Unless we get a large downward surprise, in our view the January report is unlikely to trigger a significant reaction of the Fed. We explain why in this note.
Our forecast
We expect total and core CPI to expand 51bps and 36bps in January, respectively. Figure 1 below shows the sectoral breakdown of our MoM forecast for January. We expect core goods to expand 4bps and core services 52bps, driven by shelter (69bps), and we expect core services excluding shelter to expand at about 3% annual rate. Our forecast is close to consensus and it is very close to our own forecast on December CPI report day (see here). Risks around the forecast are skewed to the upside for the reasons discussed in this note. Figure 2 shows our forecast errors since July (as circulated and discussed upon request in private meetings). The mean of our MoM forecast error is -1bps for both total and core CPI, while the absolute mean and standard error are 16bps and 8bps, respectively.
Figure 1. January CPI – MoM breakdown
Figure 2. Forecast errors of MoM UnderlyingInflation forecast
In our view and estimates, the January CPI report is unlikely to trigger a significant reaction of the Fed staff and FOMC. Last December (see here) we assessed the probability of a Fed pivot in Q1 and Q2. The result of the analysis was that the chances of a pivot in Q1 were quite low because the “main” core Phillips curve model was not expected to converge back to 2% (under a reasonable path for the MoM of core CPI). Rather, chances were that the models will deliver more favorable signals starting in Q2 (possibly at the end of Q2). Not much has changed since then. The only meaningful difference is that the model forecast of core PCE in Q1 is higher than implied by our forecast. Therefore, going forward we expect the model to revise down its medium-term forecast, although not enough to converge to 2% in this quarter. Not only, but in our view the Fed staff is well aware that the road ahead is bumpy (residual seasonality, used cars prices have stopped declining, etc..), therefore we expect the staff to be extra careful before changing its message. We are still in inning 6, not 9.
All told: it is still too early for the Fed to pivot. In our estimates, it will take more than one CPI print before it happens. Powell today has essentially tried to deliver this message again.