The Observatory

CPI Surprise Tomorrow

Welcome to The Observatory. The Observatory is how we at Prometheus monitor the evolution of the economy and financial markets in real-time. The insights provided here are slivers of our research process that are integrated algorithmically into our systems to create rules-based portfolios.

We’ll keep it brief today to emphasize our main point.

There is a very high likelihood of a CPI surprise tomorrow. While systems estimate that we are near a turning point in the market inflation cycle, there is considerable risk around tomorrow’s CPI print. Our systems estimate that CPI will increase 0.74% versus the prior month, while consensus expects a 0.2% increase. We show the fit of our monthly estimate of CPI versus the realized data below:

The primary driver of our forecast is housing inflation, with a contribution of 0.18%. As inflation becomes entrenched, the tendency to become self-reinforcing grows, and we have seen a significant uptick in the inflation pass-through from commodities to services. We note that recent commodity price action supports a deceleration in CPI. Still, our systems expect that the pass-through to services and housing is significant enough to override the downtick in commodity prices. Based on the historical performance of our forecasts, our systems estimate a 98.5% probability of a surprise. This probability is not a trivial number, and while there remains the potential that our models are wrong, it is prudent to risk-manage this event. While our systems are flagging this potential upside surprise, we think it also prudent to recall where they think we are in the inflation cycle. We show our broad inflation gauge below:

Overall, our systems remain positioned for a declining inflation impulse, but this print poses a substantial threat to these views, and we need to manage risk accordingly.

Our systems are aligning to show that the pressures for inflation to decelerate are gathering and are incrementally moving to benefit from these moves. Our systems are, therefore, highly defensive in their posture and are primarily allocated to the dollar and treasuries. Resultantly, those using our strategies as a base are running a risk tomorrow, which needs to be managed carefully. Nonetheless, our systems are designed to capture returns over the course of the economic cycle, and we expect them to perform over time.

We show the current asset allocation for our Alpha Strategy below:

At the security level, we show how the Alpha Strategy is positioned below:

Additionally, we offer the cumulative un-levered year-to-date returns on the strategy below:

Stay defensive.