Hold Your Fire, Maybe
Long story short: getting closer, but not yet. The story for the January 2024 round is pretty simple: the data have started to cooperate but there is still no certainty to reach target. The incoming data were better than expected, the distribution of price changes shows some improvements but remains very different in shape than pre-Covid and more consistent with near-term readings above target. Our “main” medium-term model forecast is revised down but still, does not converge to target at the end of the medium-term. Crucially, the estimate of pi* is a bit lower than in December (2.5% vs 2.7%) but it also remains above target. Finally, the Taylor rules signal a path of the FF rate very similar to the December SEP (with some downside risk).
Putting everything together: in our view, the FOMC (and the Fed staff) has no reason to change communication at the upcoming round. They are in “wait and see” mode. March can be a different story, of course.
Main points:
- The incoming data have been a bit weaker than expected by the Fed staff forecast inferred from the latest FOMC minutes. We estimate that the downward surprise is about 2-3 tenths. The distribution of price changes show some improvements but remains very different in shape than pre-Covid and more consistent with near-term readings a bit above target.
Figure 1. Core CPI MoM prices change distributions.
- The Fed staff medium-term judgmental forecast (the Tealbook) should be little changed. The downward surprise of the incoming data is in 2023 and standard practice is to wait to have at least some data of a given year before changing the forecast. Our “main” medium-term model forecast is revised down. Risks around the staff forecast are balanced.
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* around 2.5%, gradually declining in the medium-term. Until the estimate of pi* will be lower and close to target, it will be hard to imagine a real dovish Fed. Having said that, there is now a chance that it can be lower than 2.5% by the time of the March 2024 FOMC meeting.
- The Taylor rules signal a path of the FF rate very similar to the December SEP. The Fed staff (2021) rule is very similar to the December SEP, while the inertial Taylor rule (1999) remains a bit above it. The latest run of FRB-US (not circulated yet) signals downside risks around the SEP.
Figure 3. Taylor rules.
As usual, we would be more than happy to schedule a meeting to discuss the details.