December 2024 Core-Cast Post-PCE: Not Our Finest Nowcasting Cycle. Optimistic Outcomes Grow More Plausible For The Fed

Skanda Amarnath -

Most of the Personal Consumption Expenditures (PCE) inflation gauges are sourced from Consumer Price Index (CPI) data, but Producer Price Index (PPI) input data is of increasing relevance, import price index (IPI) data can prove occasionally relevant. There are also some high-leverage components that only come out on the days of the GDP and PCE releases.

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Summary: PCE Nowcasts

We take a lot of pride in regularly outperforming the informed consensus of PCE nowcasters, but December was a clear lowlight for our methods.

Core PCE came in softer on a month-over-month basis than what we estimated yesterday, and meaningfully softer than what we were tracking after the release of PPI, CPI, and Import Prices. There are a few reasons for this outcome, and some lessons we'll take with us in how we refine our methods from here.

Discussion

  • Waller's implicit PCE guidance proved correct: While we were worrying about upside risk to this Core PCE reading, Governor Waller's commentary on the inflation data for December proved to be correct. Core PCE was reasonably benign and Chair Powell echoed his charitable view in the press conference. We are still not as impressed as they are with how the 2024Q4 inflation data panned out, at least not until we see a full correction in Q1 residual seasonality.
  • The Fed remains rationally non-committal about rate path, but don't be surprised to see a sharper pivot towards March if the data allows it: The message from Powell on Wednesday sounded optimistic about the inflation trajectory but also cautious about the timeline for the next rate cut. That appears rational given how spiky and volatile inflation readings have been in Q1 post-pandemic. But if we do get benign inflation readings in January and February, steep base effects imply a sharp drop-off in year-over-year PCE inflation readings. We still wouldn't view a March rate cut as a base case scenario, but today's data makes that outcome incrementally more plausible.
  • What caught us offsides: Imputed Financial Services. Among the things that caught us out this month was the scale of disinflation and downward revision to prices "financial services furnished without payment."

These imputed prices are intended to capture the true cost of such services by proxying the spread between benchmark interest rates and those charged to depositors and borrowers. Today's data implies a still beneficial impact from the Fed's recent rate cuts, which have narrowed their spread to the rates banks pay on deposits.

  • What caught us offsides: International Airfares. We had penciled in a more aggressive view on international airfares PCE based on the performance of the two source data inputs, both of which are now outperforming their PCE analogue.

Seasonal adjustment may be depressing the PCE reading here, but that raises risks of a larger reversal in the next couple of months.

Inflation Overshoots At The Component Level

For the Detail-Oriented: Core PCE Heatmaps

Right now Core PCE (PCE less food products and energy) is running at a 2.79% year-over-year pace as of December, 79 basis points above the Fed's 2% inflation target for PCE. That projected overshoot is disproportionately driven by catch-up rent CPI inflation in response to the surge in household formation (a byproduct of rapidly recovering job growth) and market rents in 2021-22. Rent is on track to contribute 24 basis points to the 79 basis point Core PCE overshoot.

There are other contributors to the overshoot:

  • Measured financial service charges now likely adding 21 basis points due to the strong equity market performance over the past 12 months.
  • Contributions from input cost indices (wages in specific sectors where market prices don't exist) are now adding 17 basis points to the overshoot
  • Some contributors are more supply-driven (food inputs likely adding 6 basis points to the overshoot, unwinding motor vehicle bottlenecks now likely subtracting 4 basis points after being a substantial contributor)
  • Some contributors are more demand-driven (in-person recreation and lodging services are contributing 5 basis points)
  • Some contributors to the overshoot have an ambiguous supply & demand attribution at this stage (discretionary goods and adjacent services are adding 13 basis points)

The final heatmap below gives you a sense of the overshoot on shorter annualized run-rates. December monthly annualized Core PCE ran at a 1.89% annualized pace, a 11 basis point undershoot vs 2% target inflation.

For the Detail-Oriented: Core Services Ex Housing PCE Heatmaps

The December growth rate in "Core Services Ex Housing" ('Supercore') PCE ran at a 3.50% year-over-year pace, a 91 basis point overshoot versus the ~2.59% run rate that coincided with ~2% headline and Core PCE.

November monthly supercore ran at a 3.41% annualized rate, a 82 basis point annualized overshoot of what would be consistent with 2% Headline and Core PCE.