Less bad than it looks like, the “plateau” is here.
We have updated our estimates of core CPI price changes distributions to include the month of September 2022.
Today’s report is telling us three things: (i) the median of the distribution is going sideways, (ii) the distribution is stable and shows some sign of disinflation (although not yet in the weighted average), and (iii) price dispersion is low.
In September, the expected moderation (which indeed materialized in some goods, including used cars) was offset by the strength of some services. This is not good news for the Fed because it hints it will take longer to disinflate the economy, given the persistency of services. Today’s report implies 0.4% MoM for core CPI in the next 3-4 months, and a possible upward revision to the medium-term forecast (to be circulated tomorrow).
Put it differently: the evidence is telling us that it will take longer than the Fed staff (and FOMC) anticipated to disinflate. But it is also telling us that the situation should not get any worse than this.
It follows that the likely outcome is that the Fed will signal a higher terminal rate (north of 5%) and no cut in 2023. Having said so, it is unclear what a more aggressive frontload will achieve at this point, given that most of the effects of monetary policy are still in the pipelines. But in this environment the Fed cannot wait and will not wait.
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) we see that in September the left tail shifted down but the right tail ticked up. In other words, there is no clear signal. Also, the median ticked down to 4.1% (from 5.1%). For this reason, it is hard this month to take much signal from the weighted mean (0.6% MoM).
The standard deviation of price changes (Figure 3) remained broadly constant at a low level.
Percentiles details:
- The 5th pct is -26.7% (from -14.8%)
- The 10th pct is -15.0% (from -7.5%)
- The 25th pct is -3.6% (from -1.3%)
- The 50th pct is 4.1% (from 5.2%)
- The 75th pct is 14.5% (from 14.4%)
- The 90th pct is 28.0% (from 26.1%)
- The 95th pct is 38.9% (from 37.7%)
Probably the most important evidence comes from the distributions of the last 9 month (Figure 4) which show important signs of stabilization and possible 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 (especially in some goods) is finally happening but so far is not enough to compensate for the renewed strength in core services.
Finally, the median of the distribution (Figure 5 – left panel) ticked down in September to 4.1% (from 5.2% in the previous month). The MA(12) of the median (Figure 5 – right panel) moved up in September to 4.8 percent (from 4.7 percent), the highest reading of the last 20 years. Nevertheless, the MA(12) of the median should stabilize soon, given the readings of the last few months.
Implications for the Fed Board staff
In our view, today’s reading does have implications for the Fed Board staff because it came in a higher than expected.
Having said so, it is worth reminding that in our view and experience, at this point of the year the Fed staff is revising the 2022 forecast but not the 2023 forecast (the usual procedure implies waiting for some data at the beginning of the year before re-setting the medium-term forecast). In our view, at the time of the September FOMC, the Fed staff was working under the assumption of core CPI reaching 3.6% in June 2023. But a more realistic forecast implies a path of core CPI (at least) 1 percentage point higher at this point. Unfortunately, we doubt the Fed staff will make such a revision in a single round (or two). Therefore, we continue to think that the Fed staff (and partially the FOMC) are behind the curve, especially in their 2023 forecast.
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).