Our forecast
High core, still limited disinflation progress. We expect headline and core CPI to expand 24bps and 44bps (2.9% and 5.4% at annual rate) in March, respectively. Figure 1 below shows the sectoral breakdown of our MoM forecast for March. We expect core goods to expand 31bps and core services 52bps. Conditional on our forecast, the disinflation progresses would be limited, as the MoM of core CPI would be in line with the last 3 months. Admittedly, we have judgmentally boosted our forecast by 3-4bps (for both, headline and core) to account for the small forecast errors in recent months. Yes, despite all efforts and the fact that we are among the most hawkish forecasters in this moment, we have underestimated core inflation in the last 3 months by 5 basis points in each month – see Figure 2 below. Therefore, we have decided to judgmentally boost our March forecast distributing the upward lift across items. In any case, the standard deviation of our MoM forecast remains below the one of consensus.
Core CPI expected strong also in April and May. While this email is about the March MoM forecast, we must spend a word looking beyond March. Our models suggest large readings for core CPI in April (47bps) and May (43bps), driven by renewed strength in used car prices. (The May CPI report is expected on June 13th, the first day of the June FOMC). If our forecast is correct, at the time of the June FOMC, the Fed will have 6 consecutive CPI reports showing core inflation between 0.4% and 0.5% MoM. This is one of the reasons why it is hard to us to imagine the FOMC cutting rates in June (or July or even in September).
Figure 1. March CPI forecast – details
Figure 2. Forecast errors
Implications for the “main” model
Implications for the medium-term model-based forecast are limited. Conditional on our core CPI forecast, we expect core PCE prices to grow 4.8% (QoQ ar) in Q1. Consequently, the “main” model delivers a forecast which is nearly identical to the one at the time of the February PCE prices report (March 31 – our note here). The model (Q4/Q4) forecast is: 4.3% in 2023, 3.9% in 2024, and 3.6% in 2025 (Figure below).
Figure 3. Main model forecast of 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). First quarter of forecast: 2023:Q2. The model is based on Detmeister et al. (2014).
Conclusion
It takes time to disinflate. If our forecast is correct, core inflation will be persistent, possibly more than markets, the Fed staff and the FOMC are anticipating. Unfortunately, an upward surprise for the Fed staff or the FOMC would not be the first one or (we fear) the last one. What is pretty clear in our view and estimates is that in this environment it is very hard to imagine the FOMC cutting rates aggressively in the second half of the year. The most likely scenario remains the one in which the FOMC raises the FF rates above 5% and remains there for the rest of the year to make sure we can go back to target in a reasonable amount of time.