Macro Pulse: Not Just The Price of Eggs: Inflation Starts 2025 Hot

Takeaways

• January’s Consumer Price Index (CPI) inflation figures came in hot, surpassing both prior month price growth and consensus expectations.
  
  
• CPI accelerated to +0.5% MoM and +3.0% YoY; core CPI (ex-food and energy) accelerated to +0.4% MoM and +3.3% YoY. Core services were the key upward driver, including auto insurance, airfares, and hotel costs.
      
• This inflation report does not reflect any impact of new tariffs; rather, it demonstrates a strong consumption-led economy that is clearly not in need of policy stimulus. Expectations for the 2025 Fed easing cycle have become even shallower, with just one 25bp cut priced in for 2025, most likely in the latter half of the year.
  
  
• That said, forward-looking inflation expectations appear to be pricing in some tariff impact to come. For this reason, we believe yields are likely to be higher and more volatile in 2025.
  
  
• Investors are facing a strong call away from inflation complacency. A traditional inflation hedge sleeve points us toward gold, infrastructure, and commodity exposure. More broadly, greater inflation and yield volatility urge investors to take advantage of entry opportunities in corporate credit. 

We’ve been highlighting the risk of an inflation reacceleration. Today’s data does nothing to calm these concerns.

It’s too much of a good thing. A solid jobs market, strong yield generation and equity price performance have led to above-trend economic growth and a resilient consumer, primarily among high-income households. For a while there, the balance of growth, employment, inflation, and rates looked like Goldilocks. Today, we’ve crossed back into “too hot” territory – not just with the individual January CPI report, but a burgeoning four-month reacceleration trend in core consumer price growth.

Yes, egg prices rose 15.2% in one month (thanks, bird flu), but the real story was in core CPI (ex-food and energy), where we saw broad strength in services, driven less by shelter costs this month and more by transportation costs, from auto insurance to car rentals and used vehicles. Silver linings were a few new areas of deflation – outright cost declines – in apparel and home appliances.

The market’s strong, broad-based reaction to this print points to fears of inflation itself, and its ability to disrupt Fed easing expectations.

It has been our view that well-behaved inflation reports have been a key market underpinning, allowing equities to climb and yields to avoid disruptive spikes even as economic data has come in strong and policy uncertainty mounts. Last week, we saw just how important inflation has been as a market anchor.

Right now, market pricing suggests that volatility is related to concerns about disrupting the Fed’s easing cycle. Zooming out, we’re likely to hear consternation about the neutral rate of interest, and more concerns about the potential for Fed hikes.

We still believe the bar is high for the Fed to pivot toward hikes. For one, policymakers have signaled they have little interest in seeing the labor market weaken from current levels. In addition, the higher market-interest-rate response to inflation surprises suggests that the market may do some tightening for the Fed already.

We often say that market reactions are more durable when new data reinforces an existing trend. Today’s inflation report builds on existing drivers of a moderately higher inflation environment:

• Rising inflation expectations, both market-implied and survey-based
  
  
• Potential inflationary impact of tariffs, including new 25% tariffs on steel and aluminum
  
  
• A rising term premium in U.S. Treasuries reflecting greater policy uncertainty
  
  
• New data showing active investment in longer-term inflationary themes, including digital infrastructure 
   

Let’s double click on the inflation expectations component: forward-looking measures of inflation are on the move. Friday’s University of Michigan’s consumer sentiment survey highlighted a clear focus on inflation: inflation expectations for the next year have risen from 3.3% to 4.3% in the past month alone. Market-based measures of inflation (swaps, breakevens) signal a similar concern.

Though the stability of long-term inflation expectations show confidence that the Fed will maintain price stability in the medium and longer term, near-term volatility matters for asset allocation.

Allocation takeaways: anti-complacency options for inflation risk

As long as economic growth remains strong – and last week’s jobs report is at least a backward-looking indicator of this likelihood – today’s print does not mean we need to dust off the stagflation playbook.

• Duration: We have estimated that amid current policy uncertainty, the range for the 10-year Treasury yield could reach 5%. This means that even with the 10-year sitting comfortably above 4.4% since December, we have recommended that investors that can consider adding duration only tactically in Treasuries. Our longer duration bet is, and has been, in the upward-sloping portions of municipal bond curves.
  
  
• Traditional inflation hedges: Between gold and Bitcoin, the proven track record in inflation hedging has been with gold. Infrastructure bonds and equities, real estate, and commodity exposure also fit into a traditional “inflation beneficiary” sleeve of a portfolio.
  
  
• Equity risk: We’ve seen from 2022 that inflation itself can be a boon to corporate earnings quality when companies successfully pass costs along to consumers. While inflation itself is not necessarily a threat to equity positioning, the knock-on impacts of higher market-determined yields can certainly represent a pressure to valuation and sentiment. We are staying invested but diversified, more inclined to deploy new capital toward large cap value equities than growth equities.
  
  
• Attractive entry points in credit: Ongoing upside risks to bond yields also point us to compelling entry points across U.S. corporate credit, within which we have highest conviction in high yield corporate credit. We are not worried about credit quality yet - resilient economic growth is bolstered by solid capital management in our view- but short-duration positions can help address concerns about near-term yield volatility. We particularly like the high-quality segment of the U.S high yield asset class.
   

Structural positioning questions: As U.S. growth, inflation, and yields have outperformed their developed-market peers, we've seen a stronger impulse towards an overweight in U.S. assets and the U.S. dollar. We agree with this overall positioning, but highlight that a more robust policy-rate cutting cycle in non-U.S. markets has contributed to faster credit growth and deal flow in some regions. As many global investors are heavily underweight ex-U.S. assets already, investors may consider opportunities to broaden global exposure.