Preamble: Tariffs.
We have now factored in the recently announced tariffs on automobiles. Overall, the effect on inflation is small—approximately one-tenth of a percentage point on the year-over-year of core PCE. Both our medium-term model and our top-down forecast estimate core PCE inflation at 2.9% year-over-year in December 2025.
We have also used the FRB-US model to analyze hypothetical scenarios involving significantly larger tariffs (e.g., a 20% tariff on all major trading partners). The effect on core inflation varies depending on the specific design of the tariffs. In general: (i) imposing a 20% tariff on all trading partners except Mexico and Canada raises core PCE inflation by roughly 0.3–0.4 percentage points, while (ii) including Mexico and Canada leads to a substantially larger inflationary impact. In all scenarios, the Federal Reserve does not raise interest rates (given the hit to real GDP growth) but instead maintains higher rates for a longer period. Please contact us if you would like more detailed information.
Not at target, Upside Risks.
Today’s data confirms that we are still not at target. In fact, the reading is stronger than expected, the median ticked up significantly and the CI model estimates the strongest common component since January 2023.
Finally, the medium-term forecast is little changed and stays above target. In short, today’s report hasn’t told us much, we remain “inflationistas” and on the hawkish side. Risks remain skewed to the upside, unless a recession hits the economy.
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
Not consistent with target.
This month, the distribution is similar to last month (Figure 1). Taking a broader view (Figure 2), the distribution remains different from the pre-Covid period, with little sign of improvement in recent months—in fact, over the last three months, it has been nearly identical to the previous three or six months. Finally, the median (Figure 3) remains volatile and ticked up this month.
Overall, we remain cautious in interpreting the signals due to potential residual seasonality and, as mentioned, because the distributions are still not consistent with the target.
Figure 1. Distribution of PCE excluding food and energy items changes (%, a.r.)
Note: The figure displays the fitted Kernel (Epanechnikov) distribution of the MoM percent changes at an annualized rate for PCE prices excluding food and energy items. The colors represent different percentiles (0-10th, 10-25th, etc.), while the dashed line indicates the median of the distribution.
Figure 2. Kernel of PCE excluding food and energy items changes (%, a.r.)
Note: The figure presents the fitted Kernel (Epanechnikov) distribution of the MoM percent changes at an annualized rate for PCE prices excluding food and energy items.
Figure 3. Median PCE price increase
Note: The figure displays the median MoM % (annualized rate) of the distribution of PCE price changes excluding food and energy items (left panel) and the YoY rate (right panel).
Evidence from our Common-Idiosyncratic (CI) model
Common component above target.
Figure 4 illustrates the decomposition of the MoM core PCE into the “common” component (blue bars) and the “idiosyncratic” component (yellow bars). This month, the model estimates that the common component increased by 44bps, while the idiosyncratic shock was negative (-8bps). Notably, this month increase in the common component is the largest since January 2023 (see Figure 4). The 3m/3m annualized rate of the common component (Figure 5) is currently running above target at 2.8%.
Overall, the signal from the common component (Figure 5) is broadly aligned with that of the distributions and our latest estimate of pi* (at 2.5%-2.6%). (Note: the Fed staff has released a note in which the estimate of pi* is lower than ours -we will discuss it in a separate note soon).
An Excel file containing the results of the CI model shown in Figure 4 is available here.
Figure 4. Contributions to MoM changes of PCE excluding food and energy items (CI-C model)
Note: The figure presents the decomposition of the MoM percent changes in PCE prices excluding food and energy. Contributions are estimated using our CI model.
Figure 5. Estimated “Common” component: YoY, 3m/3m a.r. and 6m/6m a.r.
Note: The figure displays the 3m/3m annualized rate (green line), the 6m/6m annualized rate (red line), and the YoY rate (blue line) of the “common component,” as estimated using our CI model.
Implications for the medium-term forecast of core PCE price inflation
The medium-term unrevised. Today’s data raised the model forecast in 2025, as the incoming data pushed up our Q1 nowcast (now at 3.1% QoQ saar). The (Q4/Q4) model forecast is as follows: 2.9% in 2025, 2.6% in 2026, and 2.5% in 2027.
Note: the assumptions behind the model’s results now take into account the auto tariffs (but not a generalized 20% tariff on all major trading partners).
Note: The figure presents the latest run of our “main” Phillips curve model. The confidence intervals (C.I.) are estimated using quasi-out-of-sample methods—specifically, by estimating the model over a sub-sample, generating forecasts, and calculating the root mean squared forecast errors.