December CPI came in at +0.4% m/m (+2.9% y/y), in-line with consensus. However, Core CPI actually missed to the downside at +0.2% m/m (+3.2% y/y), 10 basis points below consensus, mostly thanks to cooler services inflation.
Key points are as follows:
- While still high in absolute terms, Services inflation growth is now downward sloping, actually helping to contain Core CPI. As such, we still think this pattern will ultimately allow the Fed to cut rates twice this year, in contrast to recent market pricing for ‘no landing’ and just one rate cut.
- With that said, we believe we are not out of the woods yet, as we continue to expect more volatile Goods inflation in coming months as prices rise in response to tariffs, wildfires, and bird flu. Reflecting these upside risks to goods prices, we are revising up our 2025 headline CPI forecast slightly to 2.8% from 2.6% currently (and consensus of 2.5%).
- On rates, we stick to our call that the Fed is on pause until the back half of the year amidst higher inflation uncertainty (we are still using two cuts for the full year), and we continue to see the 10-year trading in the 4.5-4.75% range in 2025 before settling around four percent in 2026.
What does this mean for markets?
This report is obviously market constructive. Our biggest take-away is that, while 3.2% y/y is a high number in an absolute sense, our Regime Change thesis does not include a runaway inflation forecast. To review, inflation hit seven to nine percent during a period of significant government stimulus and a major geopolitical event (Russia’s invasion of Ukraine). No doubt, we are a long way from pre-COVID inflation, a period defined by the Fed missing its inflation target consistently amidst a loose monetary, tight fiscal regime. Our view is that the current regime includes a two to four percent inflation environment where there is more variability around that inflation, driven by bigger deficits (read: heavier government spending), heightened geopolitics, a messy energy transition, and sticky inflation trends.
In terms of specifics, this report will weaken the dollar, cap longer-term yields, and send risk assets higher. That viewpoint is consistent with our Glass Still Half Full outlook. The longer-term trends, which is where we spend time at KKR, are more important, though, and we think that they suggest the following mega themes to invest behind:
- Get long productivity stories. In a world of higher input costs, including wages, the corporate sector is going to heavily direct resources to improving productivity. At KKR, we want to invest behind this transition.
- Focus on capital heavy to capital light opportunities. We are playing this theme across insurance, consumer receivables, and housing, as well as through corporate carve-outs, especially in PE and Infra.
- Security of everything. Corporates want more resiliency around global supply chains, including security of data, transportation, water, energy, etc. As the world moves towards more regional economies versus one synchronized, integrated global economy, there are literally trillions of dollars of investment required.
- Own picks and shovels of the AI boom. From our perch at KKR, we believe governments around the world, especially in the U.S., will invest heavily to secure energy sources. Data centers, pipelines, cooling technology, and other services companies will all be required to support a mega-theme that currently is seeing almost 25% of total technology capex coming from the Mag Seven.
- Collateral-based cash flows. We remain bullish on these type of investments in Infra, Asset-Based Finance, segments of Real Estate, and parts of Energy, that become more valuable in a higher nominal GDP environment. In the inflation environment that we envision, multiple expansion will likely occur across this thematic, we believe.
