What happened in CPI has become more clear in PCE
We have updated our estimates of (core) PCE price changes distributions to include the month of September 2022. In September, core PCE prices expanded 45bps, a bit above our expectations (40bps) after the CPI and PPI reports. Revisions to previous months were small and offsetting.
The big news is that the evidence of the September CPI is even more clear in PCE space: there are signs of stabilization and disinflation (see figures 4, 5, and 6). At the moment, there are still no signs that inflation will quickly return to target (indeed, some models suggest that inflation will moderate going forward but will remain above 3% next year and the following). But the data seem to suggest that the monthly prints are ready to moderate in the next 4-6 months.
As for the Fed, in our view it is still too early for the FOMC to change its recent communication. Everyone, including the Fed staff and Powell himself, is aware that inflation is a process, not a single event. As such, prudence first. In our view, this implies that the Fed will continue to signal it will bring the FF rate to 5%-ish. But we now think that it will be hard to see a higher terminal rate in this cycle.
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 September there is no clear signal as the bottom percentiles moved down and the top percentiles moved up. Also, the median moved sideways to 3.9% (from 3.6%).
Percentiles details:
- The 5th pct is -26.7% (from -10.9%)
- The 10th pct is -12.8% (from -7.5%)
- The 25th pct is -2.4% (from -1.5%)
- The 50th pct is 3.9% (from 3.6%)
- The 75th pct is 10.7% (from 9.9%)
- The 90th pct is 30.0% (from 20.9%)
- The 95th pct is 43.1% (from 33.3%)
The evidence of the Kernels in CPI space is more clear in PCE space: the last 3 months (black line in Figure 4) has shifted to the left compared to the distribution of 3-6 months ago (the yellow line) and 6-9 months ago.
The median of the distribution (Figure 5 – left panel) moved sideways in September to 3.9%. The MA(12) of the median (Figure 5 – right panel) ticked up in September to 4.4 percent; this value should be close to the peak of this cycle.
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 40bps MoM growth rate in September. The incoming data have been only marginally higher than expected and imply no change to the forecast (if any, only cosmetic).
As discussed in private meetings, in our view the Fed staff still cannot bring good news to the FOMC because most models continue to signal upside risks around the medium-term forecast and because at the moment nothing says that inflation will quickly converge back to target. Having said so, from our own point of view it is hard to ignore the signals from the distributions. This is not the time to celebrate victory; it will come, eventually. But this is the time to recognize that the Fed has been successful in providing an anchor and stabilizing the distributions. There is now a concrete chance that keeping the rates high (5%-ish FF rate) for 2-3 quarters will be enough to lower inflation to an acceptable level (3%-ish).
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).