Creep By Pave Pro | February 9, 2025
Let’s just say it was an inappropriate word…What letter did the word start with? T…it’s a word that will get you sent to the principal’s office, it’s a bad word.”
—Easy A
Keeping it a bit light considering America moves its violent clash between two opposing forces from Washington to New Orleans.
Tariffs is the word, is the word that you heard It's got a groove, it's got a meaning Tariffs is the way we are feeling.
Apologies to Grease and Frankie Valli
Key takeaway: A creep in three dimensions: PCE Inflation creeping higher under the surface before tariffs are even rolled out. Inflation expectations vaulting higher and are now become the key factor driving markets using my Variable Dimensionality framework. Despite Trump saying he will leave the Fed free, the focus on the 10-year yield at Treasury means too few 10-years, and by default, too many bills auctioned, perpetuating a yawning exposure to rising short-term interest rate risk, so it all comes back to the Fed. Forget the static and focus on weekly S&P 500 support. Currently at 5900, can certainly see a flush below, but it only matters unless it closes the week below. See markets section: recessionary signals coming from the yield curve and crude markets?
Variable Dimensionality Dept: I have discussed my approach before, but to refresh: There are a litany of potential market drivers that could impact the market at any one time (Pave models incorporate 90 risk factors and 60 return factors) but in assessing the macro landscape, I focus on the top three at any particular instant, because they tend to determine price action and capital flows between asset classes.
The key ist hat those factors are variable and rotate over time.
For example, a major constant has been the stance of the Federal Open Market Committee (FOMC). Cyclically, a change in an administration’s policy can come into play at the start of a presidency, and we are certainly witnessing that. Inflation was not a major factor as it had been dormant for decades but came into play with supply chain pressures in 2020.
Currently, inflation expectations had been sleeping, and while they had become a market concern, were not yet a market driver. With the arrival of tariff talk, they are now sticking their head out of the ground, and on Friday, we saw them impact prices. Perhaps tariffs will subside to the background once more, and inflation expectations fade, but for now, both are out of the proverbial bottle, and cannot be ignored.
Let us turn our attention to the creeps.
Dallas Fed PCE Inflation Decomposition
I must apologize for this chart once again. It is not the easiest chart to read, but it contains such important information that I am forced to drag it out. The Dallas Fed economists take all the inputs the Bureau of Economic Analysis use to calculate the Personal Consumption Expenditure Price Index and put them in inflation buckets:
Focus on the purple section which is the percentage of items that are rising between zero and two percent annually. The white section at the top of the chart are all items that are deflating, so the left most point in December 2023 illustrates that 50% of the PCE inflation components were either exhibiting negative inflation or were under the Fed’s 2% inflation target. As more items start to inflate above the Fed target, that purple line gets “crowded out” and begins to rise.
Moving to the right, there are four horizontal red segments that I added. In July 2024, the inflation distribution had shifted back toward that December 2023 percentage of roughly 50%. Since then, the percentage below the Fed’s 2% inflation target has shrunk consistently, as shown by the red lines in September, November, and December 2024.
The percentage of components that are behaving well from the central bank’s perspective is now roughly 30%, meaning that there has been a gradual creep higher in those components of the PCE Price Inflation Index that are inflating above 2%. The light blue area (2-3% inflation rate) has been rising lately (widening out) and the red arrow on the right of the chart shows that items inflating by a troubling 3-5% is now about as high as at any point in the past year.
Implications: Not only expect the Fed on hold until the items below 2% begin to expand, but it also means that if inflation expectations begin to take hold, the discussion at the FOMC will gradually begin to turn toward hikes this year.
Economic Indicator note: watch the Producer Price Index after tariffs are introduced to gauge the degree to which imported intermediate goods that are carrying a higher price are then carried through to finished goods. The first impact of tariffs will be seen there and will be a focus of investors and the FOMC.
Secondly, the National Federation of Independent Business Economic Trends data should be prioritized, especially the Sales, Earnings and of course Prices subcomponents. The Prices survey is broken down into actual price changes over the last three years and price plans over the next three months. Inventory plans and expected capital expenditures should also be tracked. The survey also asks respondents what their single most important problem is, and it is currently inflation, but I will be looking for the rate of increase in that answer for any red flags. ?
University of Michigan
The University of Michigan’s preliminary Survey of Consumers came out on Friday and contained the following chart. This chart of near-term inflation expectations conveys a powerful message.
The two horizontal lines show the impact that the tariff announcements had recently. While this is only one-year inflation expectations that the Fed downplays due to its typical pattern of fluctuating up and down, this data carries a striking message: Note the
The chart reveals the deepest fear of the Fed: once inflation expectations creep into people’s minds, it persists. Median inflation expectations will move higher after more details are revealed Monday about the retaliatory tariffs. Note that the president promised a ratcheting higher of the initial tariffs if any country introduced tariffs on U.S. exports.
Again, this chart can reverse over time if tariffs are not implemented, and the fact is these are only one-year ahead expectations, which are volatile. However, long-term 5-year ahead inflation expectations just pushed into new territory, so the key is how short-term fears creep into the longer-term view of consumers and businesses.
Once longer-term inflation expectations begin to take hold (and it currently appears to be happening) consumption and investment decisions start to incorporate a view of increasing prices, and that is very difficult to reverse. That is when the Fed’s hand is forced to ignore any recessionary impact and must begin to raise rates to address capping inflation expectations.
Mission Creep
Defined as the gradual expansion of a project beyond its original scope. Now at first this can be seen as the ever-expanding reach of DOGE, but I am viewing it as Trump’s new obsession with keeping the 10-year yield low. I will discuss this in Monday’s Three Pointer, but at the risk of repeating myself, while the Fed may think it DOGEd a bullet (sorry, couldn’t help myself), the need to keep the 10-year rate capped means Treasury Secretary Bessent needs to keep issuing too many Treasury Bills at the Quarterly Refunding. This puts the focus back on the Fed, since Bessent’s choice will lead to a much wider deficit if short rates rise, because that leads to bloated interest expenses.
Therefore, if the Fed is expected to raise rates because inflation or expectations are rising, fixed income investors will then push up term premiums. That means a steeper curve, and we end up with an inflated 10-year yield because of Bessent’s decision. This scenario can get ugly fast if investors begin to worry about a credit downgrade based off a widening deficit, which pushes term premiums higher, and jacks up 10-year yields even more. As can be seen below, the yield curve becomes an important indicator to track investor sentiment.
Markets:
Equity Market: Avoid the noise, follow support
Weekly Trend: Neutral but no breakdown
Weekly S&P 500 index mind the line / CPI Thursday
The weekly chart below of the S&P 500 shows that longer term players could have entered long in October 2023 (see first arrow on the left) and stayed long despite two drops below support because the weekly bar closed back above it (see second two arrows).
That key level for this week is 5900. Failed breakdowns have been a characteristic of this market, so if there is any tariff related news that drops the cash index below 5900, be on the lookout for a potential reversal back above. I had featured a trendline off the lows in NVDA that had been respected for months, and it broke down this week below the 118 level that I highlighted and then closed the week at 131.
It was of note that NVDA stayed bid near its highs all day Friday despite the general market being down. Watch NVDA this week.
Begin defensive positioning on a Friday close in the S&P 500 below 5900. Secondly, the analog I have been following has been working, and suggests that there could be a favorable reaction to the CPI inflation release Thursday. Analogs are nothing more than curiosities but still suggests to let this market prove it has topped before anticipating a top.
Risk Gauge
The daily bitcoin chart below shows it has been range bound since the election, with $92,500 support at the lower Bollinger Band finding bidders. Because it has such a strong correlation with the NASDAQ 100, any sustained move below $91,500-$92,500 range is a confirmation of a risk-off environment.
Fixed Income: Economic signal?
Weekly Trend: Bullish
The ten-year note weekly yield chart has been bullish the past three weeks, with yields breaking below support for the second consecutive week:
Treasury Note yields have been driven but curve flattening, but the longer-term trend is still in an uptrend, maintaining a steepening posture above the support line:
However, there has been a dramatic flattening looking at the 120-minute chart. The 2s-10s curve steepened consistently since late November/early December but reversed around the Trump tariff announcement mid-month. It has been pushed lower after the Quarterly Refunding Announcement and on the quick postponement of tariffs for Canada and Mexico.
Curve changes using this intraday chart will be a focus of mine on any further news regarding tariffs, or inflation expectations. A break below positive 15 basis points on the weekly chart would be a signal that reduced growth expectations are overwhelming any inflation worries.
Crude Oil: Sanctions vs. Peace Talks
Weekly Trend: Bearish
The price action is bearish despite news of Chinese refiners cutting processing rates to a 5-year low based on rising costs to acquire Russian imports thanks to U.S. sanctions. Run rates fell below 45%, reminiscent of how unprofitable it was to refine crude back at the March 2020 crude pandemic panic levels. Russian crude fell to $60/barrel. Meanwhile, the Treasury Department targeted India, the UAE, and China marked specific firms and individuals who assisted in Iranian crude exports.
The monthly chart shows crude’s fall last week has it sitting on longer term support after spiking up to $79 in mid-January:
The monthly chart doesn’t do the recent crude decline justice. Here is the daily chart:
The relentless selloff since mid-January, coupled with a flattening yield curve, one interpretation would be that fixed income and crude investors are forecasting a major economic slowdown. That view gets reinforced by any move in crude below $70.
Best,
Peter Corey
Pave Pro Team
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