Preamble: nothing included in this note changes our view for the December FOMC because today’s news cannot be incorporated in the Tealbook (which closed several days ago). Also, Powell and the FOMC members are, in our view, unlikely to change their minds based on today’s data. Therefore, we continue to defer the reader to our pre-FOMC meeting package (here).
By default, we do not (over)react to a single CPI or PPI print because the models forecasts are generally little changed. Having said that, today’s PPIs and some re-thinking of the current quarter, triggered a downward revision of our “main” model, which now projects core PCE closer to target. The new forecast is worth a discussion. We will circulate an updated FRB-US baseline after digesting the FOMC. The below shows the model’s output and updated Taylor rules in partial equilibrium.
The new run
Figure 1 shows the latest run of our “main” model (Q4 in sample). The forecast is revised down by 2 tenths to rounding. This run assumes that core PCE prices will grow at an annual rate of 2.3% QoQ saar in the current quarter (we see some downside risks). The revised nowcast is lower than yesterday, given the (very) weak PPIs and some re-thinking of the December core CPI (now expected at 22bps MoM sa). Conditional on this Q4 nowcast, the (Q4/Q4) model forecast is at 2.3% in 2024, 2.2% in 2025, and 2.2% in 2026. The projection is a couple of tenths lower than yesterday throughout the forecast horizon.
Figure 1. “Main” Phillips curve model forecast, core PCE price inflation (YoY, %).
Implications for the FF rate
FF rate close to market pricing. Figure 2 shows an update of the (partial equilibrium) Taylor rules, conditional on a forecast for core PCE price inflation as in Figure 1, and a forecast for the unemployment reaching U* and going sideways thereafter. Conditional on this forecast, the Fed staff (2021) Taylor rule implies the FF rate at 4.2% in 2024 (Q4), 3.4% in 2025, and 3% in 2026. At this point, a lower path of the FF rate requires a recession pushing U>U*. The path of the FF rate in Figure 2 is lower than at the time of our pre-FOMC meeting package, and the end point is similar to the September SEP (going below that requires a recession).
(An Excel file containing the data of Figure 2 is here. Again, we are working with FRB-US and we will circulate a note after the FOMC).
Figure 2. Taylor rules (in partial equilibrium)
Conclusion
As mentioned at the beginning, we continue to expect a very prudent Powell today. From the point of view of the Fed, there is little reason to rush to conclusions, especially considering that the road remains bumpy (revisions to seasonal factors in CPI space, January re-pricing effect, residual seasonality in PCE space, etc..). Therefore, we continue to expect the SEP to show a limited number of cuts in 2024.
Having said that, it seems that the scenario for the March 2024 meeting is changing pretty quickly. The models are unlikely to revise their forecast to target soon (that continues to require some help from the labor market or ultra-low readings in Jan-Feb-Mar). But at this point, it seems the models validate a path of the FF rate close to the currently priced one.