It was great meeting you in London, see you soon in NY, DC, and Montreal!
Confirming the big picture. We have discussed the big picture in private meetings in London, so we keep this email short.
In a nutshell: the PCE price report confirms that we might remain above target going forward. For instance, the common component of our CI model is now in line with the estimate of pi* at 2.4%-2.5% and the distributions remain different than pre-Covid. We continue to think this is what the FOMC will discuss this week. If the Fed will start lowering rates soon (September), in our estimate it will accept the risk of printing above target to save the labor market. We suspect that Powell will never admit it, but to us this is the implicit message.
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
Not consistent with target. This month, the distribution has a thicker right tail (Figure 1) but in this highly volatile environment we have learned to take little signal from a single month. Zooming out, in the last 3 months (Figure 2) there are little signs of progress and the distribution remains different than pre-Covid. Finally, the median (Figure 3) remains volatile and ticked up this month.
To sum up: considering that we are about to enter H2 (residual seasonality), it is reasonable to expect, on average, lower MoM than in H1. We expect core PCE prices to grow at an average of 17bps in H2 and the YoY at 2.7% in December 2024.
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
Common component in line with pi*. 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 June the common component increased by 21bps, while the idiosyncratic shock is a small negative (-3bp). The 3m/3m ar of the common component (Figure 5) is now running at 2.4%. Overall, the signal of the common component (Figure 5) seems in line with the one of the distributions and the latest estimate of pi* (2.47%).
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 unchanged. The June data imply no change to the medium-term forecast. The (Q4/Q4) model forecast is: 3.0% in 2024, 2.6% in 2025, and 2.5% in 2026.
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).