We have updated our Common-Idiosyncratic and Covid (or CI-C) model to include the month of July 2022. Overall, July was a soft month with no Covid effect, a solid “common” component, and a negative idiosyncratic shock.
The big news (please see Figure 1) is that according to our CI-C model the month of July is different compared to all other months since early 2021. In particular, for the first time in 17 months the model estimates no “covid effect”. This implies that for the first time in 17 months no items saw monthly changes outside their historical distribution (which is very well in line with the movement in the right tail of the distribution shown in our previous email). At the same time, the model estimates a negative idiosyncratic shock which by construction should not prove persistent going forward, and a marginally lower common component.
In great summary: a “perfect” month for the Fed, probably too good to be true. As we mentioned when commenting the monthly distributions and the July CPI report, the “true” growth rate of prices is probably an average of the last 3 months. But for the first time in several months, we finally have some indications that something might be changing for the good.
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 July the common component expanded 18bps (a bit below the average of the previous 7-8 months), that the idiosyncratic component was negative (-9bps), and that the Covid effect was null.
Given today’s reading, the YoY of the common component is estimated at 2.4 percent in July, 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 2.4%, respectively in July.
Comment
The evidence from the monthly distributions matches well the one from our CI-C model.
If we put the evidence of all our models together, we can conclude that core PCE price inflation is currently growing at about 4 percent (a.r.), that is the average of the last 3 months. The current pace is still way above the tolerance level of the Fed and the risks remain skewed to the upside, especially in 2023 and 2024. For this reason, we welcome Powell’s words at Jackson Hole and we expect the FOMC to continue with this tone in the near-term.
Having said so, today’s data are the first real victory lap for the Fed staff. One month of data implies little for the future. But as discussed, for the first time in 17 months we (finally) have some evidence that some price increases are cooling off. Not enough for the Fed to pivot.
But it is noted.
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.