We have updated our “main” model (as a reminder, the “main” model is an augmented Phillips curve model with anchored expectations as described in Detmeister et al. (2014) and it assumes a flat pi* both in history and in the forecast). As usual, our forecast includes a point forecast, as well as two types of confidence bands: A. confidence bands calculated using 100,000 draws from estimated parameters’ distributions, and B. confidence bands on the model’s historical forecast errors (quasi out-of-sample exercise).
This is the last update for 2022:Q1. The latest incoming data have resulted in higher (higher, not lower) forecast in 2022 as the downward surprise in March CPI/PPIs was more than offset by an upward surprise in March core import prices.
Results
The model is now forecasting core PCE price inflation at 4.3% in 2022, 3.2% in 2023, and 2.8% in 2024.
Comparison with previous forecasts
Compared to the time of the March 2022 FOMC meeting, the model forecast is stronger in 2022 and little changed in 2023/2024.
What explains the upward revision? Since the day of the March 2022 FOMC, we have received information on March CPI, March PPIs, labor market, and March core import prices. On net, the incoming data were a bit stronger than expected as the downward surprise in March CPI/PPIs was more than offset by an upward surprise in March core import prices.
What is the passthrough from core import prices to core PCE price inflation? We estimate that a 1% increase in relative core import prices (that is the difference between core import prices and core PCE price inflation itself) results in about 10bps upward pressure on core PCE price inflation in 4 quarters (although most of the passthrough happens in the first 2 quarters). In March, core import prices grew at 14.3% (a.r.) and they grew above 10% (a.r.) in the last 3 months. Therefore, given that core PCE price inflation is currently around 5.5%, core import prices should put an additional 4-ish tenths upward pressure on core PCE prices in the next 4 quarters (from which, the upward revision to the model forecast in 2022). A chart showing the metrics of core import prices is reported at the end.
A word of caution about the model forecast
Our “main” model is a workhorse augmented Phillips curve model, extremely popular in central banks, including at the Fed. Nevertheless, at any given point in time the information set of the econometrician is larger than the model. In this moment the information set of the econometrician is based on the narrative of the incoming data, especially about the level of durable goods. Put it differently, there is a reason to believe that the model might be overestimating future inflation if one thinks that the level of (durable) goods will drop significantly in the upcoming quarters.
Implications for the Fed Board staff
We employ our “main” model as a way to assess the risks around the Fed staff forecast. The Fed Board staff forecast (as inferred from the FOMC minutes) has been revised up significantly in the last few rounds but remains below the model (in our view, the staff is currently forecasting core PCE price inflation at 3.6%-3.7% in 2022). As previously discussed, in our view this is happening because the staff is working under the assumption that its own information set is larger than the model.
In any case, we continue to expect the Fed staff to revise its 2022 core PCE price inflation up marginally this round or the next. All models (Phillips curve “main” model, thick modelling, trend models) continue to signal upside risks around the Fed staff forecast. Not only, but the incoming data continue to be on the strong side.
All told, we continue to expect the Fed communication to remain very hawkish in the next weeks.
Figures
Inflation forecast (YoY of core PCE, %) from "main" model – latest run (2022:Q1 in sample)
A. C.I. calculated from parameters distributions
Note: the confidence intervals (C.I.) are estimated using 100,000 draws from the estimated parameters distributions to simulate the path of core PCE price inflation going forward.
First quarter of forecast: 2022:Q2.
B. C.I. calculated using quasi-out-of-sample methods
Note: the confidence intervals (C.I.) are estimated using quasi-out-of-sample methods (estimate the model over a sub-sample, forecast, and calculate the root mean squared forecast errors).
First quarter of forecast: 2022:Q2.
Core import prices metrics
The figure shows the BLS “import prices, all commodities excluding petroleum” series metrics. The red line shows the percent change between month “m” and month “m-24” at annual rate. The blue thick line shows the year-over-year percent change. The blue thin line shows the percent change between month “m” and month “m-6” at annual rate. Finally, the blue dashed line shows the percent change between month “m” and month “m-3” at annual rate. Latest month is March 2022.