Going Sideways With Some Hope
Little progress, some hope for H2. Last month (here) we wrote: “in our estimates, the March PCE price report can be another false positive disinflation signal” (based on the behavior of market-based and non-market prices). We are glad we did it because the April PCE price report confirmed it. So far, progresses on the disinflation front remains limited. As an example, Figure 0 shows the metrics of PCE price services ex food, energy, rents and OER (sometimes called “supercore PCE”). The MoM saar came in at 5.2% and the series shows no signs of deceleration. In our view, this will set the tone for the June FOMC meeting (and beyond) because it is hard to see this part of the basket disinflating without the labor market cooperating.
The good news is that, as in CPI space, below the surface the models are signaling some hope for the second half of the year: the distribution of price changes has gently shifted to the left, the median remains below the levels of last year, and the common component is losing steam.
Put it simply: a fifth of the glass is full of good news, while the rest remains empty. We might have some other good news in the coming months if the labor market slowdown further. But for the time being, it is way too little for the Fed.
Figure 0. Metrics of core PCE services prices ex rents and OER (“supercore PCE”).
Note: the figure shows the metrics of the index of PCE services prices excluding food, energy, rents and OER items (a.k.a. “supercore PCE”). “ar” stands for annual rate.
Evidence from the distributions
Some hope. This month, there is no clear signal from the percentiles (not shown) as some moved up and other moved down. However, the kernel of the last 3 months (Figure 1) is finally showing some shift to the left. We have already seen something similar last December (our note here); therefore, we are extra careful and we would like to get confirmation in the next 2-3 reports. But at least it seems there is some hope to get readings a bit softer (3%-4% ar range) in the second half of the year. The median of the distribution (Figure 2) confirms the impression of the distributions.
Figure 1. Kernel of PCE excluding food and energy items changes (%, a.r.)
Note: the Figure shows the fitted Kernel (Epanechnikov) distribution of MoM percent changes at annual rate of PCE prices excluding food and energy items.
Figure 2. Median PCE price increase
Note: the Figure shows the median (MoM %, a.r.) of the distribution of PCE prices changes excluding food and energy items (left panel) and the YoY (right panel).
Evidence from our CI-C model
Our CI-C model estimates that net of Covid and idiosyncratic shocks, the strength of the data in April is lower than in recent months. Figure 3 shows the decomposition of the MoM of core PCE in the “common” component, the “idiosyncratic” component, and the “Covid” effect. The model estimates that in April the common component increased by 15bps, a bit less than the previous 3 months. The Covid effect is estimated at 11bps, and the idiosyncratic shock is also positive (12bps). Overall, the common component seems to gradually lose steam (Figure 4), even if the progresses are limited and it will probably take a lot of time to return to pre-Covid levels.
Figure 3. Contributions to MoM changes of PCE excluding food and energy items (CI-C model)
Note: the Figure shows the decomposition of the MoM percent changes of PCE prices excluding food and energy items. The contributions are estimated using our CI-C model, a 2-stage OLS-LASSO regression model. The “Covid” effect is identified with price variations outside the 10th-90th percentiles of each item pre-Covid price change distribution.
Figure 4. Estimated “Common” component: YoY, 3m/3m a.r. and 6m/6m a.r.
Note: the Figure shows the 3m/3m at annual rate (green line), the 6m/6m at annual rate (red line), and the YoY (blue line) of the “common component” estimated using our CI-C model.
Implications for the medium-term forecast of core PCE price inflation
The medium-term forecast of core PCE is unchanged as the data came in as expected. The “main” model forecast is: 4.25% in 2023, 3.6% in 2024, and 3.2% in 2025. This forecast is unchanged compared to the time of the April CPI report (Figure below).
Note: the figure shows the latest run of our “main” Phillips curve model. The confidence intervals (C.I.) are estimated using quasi-out-of-sample methods (estimate the model over a sub-sample, forecast, and calculate the root mean squared forecast errors). First quarter of forecast: 2023:Q4.
Implications for the Fed Board staff
Higher for longer, for now. Last month we argued that the core PCE price reading was too good to be true because it was largely influenced by non-market prices. This month the reading is probably too bad to be true for the same reason, although in the opposite direction (see Figure 5). In any case, no matter what one looks at (“supercore”, market-based core PCE, the common component or the distributions), there is still little progress so far. We do think that in the second half of the year the readings will moderate especially with some help from the labor market. In that case, the Fed might consider recalibrating the message. But for the time being, hawkish shall be.
Figure 5. MoM of core PCE prices, market-based vs other than market-based.
Note: the Figure shows the MoM at annual rate of core PCE prices market-based (blue solid line) and other than market-based (light blue dashed line).