An impressive drop of the median: take it seriously
We have updated our estimates of core CPI price changes distributions to include the month of October 2022.
Last month the title of our note was “Less bad than it looks like, the “plateau” is here”. Today’s report provides more evidence not only that the peak is behind us but that the distribution is shifting back even more than expected.
Today’s report tells three important things: (i) the median of the distribution has dropped significantly, (ii) the distribution is genuinely moving back to the left, and (iii) price dispersion is low.
Today’s report is a step in the right direction for the Fed. Having said so, as discussed in private meetings, because monetary policy is set according to the medium-term models/forecast, it is still too early for any type of pivot. In our view, the Fed staff (and the FOMC) will be relieved by the incoming data but they will continue to signal the path of the FF rate hinted by Powell at the November FOMC press conference (bring it to 5%-ish and keep it there for few quarters) because it is unclear at the moment whether inflation will return to 2% or remain higher (north of 3%).
Details
In today’s report:
- All percentiles shifted to the left signaling a genuine disinflation process at work. This is a very strong signal and it should be taken seriously.
- The median dropped to 0.5% a.r. (from 4.1% a.r.) well below the weighted mean (3.3% a.r or 0.3% not annualized). For this reason, as last month, it is hard to take much signal from the weighted mean because the evidence continues to suggest it should moderate going forward.
- The standard deviation of price changes (Figure 3) remained broadly constant at a low level.
Percentiles details:
- The 5th pct is -32.3% (from -26.7%)
- The 10th pct is -25.1% (from -15.0%)
- The 25th pct is -11.6% (from -3.6%)
- The 50th pct is 0.5% (from 4.1%)
- The 75th pct is 7.2% (from 14.5%)
- The 90th pct is 18.9% (from 28.0%)
- The 95th pct is 30.5% (from 38.9%)
The most important evidence continues to come from the sequential distributions of the last 9 month (Figure 4) which show important signs of stabilization and disinflation. The Kernels of the last 3 months (black line in Figure 4) is somehow similar to the distribution of 6-9 months ago (red line). Not only but if we compare the distribution of the last 3 months to the previous 3 months, we notice a clear thicker left shoulder and less mass in the 0-10 area.
Translated: the long-waited disinflation is finally happening and it should be taken very seriously. Chances are that today’s core number was “too good to be true” (remember: monthly data tend to be noisy) but also that we will not go back to the very strong figures of the previous two months.
For this reason, we reiterate our call: the peak of inflation is behind us. We are in the “plateau” of inflation. The models sugegst that raising the FF rate to 5%-ish and keep it there for a few quarters should be enough to disinflate the US economy. Whether that will be enough to return to 2% (rather than lending to 3%) is still unclear.
Implications for the Fed Board staff
Today’s reading does have some implications for the Fed Board staff because it came in a bit lower than expected (about 10bps lower in our view).
At this point of the year the Fed staff is revising the 2022 forecast but not necessarily the 2023 forecast (the usual procedure implies waiting for some data at the beginning of the year before re-setting the medium-term forecast). Not only but monetary policy is set according to the medium-term models/forecast which are unlikely to send dovish signals for another few months.
For this reason, there are two important conclusions.
First, today’s data reinforce the view that the peak of inflation is behind us (the current phase is what we have called “the plateau” of inflation). The shift of the distribution seems genuine, as such it implies a near-term forecast a bit lower than at the time of the November FOMC.
Second, while today’s data are a very good news for the Fed staff (and FOMC) forecast, we continue to think that the Fed will remain hawkish and it will not signal a different path of the FF rate. Everyone knows that one observation is just one observation; not only but at this point the models will need at least a few soft prints before sending dovish signals. At the moment, little in the data suggests inflation will converge back to 2% (rather than landing north of 3%). Therefore, it is still not time for a pivot. This is the time to deliver what previously communicated and then wait.
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
Note: the Figure shows the median (MoM %, a.r.) of the distribution of CPI prices changes excluding food and energy items (left panel) and the YoY (right panel).