Unwinding the September FOMC. The September SEP was based on the assumption (or fear) of a weakening labor market. The data since then did not support the narrative; in fact, the data point to a solid economy, stronger than in the September (and June) SEP. Inflation remains persistent and above target with pi* little changed at 2.4% compared to recent rounds. For this reason, we expect the December SEP to look similar to the June SEP (or even stronger in some dimensions, such as real GDP growth). The FOMC is conservative and inertial by nature but all Taylor rules point to upside risks around the path of the FF rate in the September SEP. The Taylor rules estimate a terminal rate between 3.6% and 4.1%. The Fed is set to cut the FF rate in December but if so, we expect a hawkish cut.
Note: we will update this package next week but only in case of a major surprise in the CPI report. Otherwise, the big picture should remain the same.
Main points:
- The incoming data have been a bit stronger than expected by the Fed staff forecast inferred from the latest FOMC minutes. No progress in the distribution of price changes, which remains not consistent with target.
Figure 1. Core CPI MoM prices change distributions.
- The main medium-term model forecast is little changed. The “main” model forecast (sample ends in Q4) continues to project core inflation to gradually moderate. The (Q4/Q4) model forecast is: 2.9% in 2024, 2.5% in 2025, 2.5% in 2026, and 2.4% in 2027. The forecast remains higher than the Fed target.
Figure 2. Current and previous FOMC round “main” model forecast of core PCE price inflation.
- The estimate of “underlying inflation” (pi*), the crucial variable in the Fed staff forecast, is little changed. According to our models, the Fed staff is estimating pi* at 2.4 percent. Pi* is very persistent by nature and remains above the Fed target.
Figure 3. Evolution of the estimate of pi*.
- FRB-US. The model continues to see solid growth, stable unemployment rate, and core inflation a bit above target at the end of the medium-term. According to the model, the FF rate is expected at 3.65% in 2025 (100bps cumulative cuts in 2025), 3.3% in 2026, and 3.3% in 2027.
- All other Taylor rules (see slides) point to upside risks around the path of the FF rate in the September SEP. The terminal rate is estimated between 3.6% and 4.1% depending on the rule. We expect the December SEP to be close to the June SEP.
Figure 4. Latest FRB-US forecast (red dashed line) vs latest SEP (blue solid line).
As usual, we would be more than happy to schedule a meeting to discuss the details.