…unless core PCE prints above 5% (ar) for 2-3 quarters. The strong January CPI report triggered speculations the Fed could hike again. In this note, we show the path of the FF rate under different scenarios for core PCE price inflation, and the unemployment rate. Bottom line: according to the model, the Fed will not hike again unless core inflation re-accelerates substantially (at or above 5%). Rather, the Fed is expected to be on a “wait and see” mode; if necessary, it is expected to recalibrate again the message back to “for longer” (but not a higher terminal rate).
If the reader has questions, please direct them to our FRB-US specialist: Tilda Horvath (tilda.horvath@underlyinginflation.com). Tilda has programmed FRB-US at the Board and managed the model for almost 20 years. We remind the reader that we run ad-hoc scenarios using FRB-US free of charge. Do not be shy.
The baseline
We remind the reader that the latest run of the model can be seen here. In the current baseline, the path of the FF rate is broadly similar to the December SEP, just a bit higher in 2024/2025 due to a higher expected core inflation, and a bit lower in 2026 due to a more negative output gap at that horizon.
Will the Fed hike again?
The probability is very low. In the model, the Fed hikes again only if core PCE prints above 5% (ar) for a certain number of months. The strong January CPI reading has triggered speculations that the Fed can start hiking again. For this reason, we have put together a set of simulations. Figure 1 shows the baseline (the red line) together with 4 scenarios. Each scenario is built assuming that starting from 2024:Q3 core PCE price inflation will grow at a (flat and exogenous) higher rate of: 2.5% (green line), or 3.5% (gray line), 4.5% (purple line), and 5.5% (orange line). All other variables are calculated endogenously in the model. (The evolution of the 5y, 10y, 30y and real expected return on equity in each scenario is available here.) The takeaway is the following: unless core PCE re-accelerates at (or above 5% – orange line in Figure 1), the Fed is not expected to hike again. Rather, if anything, the Fed could/would recalibrate towards a “for longer” message, as in all scenarios the FF rate remains above the baseline throughout the entire horizon.
For the record: the reason why the Fed does not hike again in the model is straightforward, as the unemployment rate is expected to start ticking up in 2024:H2 (although only marginally this year). Of course, one could also assume that the unemployment rate will stay flat throughout the entire forecast horizon and force the model to run with such constraint. However, we have decided not to do it because we think it would be quite unrealistic, given that growth is expected to go below potential towards the end of this year.
Figure 1. FRB-US baseline (red line) and scenarios (all other lines).
Note: Real GDP growth and core inflation are expressed as YoY. Core inflation is core PCE price inflation. The red lines show the “inconsistent FRB-US” forecast (the current baseline), that is the model-based forecast removing the “add-factors” put by the Fed staff to match the latest SEP, updated as specified in the text.
Conclusion
The January report was a significant news but the Fed will be forced to hike again only with another 6-8 of such prints. For the time being, we can assume that the Fed is in “wait and see” mode with no need to change the message or the dots (the updated FRB-US baseline is nearly identical to the December SEP in 2024). If necessary, the model suggests that the Fed would recalibrate the message and go with a “for longer” option before being forced to hike again.