We have updated our Common-Idiosyncratic and Covid (or CI-C) model to include the month of August 2022. Overall, August was a strong month with large Covid effect, a solid “common” component, and a positive idiosyncratic shock.
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 remains in line with the average of the last 7-8 months. Based on this, in our view, the Fed staff will continue to deliver the same message: we still have a long way to go before declaring victory.
Results
Figure 1 shows the decomposition of the MoM of PCE 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 expanded 21bps, that the idiosyncratic component was positive and large (18bps), and that the Covid effect was large (17bps).
Given today’s reading, the YoY of the common component is estimated at 2.5 percent in August, unchanged to rounding compared to the last few months (Figure 2 and 3). Finally, the 3m/3m a.r. and the 6m/6m of the common component (Figure 4) are estimated at 2.5% and 2.6%, respectively in August.
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 remained solid and in line with the previous 7-8 months. 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).
The interesting evidence this month comes from Figure 1. The model estimates a large positive idiosyncratic shock which squares well with the strength of non-market prices. Put it differently, while July was “too good to be true”, August seems a bit biased to the upside by factors that should not persist going forward. In any case, even net of idiosyncratic shocks, as mentioned, the common component remains strong and well above the Fed target.
As we wrote on CPI day, 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, the evidence of disinflation is very limited (if any).
Figures
Figure 1 Contributions to MoM changes of PCE excluding food and energy items
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 2 Contributions to YoY changes of PCE excluding food and energy items
Note: the Figure shows the decomposition of the YoY 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 3 YoY of PCE prices excluding food and energy items and the “Common” component of the CI-C model
Note: the Figure shows the YoY of PCE 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.