CPI data suggest that inflation and the economy are not overheating.
Another camp argues that the Fed was right to loosen policy because the market (inverted yield curve) had priced in a high probability of a recession back in September. A stronger-than-expected labor market and a positive 33 bps yield curve (10-yr minus 3-mo) infer that the threat of a recession is gone.
There is a third camp, to which RiskBridge belongs, that believes economic growth and inflation are just fine (“growing but slowing”). Still, the spike in bond yields reflects a growing risk of lending one’s money to a U.S. government with a 123% debt-to-GDP ratio and a budget deficit of 6% of GDP.
After a 40-year bond bull market driven by falling rates (from 15% in 1981 to 0% in 2020), RiskBridge believes that, in the long term, we have entered a new regime of higher interest rates, driven by an expanding (and positive) term premium). This view is supported by (i) the potential for deficit-fueled fiscal stimulus, (ii) wage inflation due to immigration policy, (iii) goods inflation due to tariffs, and (iv) a US government generally tolerant of inflation overshoots to help address the US government’s $1 trillion annualized debt service cost.
Over the next year, we expect the 10-year Treasury yield to trade between 5.00% and 5.25%.
In the near term, however, we believe this week’s inflation data removes the threat of runaway inflation and is consistent with a pause in the Fed’s rate-cut cycle. This should halt the contraction in stock market valuation multiples, which, in our view, drove negative stock market returns in the first two weeks of 2025.
All data sourced from Bloomberg as of 01/15/2025 unless noted otherwise.
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