As expected. The August CPI report was just a bit above our expectations. Headline CPI came in exactly as expected, while core was a touch stronger. As in July, this month the story is straighforward: the CPI report changes nothing for the Fed strategy and for both our near-term and medium-term forecast.
For the record, Table 1 shows our MoM forecast errors. In the last 6 months, the std error (4bps) and the std dev (9bps) of our MoM forecast for core CPI (our focus) remains very competitive. For headline CPI our stats are even more competitive (3bps std error).
Reaction to the incoming data: no change. Today’s data imply no change to our near-term forecast. We expect Sep core CPI at 22bps. We also expect the YoY of core CPI (PCE) at 3.0% (2.7%) in December 2024. Having said that, given the composition of today’s report we are likely to make changes in the coming days as we will digest more the information. Please, be in touch if interested.
Translation CPI/PCE: our translation of today’s core CPI print is 19bps in core PCE space. Please, be aware that this is VERY tentative and it can change with PPIs.
Evidence from our models: big picture unchanged. In CPI space the distribution of price changes remains different than pre-Covid (even in August). The CI model suggests that today’s print is magnified by a small positive idiosyncratic shock, while the common component remains solid. Please, take a moment to look at the results of our CI model because they show clearly what is going on with the data. Finally, the “main” medium-term model is unchanged.
For the Fed: we will circulate our “Pre-FOMC meeting package” this week. The baseline remains 25bps cut at the upcoming FOMC and a total of 2 (3?) cuts in 2024 according to the model.
Table 1. Updated MoM (sa) UnderlyingInflation forecast errors in the last 6 months.
A PDF containing all relevant CPI charts has been posted. You can download it here.
Evidence from the distributions
Distribution, still unfriendly and not consistent with target. This month, the distribution is way more dispersed than the previous month (ridge plot here). The median (Figure 2) ticked up and remains volatile. Looking at Figure 1, however, the broad picture is unchanged: the distribution remains different than pre-Covid. Not only but in the last 9 months, the progress has been tiny. For this reason, as we wrote in previous notes, we remain careful in declaring victory or claiming that 2% is around the corner.
Figure 1. Kernel of CPI excluding food and energy items changes (MoM %, 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 2. Median (core) CPI metrics
Note: the Figure shows the median (MoM %, a.r.) of the distribution of CPI prices changes excluding food and energy items (left panel) and the YoY (right panel).
Evidence from our CI-C model
Our CI model estimates that net of Covid and idiosyncratic shocks, the common component remains above target. Figure 3 shows the decomposition of the MoM of core CPI in the “common” vs “idiosyncratic” component. The model estimates that this month the common component increased by 22bps, while the idiosyncratic shock is positive (6bps). In other words, the model attributes some of the strength of core CPI to factors that are unlikely to persist. The 3m/3m of the “common” component (Figure 4) is at 2.7%. Overall, the evidence of the CI model suggests that the “true” underlying pace of the data remains above target.
Note: the results of our CI model in this moment explains well what is going on with the data. In June and July, we got low core CPI prints but we did not take much signal as the model was suggesting that the weakness was idiosyncratic. This month, we do the same although with the opposite sign.
Figure 3. Contributions to MoM changes of CPI excluding food and energy items (CI-C model)
Note: the Figure shows the decomposition of the MoM percent changes of CPI prices excluding food and energy items. The contributions are estimated using our CI-C model, a 2-stage OLS-LASSO regression model.
Figure 4. Estimated “Common” component: YoY, 3m/3m a.r. and 6m/6m a.r.
Note: the Figure shows the 3m/3m at annual rate (green line), the 6m/6m at annual rate (red line), and the YoY (blue line) of the “common component” estimated using our CI-C model.
Implications for the medium-term forecast of core PCE price inflation
The medium-term forecast is unrevised. Today’s data did not change our Q3 nowcast in core PCE space. We are working under the assumption that core PCE prices will grow 2.1% QoQ saar in Q3. Conditional on this, the model forecast is unrevised compared to the preview. The (Q4/Q4) model forecast is: 2.8% in 2024, 2.4% in 2025, and 2.4% in 2026.
Figure 5. “Main” Phillips curve model forecast, core PCE price inflation (YoY, %).
Note: the figure shows the latest run of our “main” Phillips curve model. The confidence intervals (C.I.) are estimated using quasi-out-of-sample methods (estimate the model over a sub-sample, forecast, and calculate the root mean squared forecast errors).