We have updated our Common-Idiosyncratic and Covid (or CI-C) model to include the month of September 2022.
Our CI-C model estimates that net of Covid and idiosyncratic shocks, the strength of the data in September is a bit lower (lower, not higher) than the last 6 months. The CI-C model seems to confirm the evidence of the distributions: inflation is in a “plateau” and the common component has weakened somewhat (evidence that matches well the narrative of the incoming data). Nevertheless, the model also estimates a high degree of persistancy of the process, suggesting it might take time to disinflate the US economy.
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). The big news is that our model estimates that in September the common component increased by 21bps, below the average of the previous 6 months, and in line with the strongest months in the pre-Covid period (see the blue bars in Figure 1). The Covid effect is estimated large (31bps). Finally, the idiosyncratic part is small (5bps).
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 3.0 percent and the 6m/6m a.r. at 3.1 percent (Figure 4). This evidence suggests that the YoY of the common component is close to a peak.
Note: the evidence of the common component matches well the narrative of the incoming data. Because of the different behavior of core goods vs. core services prices, the model estimates a lower common component in September. Therefore, according to the model, today’s data are less problematic than in the last 6 months because inflation seems less widespread.
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 September the common component weakened. Not only, but if we look at the behavior of the common component in the last 6 months (Figure 4) we see that it is approaching a maximum. 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.
As we always say, “inflation is not a single episode, inflation is a process. As such, it has a persistency”. The fight against inflation will be a long one and the unit of measure will be the quarters (or years). The good news in today’s data is that the estimated persistancy of the process (the common component) is marginally lower. Nevertheless, the level of the common component remains well above the one consistent with the Fed target, confirming that disinflating the US economy will take time.
As for the Fed, in our view at this point the staff and the FOMC will deliver, no matter what. In this environment, the Fed will need robust evidence that inflation is dominated. The good news is that there are some signs of improvements even if the topline remains strong.
But again, the Fed will deliver for the time being.
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.