Nailed It! But That’s the Problem..
The February CPI report came in as expected. Core CPI came in solid, as expected (36bps vs 34bps expected by us), and headline CPI was also in line with our expectations (44bps vs 42bps expected). Our CPI preview is here. Table 1 shows our MoM forecast errors. In the last 6 months, the std error (5bps) and the std dev (11bps) of our MoM forecast remain good. (The disappoint news today is that we missed it again in the same direction for the 3rd month.. will not happen in March, be sure)
Reaction to the incoming data: raised near-term forecast. In our judgmental bottom-up forecast, we took no signal from today’s small miss but we have judgmentally raised our near-term forecast again to compensate for the recent misses in the same direction. We expect the YoY of core CPI at 3.2% in December 2024 (the cumulative NSA level in 2024 also suggests that the YoY could be around 3% in December 2024, see page 4 here). At the same time, we now expect the YoY of core PCE at 2.8% in December.
Evidence from models: 3% is the new 2%. As we always say, you can forget about all narrative stories you read (yes, all of them). Ultimately, sooner or later, the only thing that matters is the distribution of price changes. Unfortunately, in CPI space it remains different than pre-Covid, raising questions whether we can reach and stay at target (note: this is the same sentence we have been writing for several months in the CPI report – on the other hand, the distribution in PCE space is more friendly. At the end of last year we got more dovish as the PCE distribution became more friendly, but the distribution in CPI continues to suggest that “3% is the new 2%”). Also, the median in February is lower than in January but remains very elevated. The CI model suggests that there is some real broad-based pressure in today’s CPI. Finally, the medium-term model is marginally higher and its forecast is above the December SEP.
For the Fed: risks are to the upside for the FF rate in the coming SEP. Tomorrow we will circulate our “Pre-FOMC Meeting Package”. In a nutshell, the models (including FRB-US) see a risk that the upcoming SEP can show one cut less in 2024 compared to the December SEP. If Powell has in mind pi* (see our post January FOMC notes here and here), then it is hard to see it at 2% any time soon.
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. This month, all percentiles of the distribution moved down, except for the left tail (ridge plot here). The median (Figure 2) moved down compared to January but remains very elevated.
In the last three months (black line in Figure 1) the distribution shows only limited progress, in fact it shows some movements to the right. The shape of the distribution continues to be different than pre-Covid. For this reason, as we wrote in previous notes, we remain careful in declaring victory or claiming that 2% is around the corner. It cannot be done right now. If anything, the evidence in Figure 1 indicates that the US economy continues to be more consistent with an inflation rate above target going forward.
Please, note that the last paragraph is identical to what we wrote last month and the previous several months. On the other hand, the distribution in PCE space is more friendly. Put it simply: the distribution in core CPI space suggests a 3%+ reading, while in core PCE space it suggests around 2.5%. If the reader is still unconvinced, another way of putting it is the following: we need to disinflate services ex rents/OER and they are still accelerating (see here the metrics).
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 in February is strong. Figure 3 shows the decomposition of the MoM of core CPI in the “common” vs “idiosyncratic” component. The model estimates that in February the common component increased by 32bps, while the idiosyncratic shock is also positive (4bps). The common component expanded at a solid pace. The 3m/3m of the “common” component (Figure 4) is on a downward trend but likely to rebound in the coming months. Overall, the evidence of the CI model suggests that the “true” underlying pace of the data remains above target.
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 of core PCE price inflation is a bit stronger. Compared to last run, the model forecast is a bit stronger due to higher incoming data. We are working under the Q1 nowcast of 3.5% (QoQ saar). Conditional on this, the model forecast is: 3.1% (Q4/Q4) in 2024, 2.7% in 2025, and 2.65% in 2026. This forecast is now above the latest SEP at every horizon. We will finalize the forecast later today.
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).
Implications for the Fed Board staff and the FOMC
Higer FF rate in SEP in 2024? The problem is not today’s CPI. The problem is bigger. In this cycle, we have been on the (very) inflationista/hawkish side. We turned more dovish toward the end of last year when the core PCE distribution started to cooperate. But, if anything, the problem in core CPI only got worse in recent months. As we will show tomorrow, the risk is that the new SEP might show one cut less in 2024 compared to December.