We have updated our Common-Idiosyncratic and Covid (or CI-C) model to include the month of July 2022. Overall, July was a relatively “soft” month after few strong readings.
Our CI-C model is particularly revealing this month (see Figure 1 below). As mentioned in our previous post, the July CPI report looks like the March CPI report. Our CI-C model estimates that the strength of the common component is offset by negative idiosyncratic shocks. Net of Covid and idiosyncratic shocks, the strength of the data remains intact. As such, the relative “weakness” in today’s CPI should not persist going forward.
Results
Figure 1 shows the decomposition of the MoM of CPI excluding food and energy items in the “common” component (the blue bars), the “idiosyncratic” component (the yellow bars), and the “Covid” effect (the green bars). Our model estimates that in July the common component increased by 24bps, in line with the average of the last 6 months. The Covid effect is estimated solid (21bps). Finally, the idiosyncratic part is a large negative (-13bps).
For this reason, today’s report looks like the March CPI report: the model is suggesting that the “weakness” in today’s report should not persist going forward because it is driven by erratic/volatile factors.
Today’s reading brings the YoY of the common component to 3.0 percent, marginally higher than the previous months (Figure 2 and 3). At the same time, today’s reading brings the 3m/3m a.r. of the common component at 3.0 percent and the 6m/6m a.r. at 3.0 percent (Figure 4). This evidence suggests that the YoY of the common component will probably move sideways in the upcoming months.
Comment
The results of the CI-C model complement the evidence of the monthly distributions. The model is suggesting that net of Covid and idiosyncratic shocks, in July the common component continued to be strong. As previously communicated, the common component is persistent by construction; therefore, we continue to expect the data to be solid in the coming months. (reminder: the evidence of the CI-C model should be interpreted as following: net of Covid and idiosyncratic effects, the model suggests that the strength of the data is way above the Fed target).
Figure 1 is particularly revealing. Our CI-C model estimates that the idiosyncratic factors were solid and positive in April-June but turned solid and negative in July. In this dimension, the key is that the idiosyncratic factor is zero mean by construction. Therefore, what the model is suggesting is very much in line with the signals from the distributions: the “real” core CPI pace is probably in between the 0.6/0.7 of April-June and the 0.3 of July, therefore way higher than the Fed target.
All told, it is hard to make a hard conclusion based on today’s data because of the nature of the shocks (again, mostly idiosyncratic). Therefore, we do not expect any significant change in FOMC communication in the near future.
Figures
Figure 1 Contributions to MoM changes of CPI excluding food and energy items
Note: the Figure shows the decomposition of the MoM percent changes of CPI 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 2 Contributions to YoY changes of CPI excluding food and energy items
Note: the Figure shows the decomposition of the YoY percent changes of CPI 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 3 YoY of CPI prices excluding food and energy items and the “Common” component of the CI-C model
Note: the Figure shows the YoY of CPI excluding food and energy items (black line), and the YoY of the “common component” (blue line) estimated using our CI-C model.
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.