We have updated our Common-Idiosyncratic and Covid (or CI-C) model to include the month of August 2022.
Our CI-C model estimates that net of Covid and idiosyncratic shocks, the strength of the data remains intact. In fact, the model estimates that the common component is still increasing. Translated: we still have a long way to go before declaring victory.
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 August the common component increased by 26bps, above the average of the last 6 months. The Covid effect is estimated large (33bps). Finally, the idiosyncratic part is small (-3bps).
Today’s reading brings the YoY of the common component to 3.0 percent, unchanged to rounding compared to 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 3.1 percent and the 6m/6m a.r. at 3.1 percent (Figure 4). This evidence suggests that the YoY of the common component will probably tick up again in the upcoming months.
Comment
The results of the CI-C model complement the evidence of the monthly distributions. The model suggests that net of Covid and idiosyncratic shocks, in August the common component is strong. Not only but the model estimates that the common component is still trending higher on a 3m/3m basis. As previously communicated, the common component is persistent by construction; therefore, we continue to expect the data to be solid -on average- 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).
Last month the model suggested that the relatively “weak” core CPI was distorted by negative idiosyncratic shocks. This month, the model suggests a more genuine reading. Having said so, it would not be surprising to see another month of negative idiosyncratic shocks in September (or October), given the evidence of used car prices (Manheim imdex). Therefore, it would not be surprising to get a 0.3-0.4% in core CPI space in September-October and per se such a reading would contain little signal for the Fed staff and the FOMC.
All told, the fight against inflation will be a long one. The game will start to change when the Covid effect and most importantly the common component will moderate. One (or two) months of relatively “weak” core readings driven by negative idiosyncratic shocks, in our view and experience, will make no difference for the Fed staff and the FOMC.
So far, no evidence whatsoever inflation is moderating.
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.