Wait And See, Pressure Rising
Preamble: a new FRB-US dataset has finally been posted. In the next few days, we will update it with the GDP numbers and circulate a new baseline. Stay tuned!
Wait and See. Keep FF rate high. Hike Again Only if the Data Will Call for it. The story of this round seems clear: the data came in strong again and there is now a suspect that disinflation has stalled, consistent with the signals of the distributions. The medium-term models and the estimate of pi* are unchanged. The models continue to suggest that go back (and stay) at target is a question mark. At the same time, the models do not see a re-acceleration going forward. For this reason, in our view the FOMC is once again in “wait and see mode”, although the pressure is rising. We expect Powell to deliver a message along the lines “The data have been a bit stronger than expected, we will re-assess in June. We can keep the FF rate at this level for the necessary time. If the data will call for it, we will hike again but this is not our baseline right now”.
Main points:
- The incoming data have been a bit stronger than expected by the Fed staff forecast inferred from the latest FOMC minutes. We estimate that the upward surprise is about 1 tenth to rounding. The distribution of price changes remains more consistent with readings above target.
Figure 1. Core CPI MoM prices change distributions.
- The “main” medium-term model forecast is unchanged. The data came in as expected by the model and there is no reason to revise the medium-term model-based forecast this round. The (Q4/Q4) model forecast is: 3.0% in 2024, 2.65% in 2025, and 2.6% in 2026.The forecast remains higher than the Fed target.
Figure 2. Current and previous FOMC round “main” model forecast of core PCE price inflation.
Figure 3. Comparison of the evolution of the 2024 (Q4/Q4) core PCE price inflation forecast.
- The estimate of “underlying inflation” (pi*), the crucial variable in the Fed staff forecast, remains above target. In our view, the Fed staff is estimating pi* at 2.6%. This round, the estimate of pi* is unchanged. Pi* is very persistent by nature; until the estimate of pi* will be lower and close to target, it will be hard to imagine a real dovish Fed.
- The Taylor rules signal (small) upside risks around the March SEP. The Fed staff (2021) rule is very similar to the March SEP, while the inertial Taylor rule (1999) remains above it.
Figure 4. Taylor rules.
As usual, we would be more than happy to schedule a meeting to discuss the details.