In our view, the January 2023 FOMC round will be a “transition round”, as we do not expect the neither the Fed staff nor the FOMC to recalibrate their messages. The reason is that while the incoming data continue to point to some disinflation ahead, the medium-term forecast remains unfavorable. Put it simply: we are going in the right direction but the Fed needs more before pivoting.
Main points:
- The incoming data on core PCE price inflation have been –on net– a bit weaker than the Fed staff forecast inferred from the latest FOMC minutes. Nevertheless, the downward surprise does not imply a significant revision of the forecast as the weakness in the incoming data of core PCE prices was offset by the strength in core import prices.
- The medium-term model-based forecast of core PCE price inflation (figure below) is similar to the December FOMC round. We see little reason for the Fed staff to recalibrate its message; the risks around the model forecast are to the downside.
- The estimate of pi* -a crucial variable for the Fed staff- is now flattening (at about 2¾%). The staff will need more evidence, but this is the first round in which the estimate of pi* is (finally) stabilizing. For instance, our trend inflation models (shown below) estimate pi* at around 3%, one tenth lower than last round. In our view, the estimate of pi* will become progressively more important in the coming rounds.
- The Fed staff Taylor rule and the inertial Taylor (1999) rule imply a terminal FF rate at 5.3%, as in December. Because the forecast of core PCE price inflation and the unemployment rate is little changed compared to the December round, conditional on the degree of inertia consistent with the December SEP, the updated Fed staff (2021) Taylor rule fits well the December SEP dots. For this reason, we do not expect the FOMC to signal a different path of the FF rate.
The reader can download the slides by following the link below (please, get in touch should you experience issues in downloading the slides).
As usual, we would be more than happy to schedule a meeting to discuss the details.