The 10-year Treasury yield retreated after the release of December CPI data, with breach of the rising trendline signaling a correction to test support at 4.5%.
However, the monthly chart below shows the long-term uptrend is unchanged, with the 10-year yield expected to reach 5.0%. Breakout above resistance would warn of an advance to 6.0%.
CPI Inflation
Core CPI (ocher) dipped slightly to 3.2% for the twelve months to December, while headline CPI (red) increased to 2.9%, holding stubbornly above the Fed’s 2.0% target.
Monthly data shows a sharp spike in headline CPI in December, increasing at an annualized rate of 4.7%. Core CPI, however, slowed to 2.7% (annualized).
Energy
The difference is energy costs, excluded from core CPI, which jumped 2.63% in December, warning of rising energy prices in 2025. The December increase equates to an annualized rate of more than 30%.
Energy prices are a key vector for transmitting inflation. Prices rise steeply during a boom as expanding demand outstrips inelastic supply, and the opposite occurs during a recession when falling energy demand causes a surplus. Energy prices (orange below) rose ahead of headline CPI (red) in 2021 and fell ahead of its subsequent decline in 2022 – 23.
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Services
CPI for services (excluding shelter) was a low 0.099% in December or 1.2% annualized. Services generally indicate more persistent inflation, so the Fed will likely treat this as a win.
Long-term Inflation Outlook
Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.
We do not anticipate a significant hike in CPI in early 2025, but there are warning signs of a rebound.
Brent crude has climbed to above $80 per barrel on fears that new sanctions on Russian shipping will impact supply. Retracement that respects support at $80 would confirm another advance.
Stocks
Mega-cap technology stocks rebounded from yesterday’s fall, with the two most volatile Nvidia (NVDA) and Tesla (TSLA) showing gains.
The S&P 500 index recovered above resistance at 5850, indicating another test of the high at 6100.
Large caps also enjoyed support, with the equal-weighted index ($IQX) testing resistance at 7200. Breakout would indicate another test of 7600.
Growth stocks rebounded from their recent sell-off relative to defensive stocks. However, the Russell 1000 Large Cap Value ETF (IWD) has outperformed the Russell 1000 Large Cap Growth ETF (IWF) over the past month.
Financial Markets
Bitcoin is again testing resistance at $100K. Reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds, but there are signs that financial conditions are easing. Breakout above $100K would confirm.
Expanding liquidity is partly attributable to a $350 billion fall in Fed overnight reverse repo operations in January after an equally sharp rise in December caused a contraction.
The Chicago Fed National Financial Conditions Index declined to -0.63 on January 10, suggesting similar financial easing to 2021.
Moody’s Baa corporate bond spread has also narrowed to 1.44%, the lowest since the 1990s, which indicates ready credit availability.
Gold
Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.
The monthly chart below shows the long-term view, where breakout above resistance at $2,800 (green) would offer a target of $3,600.
Conclusion
Our three pillars supporting financial markets are 10-year Treasury yields, crude oil prices, and financial market liquidity.
Financial market liquidity is strong and supports demand for stocks and bonds with easy access to leverage.
Crude oil prices have been subdued since 2023, with strong production from non-OPEC+ producers (especially the US) and weak demand from China. However, geopolitical tensions now threaten supply, with Brent crude rising above $80 per barrel. The risk is that higher energy prices cause a resurgence of inflation and drive up long-term interest rates.
Inflation concerns over a tight labor market were temporarily allayed by December’s weak core CPI and services CPI growth. However, rising energy costs will likely increase input costs, causing a rebound in the months ahead. Market concerns over inflation are expected to grow as the incoming administration attempts to stimulate an economy already at close to capacity. The 10-year Treasury yield may briefly retrace to test support but is then likely to continue its long-term uptrend. Breakout above 5.0% would offer a target of 6.0%, which would be bearish for stocks and bonds.
We are underweight growth stocks trading at high earnings multiples and are avoiding financial instruments with a duration longer than two years.
Gold will likely benefit from a higher long-term inflation outlook and rising geopolitical tensions. We are overweight gold and defensive stocks trading at reasonable multiples relative to earnings.
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