No Signal From The Quarterly Miss, Still Unfriendly Distributions
Preamble: core PCE was revised up in January (MoM sa from 45bps to 50bps), and February (MoM sa from 26bps to 27bps). The March reading (at 32bps) was in line with our expectations. The upward revision was driven by a revised path for “other than market-based” prices (a.k.a. “non-market” prices), that is volatile items which carry no signal for future readings of core PCE itself (see chart here).
It changes little for the Fed. The upward revision to Q1 was certainly not good news for the Fed staff and the FOMC. Having said that, the revision comes primarily from very volatile items (“non-market” prices) which typically carry little signal for future readings of core PCE itself. For this reason, today’s data change little for the Fed, especially because the signals of the models are little changed.
An important note: there has been lots of talks recently about inflation. We continue to think that a simple, yet most effective, way of understanding the dynamics is to look at the NSA level of the series by year. Indeed, it is pretty clear that, so far, core PCE in 2024 has been following closely the 2023 path, with no real sign of deceleration, and it is pointing to a YoY of about 3% at the end of the calendar year (see figure here).
We remind the reader that we currently estimate pi* (see slide 18 and 22 here) at 2.6% in core PCE space. For the time being, the Fed cannot be dovish, but there is not even urgency to hike again.
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
Unfriendly distribution. The revised data show an unfriendly distribution, both in the last month (Figure 1), and the last 3 months (Figure 2). The median (Figure 3) remains volatile and elevated.
To sum up: the distribution suggests near-term readings above target (around 2.5%+ MoM saar).
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 strong common component. 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 March the common component increased by 29bps, while the idiosyncratic shock is a small positive (2bp). Overall, the common component (Figure 5) seems to have bottomed and it shows some acceleration in recent months. The signal of the CI model is in line with the one of the distributions.
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 marginally higher. Because the starting point (Q1) has been revised higher, the model took a tiny signal and revised up marginally the forecast. Nevertheless, the upward revisions are more cosmetic than signal. The latest model forecast is: 3.15% (Q4/Q4) in 2024, 2.7% in 2025, and 2.65% in 2026. This forecast is above the latest SEP at every horizon.
(We remind the reader that the current estimate of pi* is 2.6% in core PCE space, unaffected by today’s release)
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
It changes little for the Fed. The upward revision to Q1 was certainly not good news for the Fed staff and the FOMC. Having said that, the revision comes primarily from very volatile items (“non-market” prices) which typically carry little signal for future readings of core PCE. For this reason, today’s data change little for the Fed (look at pi*!). For the time being, the Fed cannot be dovish, but there is not even urgency to hike again.