Inflation Views – December 2024

Welcome to Prometheus Asset Allocation. The Prometheus Asset Allocation program offers a stable, macro-focused approach to asset management. Prometheus Asset Allocation aims to outperform a traditional stock and bond portfolio by leveraging our proprietary systematic macro process to rotate between 3 ETFs monthly (plus cash). As part of the program, we will be sharing our views on Growth, Inflation, and Liquidity in addition to our monthly video updates.

In today’s note, we dive deep into our inflation views. Our primary takeaways are as follows:

• The latest CPI data surprised consensus expectations and drove an acceleration in the three-month inflation trend.
• This print was dominated by food and energy inflation, particularly motor fuel and gas prices.
• Macro pressures continue to show potential for inflation in aggregate nominal spending; however, labor markets and production have begun to see significantly lower inflationary pressures.
• In the context of markets, deteriorating inflationary pressures continue to remain supportive of stocks and bonds. This is reflected in our Prometheus Asset Allocation Strategy.

We begin with our proprietary inflation index, which offers us a daily real-time insight into the pressures on future CPI. This measure continues to show downward pressures on inflation, though these pressures have been sequentially increasing over the last month.

Our inflation measures suggest modestly negative but sequentially increasing inflationary forces are likely to make their way into PPI, CPI, PCE, and the GDP Deflator. Given the centrality of CPI to both the construction of PCE and its importance for markets, we focus on today’s CPI release in this report before zooming out to the big-picture dynamic.

In November, headline CPI came in at 0.31%, surprising consensus expectations of 0.3%. Core CPI contributed 0.25% to this print, with food & energy contributing the remaining 0.07%. This print drove an acceleration in the three-month trend. Below, we display the sequential evolution of the data:

The primary drivers of CPI inflation are food, energy, transport, and shelter. These components have contributed 0.05% (Food), 0.01% (Energy), 0.05% (Transport), and 0.12% (Shelter), respectively. We display these contributions to the 0.31% change in CPI below:

As we can see above, shelter was the primary driver of inflation this month. This dynamic is line with historical contributions.

For further perspective, we show how these areas have accounted for the majority of variation in inflation both economically and statistically. Over the last year, food, energy, transport, and housing have contributed 0.32% (Food), -0.21% (Energy), 0.34% (Transport), and 1.71% (Shelter), respectively, to the change in inflation. We display these principal drivers of inflation over time below:

We now zoom back into the most recent print. Inflation was somewhat mixed with Shelter contributing most positively, and Education & Comms Services contributing most to weakness. We display the largest movers to the upside and downside below:

We now zoom into our major categories of food, energy, transport, and shelter. We begin with food. The most recent data showed food inflation was largely positive, with Meats, Poultry, Fish, and Eggs showing the most relative strength and Cereals and Bakery Products showing the most weakness.

For further perspective, we also show the evolution of food inflation over the last year with the strongest contributors in shades of blue (Limited Service Meals & Snacks, Full Service Meals & Snacks, Meats, Poultry, Fish and Eggs) and the weakest in shades of red (Cereals and Bakery Products, Food From Vending Machines & Mobile Vendors, Other food at home):

Next, we turn to energy. The most recent data showed that energy inflation was somewhat mixed, with motor fuel showing the most relative strength and electricity showing the most weakness.

We also show the contributions of these items to total energy inflation over the last year with historical context:

We now turn to transportation. The most recent data showed transport inflation was somewhat mixed, with Used Vehicles showing the most relative strength and Vehicle Fees showing the most weakness.

For further perspective, we also show the evolution of transportation inflation over the last year with the strongest contributors in shades of blue (Vehicle Insurance, Vehicle Maintenance & Repair, Public Transportation) and the weakest in shades of red (Used Vehicles, New Vehicles, Vehicle Rental):

Finally, we examine shelter, which is the largest driver of consumer inflation in the economy. The most recent data showed shelter inflation was largely positive with Owners Equivalent Rent showing the most relative strength and Housing Insurance showing the most weakness.

We also show the contributions of these items to total shelter inflation over the last year with historical context:

We now zoom out to the broader macroeconomic picture, which drives large moves in inflationary pressures. We begin by examining nominal spending growth relative to interest expense as a barometer of inflationary potential.

Spending growth less interest remains moderately aligned with inflation. However, any further divergence will be a headwind for inflation.

Next, in our macroeconomic assessment, we turn to production relative to existing capacity constraints, which determine the tightness of output conditions. The more tightness, the more the inflationary pressure:

As we can see above, capacity utilization remains in the contractionary zone i.e., a headwind for inflationary pressures.

Completing our macro assessment, we examine the growth of employment relative to labor force growth as a measure of tightness in the labor market. The higher this measure, the more upward pressure on service employment:

Finally, we turn to our systematic projections for CPI based on the constellation of current CPI prints, and macro conditions. Our current programmatic estimates point to a monthly average annualized CPI rate of 2.55% over the next twelve months. This is a substantial increase from last month’s estimates, primarily driven by energy and food inflation. We visualise this below:

Overall, the latest CPI data surprised consensus expectations and drove an acceleration in the three-month inflation trend. This print was dominated by food and energy inflation, particularly motor fuel and gas prices. Looking under the hood, we find that idiosyncratic geo-political risks were a primary driver of this upward pressure. Macro pressures continue to show potential for inflation in aggregate nominal spending; however, labor markets and production have begun to see significantly lower inflationary pressures. In the context of markets, deteriorating inflationary pressures continue to support stocks and bonds. This is reflected in our Prometheus Asset Allocation Strategy.