Convicing Disinflation
Distributions have spoken, medium-term model confirms. Only excellent news today: distribution shows convincing disinflation, the median dropped further, the common component (of our “CI” model) is around target, and the medium-term model revised down its forecast which is now below the SEP. Translated: could not be better than this. The only real question is what will happen in January, which is a weird month in terms of repricing. But at this point if we do not get a crazy number, we can bet on a March cut.
Another way of putting it: Figure 0 shows the core PCE Phillips curve using jobs opening rate as measure of “slack”. We still miss 3-4 reports before the March 2024 FOMC. At this point, the probability of the jobs opening rate to fall as needed to be consistent with target is, indeed, pretty high. Of course, there is a chance of remaining a bit above target, but it seems that the Fed will not care much, unless core PCE will re-accelerate.
Figure 0. Core PCE Phillips curve
A PPT containing all relevant CPI/PCE charts can be downloaded here.
Evidence from the distributions
Shifting left. This month, we do not have a clear signal from the distribution as some percentiles moved up and some down (Figure 1). Looking at the last three months (Figure 2) the distribution shows a movement to the left with slighlty less dispertion around its mean/median. Finally, the median of the distribution (Figure 3) ticked down again to (or below) pre-Covid levels.
To sum up: yes, a part of the story is a negative idiosyncratic shock (see next paragraph and Figure 4) but the distribution is screaming loudly.
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 large negative idiosyncratic component. Common component around target. 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 November the common component increased by 16bps, roughly in line with the average of the previous 5-6 months. The idiosyncratic shock is large and negative (-9bp). Overall, the common component (Figure 5) has moderated recently and it is around target.
(Note: giving the changing economy, we have gone back to the original “CI” model. The “CI-C” model results are available upon request)
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 lower and below the SEP. Today’s data imply no revision to our Q4 nowcast. We are working under a Q4 nowcast assumption of 2.0% (QoQ saar) as in our post-PPI run. However, we have revised down the forecast of import (and oil) prices in reaction to lower than expected data. The (Q4/Q4) model forecast is now at 2.2% in 2024, 2.1% in 2025, and 2.1% in 2026. The projection is now below the latest SEP.
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
March Cut. March cut is on the table, unless we get a crazy reading in January (reminder: January is a weird month that can, indeed, show very large MoM readings). After that, we now bet on several cuts in 2024.