Cut in March?
Distribution back to pre-Covid, medium-term model confirms. Good news today: for the first time, the distribution looks remarkably close to its pre-Covid shape (see Figure 1 below). The common component (of our “CI” model) is around target, and the medium-term model projects core inflation at target.
Translated: at this point, if we do not get a crazy core CPI in January, we bet on a March cut.
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
(Almost) Back to Pre-Covid. This month, we do not have a clear signal from the distribution as some percentiles moved up and some down (Figure 1). Having said that, December is the first month in which the distribution looks remarkably similar to pre-Covid. Looking at the last three months (Figure 2) the distribution shows a movement to the left with slightly less dispersion around its mean/median. Finally, the median of the distribution (Figure 3) ticked up and remains around pre-Covid levels.
To sum up: the distribution has spoken.
Figure 1. Distribution of PCE excluding food and energy items changes (%, 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. The colors indicate the percentiles: 0-10pct, 10-25pct, etc. The dashed line shows the median of the distribution.
Figure 2. Kernel of PCE excluding food and energy items changes (%, 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. Median PCE price increase
Note: the Figure shows the median (MoM %, a.r.) of the distribution of PCE prices changes excluding food and energy items (left panel) and the YoY (right panel).
Evidence from our Common-Idiosyncratic (CI) model
Our CI model estimates a small negative idiosyncratic component. Common component around target. Figure 4 shows the decomposition of the MoM of core PCE in the “common” component (blue bars) and the “idiosyncratic” component (yellow bars). The model estimates that in December the common component increased by 21bps, a bit higher than the previous months. The idiosyncratic shock is negative (-4bp). Overall, the common component (Figure 5) has moderated recently and it is around target.
Figure 4. Contributions to MoM changes of PCE excluding food and energy items (CI-C model)
Note: the Figure shows the decomposition of the MoM percent changes of PCE prices excluding food and energy items. The contributions are estimated using our CI-C model, a 2-stage OLS-LASSO regression model. The “Covid” effect is identified with price variations outside the 10th-90th percentiles of each item pre-Covid price change distribution.
Figure 5. 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 marginally lower and below the SEP. Today’s data imply only a marginal downward revision (to rounding). The (Q4/Q4) model forecast is now at 2.0% in 2024, 2.1% in 2025, and 2.1% in 2026. The projection is below the latest SEP.
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).
Implications for the FOMC and the Fed Board staff
March Cut? March cut is on the table, unless we get a crazy reading in January (reminder: January is a weird month that can, indeed, show very large MoM readings). As explained in our yesterday’s FRB-US note, it is possible the US economy is experiencing a positive supply shock (and some contraction in aggregate demand). Normalizing rates closer to neutral can be an option for the FOMC, at this point.