A very complicated report. How can we say such a thing after a 6bps in core CPI and very low rents/OER? Is they story over? We wish we could say that but it is more complicated. First, today’s weakness is overstated by seasonal issues, part of which is expected to reverse in coming months. Just as an example, Figure 0 shows the NSA level of CPI rents of primary residencies. While most people are celebrating the SA print, the NSA level shows no deviation. By saying this we do not want to downplay the 6bps we got today in core CPI; rather, it is a reminder to be careful about any SA figure. Also, as explained below, according to our models today’s print is less friendly than it looks like and has limited (if any) implications for the medium-term.
For the record, 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 for core CPI (our focus) remain competitive.
Reaction to the incoming data: slightly lower near-term. We run our 22 sectoral models (detailed results available upon request). The models took some signal from today’s data and revised down a bit the near-term. We now expect July core CPI at 18bps MoM sa, Aug at 23bps, and Sep at 22bps. We also expect the YoY of core CPI at 2.9% in December 2024.
Translation CPI/PCE: our translation of today’s core CPI print is 20bps in core PCE space.
Evidence from our models: less friendly than it looks like. In CPI space the distribution of price changes remains different than pre-Covid (even in June). The CI model suggests that today’s low print is driven by a large negative idiosyncratic shock, while the common component is more solid than last month. Finally, the “main” medium-term model is unrevised.
For the Fed: today’s report put on the table a judgmental cut in September (as shown yesterday, the models likely will not call for a cut in September, yet). Needless to say, given the level of complexity of today’s report, we will keep working on the forecast in the coming days and update you if anything changes.
Figure 0. CPI rents of primary residencies – cumulated NSA by year
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, the distribution is very similar to the previous month (ridge plot here). The median (Figure 2) also remained low. Looking at Figure 1, however, the broad picture is unchanged: the distribution has moved slighly to the left but overall remains very 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. Rather, the distribution suggests that the tails are thick and that the MoM can be very bumpy.
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 remains above target. Figure 3 shows the decomposition of the MoM of core CPI in the “common” vs “idiosyncratic” component. The model estimates that this month the common component increased by 21bps, while the idiosyncratic shock is large and negative (-15bps). In other words, the model attributes the weakness of core CPI to factors that are unlikely to persist. The 3m/3m of the “common” component (Figure 4) remains around 3%. 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 is unchanged. Today’s data have no implications for our nowcast of the current quarter (Q2 core PCE at 2.8% QoQ saar). For this reason, the “main” model medium-term forecast is unrevised. The (Q4/Q4) model forecast is: 3.0% in 2024, 2.6% in 2025, and 2.5% in 2026.
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).