Terrible CPI for the Fed. Even worse than what it looks like
We have updated our estimates of core CPI price changes distributions to include the month of June 2022.
Today’s report showed, once again, diffuse and increasing strength (core CPI came in at 8.8% – MoM a.r.), more than expected and higher than last month. Last month (May) the median was at 4.5% (MoM, a.r.). This month (June) it jumped to 6.6%, one of the highest readings of the last 20 years.
In our view, today’s report should open a serious discussion. The “whatever it takes” moment is here. The situation is serious (see below for details) and, as we wrote previously, the war against inflation is certainly not at the end. Time to consider the nuclear option: 100bps at each meeting until FF rate is at least at 4%.
Details
The distribution of MoM% changes (Figure 1) suggests that positive outliers have been more frequent in the last 12 months compared to pre-Covid. The fitted Kernel density (Figure 2) shows a thicker right shoulder in the last 12 months, indicating that price increases have been more frequent and larger than just the outliers at the end of the right tail.
Looking at the percentiles (Figure 3) is particularly revealing this month. In June, both the left and the right tails moved down (and quite significantly). But the the remaining 80 percent of the distribution (between 10pct and 90pct) moved up. In other words, the super strong core CPI is not the result of bizarre/extreme readings in the tails but it is (once again) the result of a genuine upward movement of the distribution. Given previous communication, we are not surprised. Having said so, today’s move is even larger than expected and in our view signals more pain ahead for the Fed.
Given the movements of the percentiles, the standard deviation of price changes (Figure 3) moved down sharply, which is another bad news for the Fed given the upward movement of the median. Translated: the Fed would need help from the left tail but it is hard to imagine it in the near-term.
Percentiles details:
- The 5th pct is -21.5% (from -17.4%)
- The 10th pct is -8.8% (from -8.8%)
- The 25th pct is 1.0% (from -0.4%)
- The 50th pct is 6.6% (from 4.5%)
- The 75th pct is 15.4% (from 13.1%)
- The 90th pct is 24.7% (from 28.3%)
- The 95th pct is 28.7% (from 35.9%)
The shift of the distribution is visible comparing the Kernels of the last 3 months (black line in Figure 4) to the one of 3-6 months ago (yellow line), and to the one of 6-9 months ago (red line): the distribution is clearly travelling to the right.
The median of the distribution (Figure 5 – left panel) jumped up in June to 6.6%. The MA(12) of the median (Figure 5 – right panel) also moved up in June to 4.5 percent, the highest reading of the last 20 years.
Implications for the Fed Board staff
Today’s reading has implications for the Fed Board staff which, in our view, has been upward surprised by the data by about 15bps. The magnitude of the upward surprise is relatively small but it is, once again, an upward surprise (the fifth one since the beginning of the year).
In our “Pre June FOMC Meeting” package we assumed that the staff was expecting Q2 to be 4.4% (ar) in core PCE space. Considering all data we got since the June Tealbook, the second quarter should be very close to expectations in core PCE space.
In any case, in our view the strengh of today’s data (especially in core services) will force the FOMC communication to be even more hawkish. This is not the time for details. All evidence is telling us that the situation is very serious and the Fed reputation is at risk.
Figures
Figure 1. Distribution of MoM changes (CPI prices ex food and energy items, % a.r.)
Note: the Figure shows the distribution of MoM percent changes at annual rate of CPI prices excluding food and energy items.
Figure 2. Kernel of CPI excluding food and energy items changes (%, a.r.)
Note: the Figure shows the fitted Kernel (Epanechnikov) distribution of MoM percent changes at annual rate of CPI prices excluding food and energy items.
Figure 3. Percentiles and Standard Deviation of the distribution of MoM changes (CPI prices excluding food and energy items, % a.r.)
Note: the Figure shows the distribution percentiles of CPI prices changes excluding food and energy items (left panel), and the cross-sectional standard deviation (right panel).
Figure 4. Kernel of CPI price changes excluding food and energy items (%, a.r.)
Note: the Figure shows the fitted Kernel (Epanechnikov) distribution of MoM percent changes at annual rate of CPI prices excluding food and energy items (for a total of 183 items).
Figure 5. Median CPI price increase (%, a.r.) and MA(12) of the median
Note: the Figure shows the median (%, a.r.) of the distribution of CPI prices changes excluding food and energy items (left panel) and the MA(12) of the median (right panel).