Hawkish Pause
June 2023 FOMC: hold, for now. The story for the June FOMC is pretty straightforward: there are tentative signs of disinflation in the incoming data but the medium-term forecast remains unfavorable. Virtually nothing says the US can go back to 2% by the end of the forecast horizon. Not only, but in our view and estimates, the FOMC can raise its 2023 forecast (the dots) of core PCE price inflation, given the move of the Fed staff last meeting (our note here). Finally, the Taylor rules continue to suggest a terminal rate between 5.3% and 5.9% (see below for details).
All told, we do not expect the Fed to raise rates at this meeting because, as mentioned, the data might be cooperating in H2. But in terms of risk management, it makes sense to signal a potentially higher terminal rate in the dots (say from 5.1% to 5.3%), just in case the FOMC will be upwardly surprised by the data again.
Main points:
- The incoming data on core PCE price inflation have been in line with the Fed staff forecast inferred from the latest FOMC minutes. In fact, the incoming data (finally!) show some encouraging progress. For instance, the median of the cross-sectional core PCE prices change distribution (figure below) has dropped in the last two months, although it remains above pre-Covid levels. All considered, we do not expect the Fed staff to revise its near-term forecast meaningfully.
- The medium-term forecast remains unfavorable. Risks around the Fed staff forecast continue to be skewed to the upside. The medium-term model-based forecast of core PCE price inflation (left panel in the figure below) is broadly similar to the time of the May FOMC. The estimated persistency of the process continues to be high and the forecast remains above target throughout the entire medium-term. When assessing the model uncertainty (thick modelling approach, right panel below), it is clear that alternative specifications convey the same message. Simulations shows that the models need to be downwardly surprised by 2-3 consecutive quarters to trigger large downside revisions.
“Main” model forecast (YoY) of core PCE price inflation.
Note: the confidence intervals (C.I.) are estimated using 100,000 draws from the estimated parameters distributions to simulate the path of core PCE price inflation going forward.
Thick modelling approach.
Note: The figure shows the distribution of point forecasts of core PCE price inflation of a large set of models (around 50,000 in total), each differing by one assumption (i.e. different type of slack, different number of lags of the endogenous variable, etc..).
- The Fed staff (2021) Taylor rule implies a terminal FF rate of 5.3%, unchanged compared to May. The inertial Taylor rule implies a terminal rate of 5.7%, while FRB-US has a terminal rate of 5.9%. No Taylor rule expect a cut of the FF rate. We do not expect the Fed to raise rates at this meeting but we do expect a higher terminal rate in the dots (say from 5.1% to 5.3%).
As usual, we would be more than happy to schedule a meeting to discuss the details.