Hawkish, Shall Be
A hawkish round. The story of this round is pretty clear: the data came in very unfriendly and the models revised up the forecast at any horizon. Pi* is estimated marginally higher than at the time of the January round, and the distributions show very limited progress. As for the new SEP, as usual we use FRB-US as a guidance (see here why): the model sees higher GDP growth in 2024 (to about 1.5% Q4/Q4), higher potential growth (to 1.9%), the unemployment rate at 4.1% in 2024:Q4, core PCE at 2.7% (Q4/Q4), and a slightly more hawkish path of the FF rate (one cut less in 2024).
Main points:
- The incoming data have been stronger than expected by the Fed staff forecast inferred from the latest FOMC minutes. We estimate that the upward surprise is about 3 tenths. The distribution of price changes shows little improvements recently and remains more consistent with near-term readings above target.
Figure 1. Core CPI MoM prices change distributions.
- The “main” medium-term model is revised up. The upward surprise of the incoming data is reflected in an upward revision to the medium-term model-based forecast of about 4 tenths. This is a large revision. We also estimate an upward revision to the Fed staff judgmental forecast (the “Tealbook”).
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%. This round, the estimate of pi* is marginally higher than last round, as both the trend-based measures and the general equilibrium estimates revised up. 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 and FRB-US signal upside risks around the December SEP. The Fed staff (2021) rule is very similar to the December SEP, while the inertial Taylor rule (1999) remains above it. The latest run of FRB-US signals one cut less in 2024 than the December SEP. (Note: given what Fed Mester said about R*, we run a simulation assuming R* at 1.5%. The results are here. Assuming R* at 1.5% results in no cuts to the FF rate this year and a more hawkish path of the FF rate in the entire medium-term. While we do not think this scenario is realistic for the upcoming SEP, in any case we see risks to the upside around R*).
Figure 4. Latest run of FRB-US model.
Figure 5. Taylor rules.
As usual, we would be more than happy to schedule a meeting to discuss the details.