The answer depends on two words: residual seasonality. Data released last week confirmed that January inflation was hotter than it was meant to be at this stage, according to the Federal Reserve's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index. Despite that, a growing chorus attributes the flames to technical matters. January, the story goes, is a month that always runs hot for inflation.
Could the January print – and the potential of outright inflation reacceleration – be a mirage? Or does the core-services-led surge in price pressure indicate the disinflationary pressure experienced to date is dissipating and that much work remains for the Federal Reserve to deliver on its price-stability mandate?
The answer depends on the two sexiest words in the English language (not really): residual seasonality. If there is a steady monthly pattern from year to year, like retail sales surging during the holidays, then the seasonal-adjustment process at our statistical agencies is supposed to remove it so we can get the true underlying signal. This process allows us to ask the question: Of course retail sales surge every December, but did they surge by more than they normally do? Residual seasonality refers to the seasonal patterns that the adjustment process doesn't account for.
A look at the residual seasonality in the January PCE over the past two decades suggests that both can be true and that complete dismissal of the January data comes with notable risk.
January 2024 has drawn parallels to January 2023. In January 2024, the core PCE price index rose at a 5.1 percent annualized pace from the prior month. In the six months prior, the monthly annualized rate averaged 1.9 percent. The January 2024 rate happened to be the fastest monthly pace since January 2023, when core PCE jumped 6.3 percent relative to the average over the previous six months of 4.6 percent.
Rather than relying on a single parallel, however, we looked at the annualized rate of inflation in each month and compared it to the annualized rate observed over the subsequent six-month period in every month since January 2000. So if, for example, the annualized rate of inflation for the month of January were 4 percent, and the actual inflation over the next six months were 3 percent, then it would show up as a 1 percent on our chart.
On average over the past 23 years, January's annualized core PCE rate was 0.7 percentage points above the average annualized rate that followed in the next six months. The pattern holds for both headline PCE and the supercore (excludes housing) services PCE. So residual seasonality is absolutely there.
But notice how one-sided the conversation has been, which perhaps highlights the political motivation of pundits who claimed late last year that some measures of inflation were falling. It seems like the residual seasonality also leads to false slowing signals in the late fall and winter. Why didn't we hear about it then?
Recent commentary from Federal Open Market Committee (FOMC) members indicates that they are attempting to look past the January print when considering the right policy path. Governor Lisa Cook remarked that the risk of persistently high inflation has diminished, though it has not disappeared. Vice Chair Philip Jefferson called the January CPI data disappointing, though framed it in the context of a bumpy disinflationary process, rather than a reacceleration signal. Governor Chris Waller, however, struck a slightly different tone. In a speech adeptly titled What's the Rush? he called out upside risk to his own inflation outlook and requested a couple more months of data to determine if January was a speed bump or a pothole.
Waller may be wise to remain unconvinced by the dominance of residual seasonality in January's figure. Ultimately, inflation today holds a great deal of information about inflation over the coming six months. It turns out that correcting for seasonality, the January rate provides a pretty good prediction of inflation over the subsequent six months. Over the same estimation period – January 2000 through 2023 – the January 2024 annualized rate would suggest that over the next six months, core PCE would rise at a 3.2 percent annualized rate. In the six months through January, core PCE rose at a 2.5 percent annualized rate. In other words, the inflation fight may not be over.
If there is one consistently observable pattern over the past three years, it is the persistence at which inflation – and therefore the monetary-policy restrictiveness necessary to contain it – has been discounted by markets and policy-makers alike using hard to understand technical explanations. Here at Capital Matters, despite sometimes using technical explanations of our own, we promise not to let them get away with it.
Kevin A. Hassett is the senior adviser to National Review's Capital Matters and the Brent R. Nicklas Distinguished Fellow in Economics at the Hoover Institution.