Below are a few follow-on thoughts since my longer Fed preview piece on Friday, inspired by some client conversations which helped clarify my own thinking and highlighted a few areas worth emphasizing (link to my full Fed meeting preview here).
- Assuming my SEP forecast (growth revised up tenth or two and 2024 core PCE up to 2.7%), 3 cuts is admittedly a somewhat risky base case for the dot plot. If the Fed puts 2.7% for core PCE I’d expect roughly 60:40, or even a bit closer to 50:50, 3 cuts vs 2 cuts odds in 2024.
- None of the data since December has really favored more cuts rather than the same or fewer, with the exception of the employment reports’ household survey, which is largely attenuated by other data. I doubt they want to take away the default towards cutting fairly soon if the March and April inflation data is well-behaved, which 2 cuts as Dot Plot base case would lean against strongly in the markets’ eyes.
- When thinking through the distributions of possible forecasts in the SEP and Dot Plot, 3 remains on somewhat more solid footing but is still nowhere near a lock. First, there are decent odds round down whenever possible in the inflation forecast and get 2.6 (reasonable if mildly dovish) or 2.5 (requires assuming the hot data was almost all residual seasonality) which would both still be 3 cut dot plot base cases. Second, the Fed may also be more hesitant to upgrade the 2024 growth forecast despite 2023Q4’s outturn and Q1 tracking, which would keep a bit more of a dovish case present. Third, as noted above, given a seeming preference for cutting fairly soon that Powell articulated a few weeks ago in front of Congress there may be a bit of a thumb on the scale in favor of 3 cuts vs 2.
- The current debate around residual seasonality in the inflation data hasn’t framed the implications of different assumptions particularly clearly. If residual seasonality is seen as the primary driver it would call for a notable reduction of forward looking forecasts in 2024 because, if embraced as a ~100% explanation, the year-end forecast should be see little-to-no change because residual seasonality should be largely neutral across the year (perhaps making some allowance on the effect’s size for dependence on past inflation). In the middle, one can chose to make quite minimal shifts to the near-term outlook; this is my baseline approach and assumes the recent heat is noise more than exact residual seasonality. Lastly, as most conventional models top-down and some bottoms-up models would, the recent heat could impart some additional momentum to the forecast. Many of the staff’s models likely do incorporate this additional momentum, to varying extents, but the briefing books are surely quite focused on this complicated and largely currently judgmental debate.
- My forecast revision up to 2.7% for 2024 core PCE (up from 2.4%) in the SEP is based on an effectively unchanged forecast for the March-onwards months of 2024. Depending on existing assumptions about ex ante residual seasonality and any other short-term forecasts which may have favored a hotter 24Q1 forecast, or not, one can I think reasonably get forecasts between 2.6% and 2.8% with little-to-no change to the near-term outlook. 2.5% or unchanged forecasts required a stronger (ex post) lean towards residual seasonality as the primary or sole explanation of the hot data which i think a still inflation risk averse Fed will be hesitant to embrace. That is a reasonable partial explanation but with further core goods deflation looking less sure, market rents seeming to be bouncing, and other underlying measures of inflation looking like their troughs are behind us, I would be quite surprised to see the Fed embrace a residual seasonality fully.
- I don’t think the possibility of raising the inflation forecast in the current year by a few tenths while leaving the near-term rate path unchanged is an insurmountable challenge in the press conference for Chair Powell. Given the Fed’s forecasting assumptions, he can acknowledge that the near-term data flow has been hotter than hoped for but continued easing of labor market heat, anchored inflation expectations, and the lagged impacts of restrictive policy have not caused the Fed to shift its base case forecast of appropriate policy but they are being cautious and data dependent in the actual setting of policy.
- My views on underlying outcomes’ probabilities in 2024, as distinct from the forecasting the forecasters game that is projecting the SEP and Dot Plot at any given meeting, will shift less if they’re dovish seeming (hawkish or not dovish data can push them around given that they are not yet fully confident in inflation’s durable return to target) than if they’re hawkish (a statement of concern about inflation risks that’s more likely to be persistent and thus truncates away some dovish non-recessionary parts of the distribution).
