The Pivot
Long Story Short: The Pivot. The FOMC tried to push back against markets by signaling a lower number of cuts in 2024, as we expected. However, this was probably the only real attempt. The new statement has a clear dovish tilt because it stresses that the risks are shifting. More importantly, Powell could not sound more dovish than he did. And we suspect this is only the beginning, net of big surprises. In summary: only green lights from DC tonight.
The new statement
Risks have shifted. The new statement is very similar to the previous. However, it is pretty clear that the new statement stresses that the risks are shifting: growth “has slowed” and inflation “has eased”. Overall, to us, this is giving a clear dovish tilt to the statement.
The new projection
One surprise. To our eyes, the new SEP was overall as expected. In private meetings, we discussed the possibility that the path of the FF rate could be similar to the June SEP and in the end, this turned out to be the case. The only surprise is that the new SEP shows core PCE at 3.2% in 2023, therefore already reflecting the latest information. Considering that the forecast of the unemployment rate is unchanged and the risks are to the upside, at this point it becomes hard to think that the Fed will cut only 3 times in 2024. It is becoming increasingly possible to have many more cuts. (see our post PPI note here).
Q&As
Question. Do you believe we are at a point where inflation has come down credibly?
Powell. “I think if you look at the six-month measures, you see very low, low numbers. If you look at 12 months measures, they are still well above 2%, actually above 3% on core […] I’m not calling into question the progress, it’s great, we just need to see more, we need to see, you know, continued further progress toward getting back to 2%. That’s what we need to see. So, you know, it’s our job to restore price stability. And that is one of our two jobs along with maximum employment and they’re equal. So, we’re very focused on doing that. As I mentioned, we’re moving carefully at this point. And we’re pleased with the progress. But we see the need for further progress. I think, I think it’s fair to say there is a lot of uncertainty about going forward, we’ve seen the economy moving in surprising directions so, we’re just going to need to see more progress.”
Comment. Powell cannot declare victory right now because the forecast still does not converge to target. But the suspect is that at this point he truly believes inflation will not reaccelerate. We continue to be a bit more prudent because it can be bumpy, but the models have spoken (in case the reader has missed it, please see our post-PPI note here).
Question. How sticky is core inflation right now?
Powell. “Well, that’s what we’re finding out. And we’ve seen real progress in core inflation; it has been sticky and famously the service sector is thought to be stickier. But we’ve actually seen reasonable progress in non-housing services, which was the area where you would expect to see less progress. We are seeing some progress there. In fact, all three of the categories of core are now contributing: goods, housing services, not housing services, they’re all contributing”.
Comment. This was a very surprising answer and we are not sure Powell is getting the facts right. For instance, the figure below shows the metrics of core CPI services excluding rents and OER. In November, the index increased 5.4% MoM saar (and 4.95% on 3m/3m saar basis), showing basically no real progress. Not only, but rents and OER came in at 6.1% MoM saar in November, with no progress in the last 8 months or so. The key, we suspect, is that core CPI figures are currently translating into lower core PCE readings. But even in core PCE space, we are not quite sure Powell is right.
Figure 1. Core CPI services ex rents/OER – metrics
Question. Data this morning (PPI) incorporated in the forecast?
Powell. “We got CPI the morning of the first day and we got PPI the next day which informs you know, the translation into PCE. So, it’s very, very late in the game […] but nonetheless, participants are allowed or encourage to update their SEP forecasts until probably mid-morning. […] It’s okay to update, and I believe some people did update their forecasts based on what we saw today”.
Comment. As we mentioned earlier today, the standard practice for the Fed staff is to not update the medium-term forecast on FOMC day(s) when receiving a CPI/PPI report. The staff generally submits only the so-called “translation” (what CPIs and PPIs imply in PCE space). It seems that some FOMC member have updated their core PCE forecast based on that. But it also seems that they have not updated their FF rate forecast. Indeed, as mentioned post-PPI, at this point the Taylor rules imply more cuts than the one suggested by the new SEP. Another way of putting this is the following: it seems that the FOMC tried to be cautious in the SEP by showing a limited number of cuts in 2024 but revealed the bluff with the core PCE inflation forecast.
Question. Last mile – how hard is it? Do you think something has changed in our understanding of inflation?
Powell. “I think that this inflation was not the classic demand overload […], it was a combination of very strong demand without question and unusual supply side restrictions both on the good side, but also on the labor side. [Powell then talked about strong demand hitting a vertical short-run supply curve, followed by a moderation in demand and a positive supply shock both in the goods and the labor market]. The question is, you know, once that part of it runs out [the positive supply-side shock, ndr], you will run out of supply side help and then it gets down to demand and it gets harder. That’s very possible, but to say with certainty that the last mile is going to be different, I’m reluctant to suggest that we have any certainty around that. We just don’t know. I mean, inflation keeps coming down. The labor market keeps getting back into balance. And it’s, you know, so far so good. We kind-of-assumed that that it will get harder from here, but so far it hasn’t”.
Comment. In general, there are good theoretical reasons to think that the last mile is harder, as explained by Isabel Schnabel in this speech. In the last couple of months, we certainly got good news and we have travelled faster than expected. We continue to be cautious in declaring victory for the reasons we discussed on CPI day.