Fed on Hold
Models are unfriendly, unclear how persistent the process is. The strong January reading in core PCE space was expected after the CPI and PPI data. Therefore, it is unsurprising that the distributions are very unfriendly this month. It remains unclear how much of this reading is (possibly) due to residual seaonality vs signal. Having said that, net of noise, the distributions and the models all suggest that there are questions marks about if (and when) core PCE can return to target. As we recently wrote (here), the most likely scenario is for core PCE to average above target going forward, which is in line with the current estimate of pi* (around 2.5% in core PCE space).
Putting everything together: based on today’s information set, in our view, the Fed is “on hold”. No reason to think the new SEP will be materially different than the December one.
(Note: Afterall, it seems that we are somehow back to what we wrote last October – here)
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
Unfriendly movement. This month, the entire distribution has shifted up, driven by the January “repricing effect” (Figure 1). However, looking at the last three months (Figure 2) the distribution also shows some movements to the right, a signal that should not be dismissed. Finally, the median of the distribution (Figure 3) also jumped up this month.
To sum up: the signals from the distribution are very unfriendly this month. We are careful because everything seems to be driven by the January “repricing effect” which is not necessarily persistent. Having said that, it is also hard to think that core PCE can average 2% in the near-term going forward.
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 very strong common component, in acceleration. 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 January the common component increased by 32bps, higher than the previous months. The idiosyncratic shock is positive (9bp). Overall, the common component (Figure 5) has bottomed and it shows some acceleration in recent months, likely to continue in the near-term.
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 revised up marginally. We are currently assuming that core PCE price inflation will grow 3.3% (QoQ saar). Compared to last run (here), the model forecast is revised up marginally because we have revised our Q1 nowcast. The model forecast is: 3.0% (Q4/Q4) in 2024, 2.7% in 2025, and 2.6% in 2026. This forecast is now above the latest SEP at every horizon.
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
FOMC on hold. Conditional on our Q1 nowcast, the models suggest that the upcoming SEP can be broadly similar to the December SEP (see here our analysis). Not only but we still have one CPI report before the FOMC. Therefore, for the time being the Fed is “on hold” in our view.