Way too early to pivot. But July was different..
We have updated our estimates of (core) PCE price changes distributions to include the month of July 2022. In July, core PCE prices expanded 8bps, a bit below our expectations (14bps) after the CPI and PPI report, and higher than June (61bps, revised up 2bps) and May (35bps).
The evidence of the distributions in PCE space is slightly different than the one in CPI space. The July report, as in CPI space, shows a downward movement of the median and a decrease in the cross sectional dispersion.
But the most important evidence of this report is that in July virtually all percentiles of the distribution moved down. The downward movement is particularly evident in the right tail but also the median and the left shoulder moved down.
The July report is certainly distorted by factors that should not persist (in particular the weakness in non-market prices and the negative idiosyncratic shocks to some items – see our upcoming email on CI-C model on this point). Having said so, this is the first month in which we observe what could be a genuine shift of the distribution. We generally discount monthly readings because they tend to be noisy (and so the Fed staff does in our experience). But for the first time we suspect that something might be changing.
(Note: please note that the above statement is not in contradiction with the evidence from other models, including our “main” Phillips curve model. Indeed, most models have been signaling that inflation will moderate going forward. Therefore, in our view the debate is not *if* core PCE price inflation will moderate but about the persistency of the process. Despite being a “perfect” month for the Fed, the median of the distribution came in at 3%, roughly in line with the evidence of the trend models and estimated pi*. At the moment, we can take that value as a guide for where inflation will land in around 1 year from now).
All told, we continue to think it is way too early for the Fed staff and FOMC to pivot. The Fed remains very committed, and Powell today delivered at Jackson Hole.
Details
The fitted Kernel density (Figure 2) continues to show a thicker right shoulder/tail in the last 12 months, indicating that price increases have been more frequent and larger than just the outliers at the end of the distribution. The left shoulder of the distribution is (marginally) less thick, indicating that price contractions are less frequent.
If we look at the percentiles (Figure 3), in July virtually all percentiles moved downward. Also, the median moved down to 3.0% (from 4.0%), a value that in any case remains well above the pre Covid period.
Percentiles details:
- The 5th pct is -21.3% (from -22.8%)
- The 10th pct is -14.9% (from -7.6%)
- The 25th pct is -3.5% (from -0.1%)
- The 50th pct is 3.0% (from 4.0%)
- The 75th pct is 7.9% (from 11.3%)
- The 90th pct is 16.3% (from 20.9%)
- The 95th pct is 19.6% (from 34.4%)
The Kernel of the last 3 months (Figure 4) remained up/right compared to 3-6 (and 6-9) months ago, but the right tail is now less thick.
Importantly, the median of the distribution (Figure 5 – left panel) moved down in July, although it remained well above the pre Covid readings. Finally, the MA(12) of the median (Figure 5 – right panel) was unchanged to rounding in July to 3.7%.
Implications for the Fed staff
In our pre-FOMC meeting package we assumed that the near-term forecast of the Fed staff was constructed with a 36bps MoM growth rate in July (14bps after the July CPI and PPIs).
Therefore, in our view today’s data should be a relief for the Fed staff forecast. Also, today’s data reinforce our view that the Fed staff will revise down their 2022 forecast to about 3.8% in the September Tealbook, but should leave unchanged its 2023 and 2024 forecast. Therefore, in our view, the Fed staff will continue to convey a hawkish message until (at least) the September FOMC. But for the first time we recommend some prudence. If the distributions will shift again in August, we might be entering a new phase: the “plateau” of inflation.
Figures
Figure 1. Distribution of MoM changes (PCE prices ex FE, % a.r.)
Note: the Figure shows the distribution of MoM percent changes at annual rate of PCE prices excluding food and energy items.
Figure 2. Kernel of PCE 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 PCE prices excluding food and energy items.
Figure 3. Percentiles and Standard Deviation of the distribution of MoM changes (PCE prices ex FE, % a.r.)
Note: the Figure shows the MA(12) of the distribution percentiles of PCE prices changes excluding food and energy items (left panel), and the cross-sectional standard deviation (right panel).
Figure 4. Kernel of PCE 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 PCE prices excluding food and energy items (for a total of 183 items).
Figure 5. MA(12) of median price increase (%, a.r.)
Note: the Figure shows the median (%, a.r.) of the distribution of PCE prices changes excluding food and energy items (left panel) and the MA(12) of the median (right panel).