The November CPI report was just a bit softer than expected. The composition of the monthly changes across sectors seem to reflect the sectoral miss(and re-)allocations due to Covid. Core CPI came in a bit softer than expected (28bps vs 34bps), while headline CPI was in line with our expectations (10bps vs 11bps). Our CPI preview is here. The downward surprise for core in November is in line with previous misses (or lower) and comes from a miss in some volatile items (i.e. apparel) and new vehicles. Overall, the std error and std deviation of our forecast continues to be competitive. Nevertheless, in recent months our forecast has been slightly upwardly biased (2bps in core space, see Table 1 below). We will account for this next month.
Reaction to the incoming data is small. In our judgmental bottom-up forecast, we did not take much signal from today’s misses and we continue to expect the December MoM (sa) of core CPI at 27bps based on continuing strength in rents/OER and continuing disinflation in other categories. (as usual, this is a preliminary forecast subject to revisions)
Overall comment: this CPI report seems to reflect the sectoral misallocations due to Covid. The good news is that the November distribution (especially the median) and the CI-C model shows convincing signs of disinflation. However (i) the shape of the distribution continues to be far from consistent with target, (ii) in November core services ex rents and OER came in at 5.4% (MoM saar – metrics chart here), and (iii) rents and OER came in at 6.1% (MoM saar). Translated: disinflation is on its way, but the persistency of housing and possible repricing in lagging sectors makes it hard to say the US can go back to target without additional help from the labor market. Our guidance is the medium-term model, the forecast of which is unchanged to rounding and remains above target at the end of the horizon.
For the Fed: it changes nothing. Today’s small surprise is unlikely to derail the December FOMC. We defer the reader to our pre-FOMC meeting package here.
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
Some good news from the distributions. This month, the distribution moved down (ridge plot here), especially the median (Figure 2). This is a promising sign but we need more evidence because the evolution in the last three months (black line in Figure 1) shows no real progress compared to the previous three months (yellow line), and the shape of the distribution 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. If anything, the evidence in Figure 1 indicates that the US economy continues to be more consistent with an inflation rate above target going forward.
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-C model estimates that net of Covid and idiosyncratic shocks, the common component in November was weak. Figure 3 shows the decomposition of the MoM of core CPI in the “common” component, the “idiosyncratic” component, and the “Covid” effect. The model estimates that in November the common component increased by 14bps, lower than previous months. The Covid effect is small negative (-5bps), and the idiosyncratic shock is large (19bps). Figure 3-bis shows the run of the CI model (that is, not including the “Covid” effect, as in Luciani (2020)). The message remains the same: the common component is estimated weak in November and the core reading was “artificially” higher due to some positive idiosyncratic shock which is unlikely to remain there in coming months.
Figure 3. Contributions to MoM changes of CPI excluding food and energy items (CI-C model)
Figure 3-bis. 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. The “Covid” effect is identified with price variations outside the 10th-90th percentiles of each item pre-Covid price change distribution.
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 of core PCE price inflation is unchanged to rounding. Following today’s release, we are assuming that core PCE prices will expand 2.8% (QoQ ar) in Q4, a touch lower than our assumption at the time of our pre-FOMC meeting package. The latest model-based forecast of core PCE price inflation is at 2.5% in 2024, 2.4% in 2025, and 2.4% in 2026. The forecast remains above the Fed target. The model continues to suggest that the US can remain above target going forward without additional downward surprises or help from the labor market (in line with the message of our “agnostic” Phillips curve – chart here).
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). First quarter of forecast: 2024:Q1.
Implications for the Fed Board staff and the FOMC
It changes nothing for the Fed. Today’s small surprise is unlikely to derail the upcoming FOMC, as the medium-term forecast is unchanged. We defer the reader to our pre-FOMC meeting package here.