Moving Away from Dovishness as Inflation Doesn’t Follow the Forecast
- After the CPI and PPI data, nowcasts for core PCE point to a roughly 0.30% print in April.
- Just since the March SEP, the data have mechanically pushed up the Fed’s 2026 forecast to at least 2.9% (from a surprisingly soft 2.7% in March and 2.5% in Dec). Unless the data turns in an unexpectedly optimistic direction, the next few months will push it up even further (3.1-3.2% is in play by June).
- Given that the data seems pushing further against the old, already tentative, easing bias, June will likely see the Fed move away from it formally. This also presents an opportunity for Warsh to follow through on his long-held dislike of forward guidance by striking any of it from the statement.
- Moving from no bias to a hawkish bias (if Warsh allows it), if not yet outright hawkish policy, would likely requite a series of prints over the summer hot enough (roughly a series of 0.3s) to bring the Fed’s 2026 forecast close to 3.5%. Fundamentally, hawkish policy would come from the Fed being forced to capitulate on their benign ‘26H2 and ’27 inflation forecasts.
Fed officials have consistently been too optimistic about the medium-term trend in inflation. This goes beyond the recent policy driven sequence of supply shocks which have largely hit core goods inflation, as core services ex housing inflation is appreciably above pre-covid levels and may be reaccelerating. These inflationary shocks combined with more robust than expected growth and increasingly reassuring labor market outcomes, seems to be making them even more cautious.
Last week, Gov. Barr swung notably to the hawkish side, saying he remains “still quite attentive to concerns about what’s going to happen with the labor market, but to me the risk is much higher right now that inflation will not behave.” This echoes comments from the centrists Collins (“at this point, [I] am particularly concerned about inflation”) and Goolsbee (“if you look at the components that are not energy, like services, if that is an indication that the underlying economy is overheating, then the Fed’s got to be thinking about, how do we break the chain of escalating inflation?”).
Assuming we do not see very benign post-tariff pre-second round war-related inflationary effects n Q2, this process will take time. So far, the Fed’s shifts have been driven by a decreasing degree of concern about the labor market (becoming overheated still seems a very distant risk) and the inflation data in hand being less good, even making allowances for residual seasonality, tariffs, the war, and the inflationary impacts of the AI boom, than hoped for in December and March.
The more multicausal the explanation for overshooting inflation, the less comfort central bankers will feel in trying to look through that. This reflect messy analytic realities (it is harder to disentangle 3-4 overlapping shocks than 1) but also the basic point that many shocks may be much close to an underlying policy-offsetable medium-term economic force than something more easily looked through.
Given the recent data in hand the Fed’s March forecast for core PCE inflation in 2026 should move from 2.7% to at least 2.9% in June. Trying to keep some degree of forecast consistency across the meetings, in March the FOMC leaned heavily on notions of fading tariff pass-throughs and aggressive residual seasonality to pencil in such a small move higher from Dec’s 2.5%. The data since the March meeting make those look like fairly fraught assumptions. The 2.9% above is what happens with an unchanged monthly path from May-on; we will of course get a good read of the PCE data for May by the meeting. Given base effects and optimistic assumptions, an 0.25% in May likely moves the June forecast to at 3.1% without any shifts in the forecast months.
Assuming no forecast shifts beyond those forced by the data, given the stabilizing labor market, inflation data, and continued impacts from tariffs and the war, seems like an increasing strong assumption nearly halfway through the year. It is this process that really shows the increasingly less dovish FOMC’s underlying inflationary concerns far more than just following the data higher.
