The US CPI forecasts are a critical input for market reactions, as they can create a surprise effect when actual data deviates from expectations. However, the distribution of these forecasts is not always as straightforward as it seems. While we can have a range of estimates, most forecasts might be clustered on the upper bound of the range. This means that even if the data comes out inside the range of estimates but on the lower bound of the range, it can still create a surprise effect.
The current CPI data shows a range of estimates for both Y/Y and M/M, with the consensus being 3.7% for Y/Y and 0.3% for M/M. However, the market's reaction to this data is not solely dependent on the actual numbers, but also on the distribution of forecasts. For instance, the consensus for Y/Y is 3.7%, but the range of estimates is quite wide, with 9% and 2% also being mentioned. This wide range of estimates can create uncertainty in the market, as it is not clear which forecast is the most likely.
One thing that immediately stands out is the impact of elevated energy prices on headline inflation. While inflation was already elevated before the war started, the latest shock has added more upside risk. However, I don't think today's data is going to change much for the market unless we get significant deviations from the expected numbers. The annual Core PCE rate, which is what the Fed targets, has been sticky near the 3.0% level since 2024, and the Fed has been missing its 2% target since 2021. This raises a deeper question: how can the Fed achieve its target without a more significant slowdown in the economy?
From my perspective, the Fed's focus on the labor market and the soft landing has had the side-effect of indirect financial easing through stock markets. This has made it difficult for the Fed to achieve its target without a more significant slowdown in the economy. In my opinion, the market's consensus that the Fed has abandoned the 2% target and now focuses more on keeping it in a 2-3% range is a reasonable one. However, this also means that it could be very hard to get inflation sustainably back to the 2% target without a more significant slowdown in the economy.
One thing that many people don't realize is the psychological impact of inflation on people's minds. The Fed's Hammack recently said that there are concerns among businesses that an inflationary mindset is starting to become entrenched in people's minds. This raises a deeper question: how can the Fed change people's mindset towards inflation without a more significant slowdown in the economy? In my opinion, the answer lies in the Fed's ability to communicate its goals and targets more effectively and to take a more proactive approach to achieving its targets.
