Tag: 12-month inflation v. 1-month inflation

Latest PCE Report Shows Inflation Slowing

Chair Jerome Powell and other members of the Federal Open Market Committee (Photo from federalreserve.gov)

On Friday, June 28, the Bureau of Economic Analysis (BEA) released its “Personal Income and Outlays” report for April, which includes monthly data on the personal consumption expenditures (PCE) price index. Inflation as measured by annual changes in the consumer price index (CPI) receives the most attention in the media, but the Federal Reserve looks instead to inflation as measured by annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.  

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the change in the PCE from the same month in the previous year. Measured this way, in May PCE inflation (the blue line) was 2.6 percent in May, down slightly from PCE inflation of 2.7 percent in April. Core PCE inflation (the red line) in May was also 2.6 percent, down from 2.8 percent in April.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation sharply declined from 3.2 percent in April to -0.1 percent in in May—meaning that consumer prices actually fell during May. Core PCE inflation declined from 3.2 percent in April to 1.0 percent in May.  This decline indicates that inflation by either meansure slowed substantially in May, but data for a single month should be interpreted with caution.

The following figure shows another way of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and the trimmed mean rate of PCE inflation (the blue line). Fed Chair Jerome Powell and other members of the Federal Open Market Committee (FOMC) have said that they are concerned by the persistence of elevated rates of inflation in services. The trimmed mean measure is compiled by economists at the Federal Reserve Bank of Dallas by dropping from the PCE the goods and services that have the highest and lowest rates of inflation. It can be thought of as another way of looking at core inflation by excluding the prices of goods and services that had particularly high or particularly low rates of inflation during the month.

Inflation using the trimmed mean measure was 2.8 percent in May (calculated as a 12-month inflation rate), down only slightly from 2.9 percent in April—and still well above the Fed’s target inflation rate of 2 percent. Inflation in services remained high in May at 3.9 percent, down only slightly from 4.0 percent in April.

This month’s PCE inflation data indicate that the inflation rate is still declining towards the Fed’s target, with the low 1-month inflation rates being particularly encouraging. But the FOMC will likely need additional data before deciding to lower the committee’s target for the federal funds rate, which is currently 5.25 percent to 5.50 percent. The next meeting of the FOMC is July 30-31. What do financial markets think the FOMC will decide at that meeting?

Futures markets allow investors to buy and sell futures contracts on commodities–such as wheat and oil–and on financial assets. Investors can use futures contracts both to hedge against risk—such as a sudden increase in oil prices or in interest rates—and to speculate by, in effect, betting on whether the price of a commodity or financial asset is likely to rise or fall. (We discuss the mechanics of futures markets in Chapter 7, Section 7.3 of Money, Banking, and the Financial System.) The CME Group was formed from several futures markets, including the Chicago Mercantile Exchange, and allows investors to trade federal funds futures contracts. The data that result from trading on the CME indicate what investors in financial markets expect future values of the federal funds rate to be. The following chart from the CME’s FedWatch Tool shows the current values from trading of federal funds futures.

The probabilities in the chart reflect investors’ predictions of what the FOMC’s target for the federal funds rate will be after the committee’s July meeting. The chart indicates that investors assign a probability of only 10.3 percent to the FOMC cutting its federal funds rate target by 0.25 percentage point at that meeting and an 89.7 percent probability of the commitee leaving the target unchanged.

In contrast, the following figure shows that investors expect that the FOMC will cut its federal funds rate at the meeting scheduled for September 17-18. Investors assign a 57.9 percent probability of a 0.25 percentage point cut and a 6.2 percent probability of a 0.50 percentage point cut. The committee deciding to leave the target unchanged at 5.25 percent to 5.50 percent is assigned a probability of only 35.9 percent.

Latest CPI Report Shows Slowing Inflation and the FOMC Appears Likely to Cut Its Target for the Federal Funds Rate at Least Once This Year

Image of “a woman shopping in a grocery store” generated by ChatGTP 4o.

Today (June 12) we had the unusual coincidence of the Bureau of Labor Statistics (BLS) releasing its monthly report on the consumer price index (CPI) on the same day that the Federal Open Market Committee (FOMC) concluded a meeting. The CPI report showed that the inflation rate had slowed more than expected. As the following figure shows, the inflation rate for May measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 3.3 percent—slightly below the 3.4 percent rate that economists surveyed by the Wall Street Journal had expected, and slightly lower than the 3.4 percent rate in April. Core inflation (the red line(—which excludes the prices of food and energy—was 3.4 percent in May, down from 3.6 percent in April and slightly lower than the 3.5 percent rate that economists had been expecting.

As the following figure shows, if we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the declines in the inflation rate are much larger. Headline inflation (the blue line) declined from 3.8 percent in April to 0.1 percent in May. Core inflation (the red line) declined from 3.6 percent in April to 2.0 percent in May. Overall, we can say that inflation has cooled in May and if inflation were to continue at the 1-month rate, the Fed will have succeeded in bringing the U.S. economy in for a soft landing—with the annual inflation rate returning to the Fed’s 2 percent target without the economy being pushed into a recession. 

But two important notes of caution:

1. It’s hazardous to rely to heavily on data from a single month. Over the past year, the BLS has reported monthly inflation rates that were higher than economists expected and rates that was lower than economists expected. The current low inflation rate would have to persist over at least a few more months before we can safely conclude that the Fed has achieved a safe landing.

2. As we discuss in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI in evaluating whether it is hitting its 2 percent inflation target. So, today’s encouraging CPI data would have to carry over to the PCE data that the Bureau of Economic Analysis (BEA) will release on January 28 before we can conclude that inflation as the Fed tracks it did in fact slow significantly in April.

The BLS released the CPI report at 8:30 am eastern time. The FOMC began its meeting later in the day and so committee members were able to include in their deliberations today’s CPI data along with other previously available information on the state of the economy. At the close of the meeting, , the FOMC released a statement in which it stated, as expected, that it would leave its target range for the federal funds rate unchanged at 5.25 percent to 5.50 percent. After the meeting, the committee also released—as it typically does at its March, June, September, and December meetings—a “Summary of Economic Projections” (SEP), which presents median values of the committee members’ forecasts of key economic variables. The values are summarized in the following table, reproduced from the release.

The table shows that compared with their projections in March—the last time the FOMC published the SEP—committee members were expecting higher headline and core PCE inflation and a higher federal funds rate at the end of this year. In the long run, committee members were expecting a somewhat highr unemployment rate and somewhat higher federal funds rate than they had expected in March.

Note, as we discuss in Macreconomics, Chapter 14, Section 14.4 (Economics, Chapter 24, Section 24.4 and Essentials of Economics, Chapter 16, Section 16.4), there are twelve voting members of the FOMC: the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four of the other 11 Federal Reserve Banks, who serve one-year rotating terms. In 2024, the presidents of the Richmond, Atlanta, San Francisco, and Cleveland Feds are voting members. The other Federal Reserve Bank presidents serve as non-voting members, who participate in committee discussions and whose economic projections are included in the SEP.

Prior to the meeting there was much discussion in the business press and among investment analysts about the dot plot, shown below. Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 19 dots, representing the 7 members of the Fed’s Board of Governors and all 12 presidents of the Fed’s district banks. 

The plots on the far left of the figure represent the projections of each of the 19 members of the value of the federal funds rate at the end of 2024. Four members expect that the target for the federal funds rate will be unchanged at the end of the year. Seven members expect that the committee will cut the target range once, by 0.25 percentage point, by the end of the year. And eight members expect that the cut target range twice, by a total of 0.50 percent point, by the end of the year. Members of the business media and financial analysts were expecting tht the dot plot would project either one or two target rate cuts by the end of the year. The committee was closely divided among those two projections, with the median projection being for a single rate cut.

In its statement following the meeting, the committee noted that:

“In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‐backed securities. The Committee is strongly committed to returning inflation to its 2 percent objective.”

In his press conference after the meeting, Fed Chair Jerome Powell noted that the morning’s CPI report was a “Better inflation report than nearly anyone expected.” But, Powell also noted that: “You don’t want to be motivated any one data point.” Reinforcing the view quoted above in the committee’s statement, Powell emphasized that before cutting the target for the federal funds rate, the committee would need “Greater confidence that inflation is moving back to 2% on a sustainable basis.”

In summary, today’s CPI report was an indication that the Fed is on track to bring about a soft landing, but the FOMC will be closely analyzing macroeconomic data over at least the next few months before it is willing to cut its target for the federal funds rate.

Another Middling Inflation Report

A meeting of the Federal Open Market Committee (Photo from federalreserve.gov)

On Friday, May 31, the Bureau of Eeconomic Analysis (BEA) released its “Personal Income and Outlays” report for April, which includes monthly data on the personal consumption expenditures (PCE) price index. Inflation as measured by changes in the consumer price index (CPI) receives the most attention in the media, but the Federal Reserve looks instead to inflation as measured by changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. 

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the change in the PCE from the same month in the previous year. Measured this way, PCE inflation in April was 2.7 percent, which was unchanged since March. Core PCE inflation was also unchanged in April at 2.8 percent. (Note that carried to two digits past the decimal place, both measures decreased slightly in April.)

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation declined from 4.1 percent in March to 3.1 percent in April. Core PCE inflation declined from 4.1 percent in March to 3.0 percent in April.  This decline may indicate that inflation is slowing, but data for a single month should be interpreted with caution and, even with this decline, inflation is still above the Fed’s 2 percent target.

The following figure shows another way of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and the trimmed mean rate of PCE inflation (the blue line). Fed Chair Jerome Powell has said that he is particularly concerned by elevated rates of inflation in services. The trimmed mean measure is compiled by economists at the Federal Reserve Bank of Dallas by dropping from the PCE the goods and services that have the highest and lowest rates of inflation. It can be thought of as another way of looking at core inflation by excluding the prices of goods and services that had particularly high or particularly low rates of inflation during the month.

Inflation using the trimmed mean measure was 2.9 percent in April, down from 3.0 percent in March. Inflation in services remained high, although it declined slightly from 4.0 percent in March to 3.9 percent in April.

It seems unlikely that this month’s PCE data will have much effect on when the members of the Fed’s policy-making Federal Open Market Committee (FOMC) will decide to lower the target for the federal funds rate. The next meeting of the FOMC is June 11-12. That meeting is one of the four during the year at which the committee publishes a Summary of Economic Projections (SEP). The SEP should provide greater insight into what committee members expect will happen with inflation during the remained of the year and whether it’s likely that the committee will lower its target for the federal funds rate this year.

Inflation Cools Slightly in Latest CPI Report

Inflation was running higher than expected during the first three months of 2024, indicating that the trend in late 2023 of declining inflation had been interrupted. At the beginning of the year, many economists and analysts had expected that the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target for the federal funds rate sometime in the middle of the year. But with inflation persisting above the Fed’s 2 percent inflation target, it has become likely that the FOMC will wait until later in the year to start cutting its target and might decide to leave the target unchanged through the remainder of 2024.

Accordingly, economists and policymakers were intently awaiting the report from the Bureau of Labor Statistics (BLS) on the consumer price index (CPI) for April. The report released this morning showed a slight decrease in inflation, although the inflation rate remains well above the Fed’s 2 percent target. (Note that, as we discuss in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI in evaluating whether it is hitting its 2 percent inflation target.)

The inflation rate for April measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.4 percent—about the same as economists had expected—down from 3.5 percent in March. As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.6 percent in April, down from 3.8 percent in March.

If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the declines in the inflation rate are larger. Headline inflation declined from 4.6 percent in March to 3.8 percent in April. Core inflation declined from 4.4 percent in March to 3.6 percent in April. Note that the value for core inflation is the same whether we measure over 12 months or over 1 month. Overall, we can say that inflation seems to have cooled in April, but it still remains well above the Fed’s 2 percent target.

As has been true in recent months, the path of inflation in the prices of services has been concerning. As we’ve noted in earlier posts, Federal Reserve Chair Jerome Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Powell has been particularly concernd about how slowly the price of housing has been declining, a point he made again in the press conference that followed the most recent FOMC meeting.

The following figure shows the 1-month inflation rate in service prices and in service prices not included including housing rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023, but inflation in service prices slowed markedly from 6.6 percent in March to 4.4 percent in April. Inflation in service prices not including housing rent declined more than 50 percent, from 8.9 percent in March to 3.4 percent in April. But, again, even though inflation in service prices declined in April, as the figure shows, the 1-month inflation in services is volatile and even these smaller increases aren’t yet consistent with the Fed meeting its 2 percent inflation target.

Finally, in order to get a better estimate of the underlying trend in inflation, some economists look at median inflation, which is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. As the following figure shows, at 4.3 percent, median inflation in April was unchanged from its value in March.

Today’s report was good news for the Fed in its attempts to reduce the inflation rate to its 2 percent target without pushing the U.S. economy into a recession. But Fed Chair Jerome Powell and other members of the FOMC have made clear that they are unlikely to begin cutting the target for the federal funds rate until they receive several months worth of data indicating that inflation has clearly resumed the downward path it was on during the last months of 2023. The unexpectedly high inflation data for the first three months of 2024 has clearly had a significant effect on Fed policy. Powell was quoted yesterday as noting that: “We did not expect this to be a smooth road, but these [inflation readings] were higher than I think anybody expected,”

Latest Monthly Report on PCE Inflation Confirms Inflation Remains Stubbornly High

Federal Reserve Chair Jerome Powell (Photo from federalreserve.gov)

In a post yesterday, we noted that the quarterly data on the personal consumption expenditures (PCE) price index in the latest GDP report released by the Bureau of Economic Analysis (BEA) indicated that inflation was running higher than expected. Today (April 26), the BEA released its “Personal Income and Outlays” report for March, which includes monthly data on the PCE. The monthly data are consistent with the quarterly data in showing that PCE inflation remains higher than the Federal Reserve’s 2 percent annual inflation target. (A reminder that PCE inflation is particularly important because it’s the inflation measure the Fed uses to gauge whether it’s hitting its inflation target.)

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—with inflation measured as the percentage change in the PCE from the same month in the previous year. Many economists believe that core inflation gives a better gauge of the underlying inflation rate. Measured this way, PCE inflation increased from 2.5 percent in February to 2.7 percent in March. Core PCE inflation remained unchanged at 2.8 percent.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation declined from 4.1 percent in February to 3.9 percent in March. Core PCE inflation increased from 3.2 percent in February to 3.9 in March. So, March was another month in which both PCE inflation and core PCE inflation remained well above the Fed’s 2 percent inflation target.

 

The following figure shows other ways of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and the rate of inflation (the blue line) excluding the prices of housing, food, and energy. Fed Chair Jerome Powell has said that he is particularly concerned by elevated rates of inflation in services. Some economists believe that the price of housing isn’t accurately measured in the PCE, which makes it interesting to see if excluding the price of housing makes much difference in calculating the inflation rate. All three measures of inflation increased from February to March, with inflation in services remaining well above overall inflation and inflation excluding the prices of housing, food, and energy being somewhat lower than overall inflation.

The following figure uses the same three inflation measures as the figure above, but shows the 1-month inflation rate rather than the 12-month inflation rate. Measured this way, inflation in services increased sharply from 3.2 percent in February to 5.0 percent in March. Inflation excluding the prices of housing, food, and energy doubled from 2.0 percent in February to 4.1 percent in March.

Overall, the data in this report indicate that the decline in inflation during the second half of 2023 hasn’t continued in the first three months of 2024. In fact, the inflation rate may be slightly increasing. As a result, it no longer seems clear that the Fed’s policy-making Federal Open Market Committee (FOMC) will cut its target for the federal funds rate this year. (We discuss the possibility that the FOMC will keep its target unchanged through the end of the year in this blog post.) At the press conference following the FOMC’s next meeting on April 30-May 1, Fed Chair Jerome Powell may explain what effect the most recent data have had on the FOMC’s planned actions during the remainder of the year.

How Will the Fed React to Another High Inflation Report?

In a recent podcast we discussed what actions the Fed may take if inflation continues to run well above the Fed’s 2 percent target. We are likely a step closer to finding out with the release this morning (April 10) by the Bureau of Labor Statistics (BLS) of data on the consumer price index (CPI) for March. The inflation rate measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.5 percent, slightly higher than expected (as indicated here and here). As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, the same as in January.

If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the values seem to confirm that inflation, while still far below its peak in mid-2022, has been running somewhat higher than it did during the last months of 2023. Headline CPI inflation in March was 4.6 percent (down from 5.4 percent in February) and core CPI inflation was 4.4 percent (unchanged from February). It’s worth bearing in mind that the Fed’s inflation target is measured using the personal consumption expenditures (PCE) price index, not the CPI. But CPI inflation at these levels is not consistent with PCE inflation of only 2 percent.

As has been true in recent months, the path of inflation in the prices of services has been concerning. As we’ve noted in earlier posts, Federal Reserve Chair Jerome Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices and in services prices not included including housing rent. Some economists believe that the rent component of the CPI isn’t well measured and can be volatile, so it’s worthwhile to look at inflation in service prices not including rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023. Inflation in service prices increased from 5.8 percent in February to 6.6 percent in March . Inflation in service prices not including housing rent was even higher, increasing from 7.5 percent in February to 8.9 percent in March. Such large increases in the prices of services, if they were to continue, wouldn’t be consistent with the Fed meeting its 2 percent inflation target.

Finally, some economists and policymakers look at median inflation to gain insight into the underlying trend in the inflation rate. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. As the following figure shows, although median inflation declined in March, it was still high at 4.3 percent. Median inflation is volatile, but the trend has been generally upward since July 2023.

Financial investors, who had been expecting that this CPI report would show inflation slowing, reacted strongly to the news that, in fact, inflation had ticked up. As of late morning, the Dow Jones Industrial Average had decline by nearly 500 points and the S&P 5o0 had declined by 59 points. (We discuss the stock market indexes in Macroeconomics, Chapter 6, Section 6.2 and in Microeconomics and Economics, Chapter 8, Section 8.2.) The following figure from the Wall Street Journal shows the sharp reaction in the bond market as the interest rate on the 10-year Treasury note rose sharply following the release of the CPI report.

Lower stock prices and higher long-term interest rates reflect the fact that investors have changed their views concerning when the Fed’s Federal Open Market Committee (FOMC) will cut its target for the federal funds and how many rate cuts there may be this year. At the start of 2024, the consensus among investors was for six or seven rate cuts, starting as early as the FOMC’s meeting on March 19-20. But with inflation remaining persistently high, investors had recently been expecting only two or three rate cuts, with the first cut occurring at the FOMC’s meeting on June 11-12. Two days ago, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC might not cut its target for the federal funds rate during 2024. Some economists have even begun to speculate that the FOMC might feel obliged to increase its target in the coming months.

After the FOMC’s next meeting on April 30-May 1 first, Chair Powell may provide some additional information on the committee’s current thinking.

Latest PCE Report Shows Moderate, but Persistent, Inflation

McDonald’s raising the price of its burgers by 10 percent in 2023 led to a decline in sales. (Photo from mcdonalds.com)

Inflation as measured by changes in the consumer price index (CPI) receives the most attention in the media, but the Federal Reserve looks instead to inflation as measured by changes in personal consumption expenditures (PCE) price index when evaluating whether it is meeting its 2 percent inflation target. The Bureau of Economic Analysis (BEA) released PCE data for February as part of its “Personal Income and Outlays” report on March 29.  

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the change in PCE from the same month in the previous year. Measured this way, PCE inflation increased slightly from 2.4 percent in January to 2.5 percent in February. Core PCE inflation decreased slightly from 2.9 percent to 2.8 percent.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, both PCE inflation and core PCE inflation declined in February, but the decline only partly offset the sharp increases in December and January. Both PCE inflation—at 4.1 percent—and core PCE inflation—at 3.2 percent—remained well above the Fed’s 2 percent target. 

The following figure shows another way of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and the trimmed mean rate of PCE inflation (the blue line). Fed Chair Jerome Powell has said that he is particularly concerned by elevated rates of inflation in services. The trimmed mean measure is compiled by economists at the Federal Reserve Bank of Dallas by dropping from the PCE the goods and services that have the highest and lowest rates of inflation. It can be thought of as another way of looking at core inflation.

In February, 12-month trimmed mean PCE inflation was 3.1 percent, a little below core inflation of 3.3 percent. Twelve-month inflation in services was 3.8 percent, a slight decrease from 3.9 percent in January. Trimmed mean and services inflation tell the same story as PCE and PCE core inflation: Inflation has decline significantly from its highs of mid-2022, but remains stubbornly above the Fed’s 2 percent target.

It seems unlikely that this month’s PCE data will have much effect on when the members of the Federal Open Market Committee will decide to lower the target for the federal funds rate.

Consumer Price Inflation Comes in Somewhat Higher than Expected

Federal Reserve Chair Jerome Powell (Photo from Bloomberg News via the Wall Street Journal.)

Economists, policymakers, and Wall Street analysts have been waiting for macroeconomic data to confirm that the Federal Reserve has brought the U.S. economy in for a soft landing, with inflation arrving back at the Fed’s target of 2 percent without the economy slipping into a recession. Fed officials have been cautious about declaring that they have yet seen sufficient data to be sure that a soft landing has actually been achieved. Accordingly, they are not yet willing to begin cutting their target for the federal funds rate.

For instance, on March 6, in testifying before the Commitee on Financial Services of the U.S. House of Representatives, Fed Chair Jerome Powell stated that the Fed’s Federal Open Market Committee (FOMC) “does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” (Powell’s statement before his testimony can be found here.)

The BLS’s release today (March 12) of its report on the consumer price index (CPI) (found here) for February indicated that inflation was still running higher than the Fed’s target, reinforcing the cautious approach that Powell and other members of the FOMC have been taking. The increase in the CPI that includes the prices of all goods and services in the market basket—often called headline inflation—was 3.2 percent from the same month in 2023, up slightly from 3.1  In January. (We discuss how the BLS constructs the CPI in Macroeconomics, Chapter 9, Section 19.4, Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 3, Section 13.4.) As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, down slightly from 3.9 percent in January.

If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the values are more concerning, as indicated in the following figure. Headline CPI inflation is 5.4 percent (up from 3.7 percent in January) and core CPI inflation is 4.4 percent (although that is down from 4.8 percent in January). The Fed’s inflation target is measured using the personal consumption expenditures (PCE) price index, not the CPI. But CPI inflation at these levels is not consistent with PCE inflation of only 2 percent.

Even more concerning is the path of inflation in the prices of services. As we’ve noted in earlier posts, Chair Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices and in services prices not included including housing rent. Some economists believe that the rent component of the CPI isn’t well measured and can be volatile, so it’s worthwhile to look at inflation in service prices not including rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023. Although inflation in service prices declined from January, it was still a very high 5.8 percent in February. Inflation in service prices not including housing rent was even higher at 7.5 percent. Such large increases in the prices of services, if they were to continue, wouldn’t be consistent with the Fed meeting its 2 percent inflation target.

Finally, some economists and policymakers look at median inflation to gain insight into the underlying trend in the inflation rate. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. As the following figure shows, although median inflation declined in February, it was still high at 4.6 percent and, although median inflation is volatile, the trend has been generally upward since July 2023.

The data in this month’s BLS report on the CPI reinforces the view that the FOMC will not move to cut its target for the federal funds rate in the meeting next week and makes it somewhat less likely that the committee will cut its target at the following meeting on April 30-May 1.

The Latest PCE Report and PCE Inflation v. CPI Inflation

Photo courtesy of Lena Buonanno.

Wall Street Journal columnist Justin Lahart notes that when the Bureau of Labor Statistics (BLS) releases its monthly report on the consumer price index (CPI), the report “generates headlines, features in politicians’ speeches and moves markets.” When the Bureau of Economic Analysis (BEA) releases its monthly report “Personal Income and Outlays,” which includes data on the personal consumption expenditures (PCE) price index, there is much less notice in the business press or, often, less effect on financial markets. (You can see the difference in press coverage by comparing the front page of today’s online edition of the Wall Street Journal after the BEA released the latest PCE data with the paper’s front page on February 13 when the BLS released the latest CPI data.)

This difference in the weight given to the two inflation reports seems curious because the Federal Reserve uses the PCE, not the CPI, to determine whether it is achieving its 2 percent annual inflation target. When a new monthly measure of inflation is released much of the discussion in the media is about the effect the new data will have on the Federal Open Market Committee’s (FOMC) decision on whether to change its target for the federal funds rate. You might think the result would be greater media coverage of the PCE than the CPI. (The PCE includes the prices of all the goods and services included in the consumption component of GDP. Because the PCE includes the prices of more goods and services than does the CPI, it’s a broader measure of inflation, which is the key reason that the Fed prefers it.)

That CPI inflation data receive more media discussion than PCE inflation data is likely due to three factors:

  1. The CPI is more familiar to most people than the PCE. It is also the measure that politicians and political commentators tend to focus on. The media are more likely to highlight a measure of inflation that the average reader easily understands rather than a less familiar measure that would require an explanation. 
  2. The monthly report on the CPI is typically released about two weeks before the monthly report on the PCE. Therefore, if the CPI measure of inflation turns out to be higher or lower than expected, the stock and bond markets will react to this new information on the value of inflation in the previous month. If the PCE measure is roughly consistent with the CPI measure, then the release of new data on the PCE measure contains less new information and, therefore, has a smaller effect on stock and bond prices.
  3. Over longer periods, the two measures of inflation often move fairly closely together as the following figure shows, although CPI inflation tends to be somewhat higher than PCE inflation. The values of both series are the percentage change in the index from the same month in the previous year.

Turning to the PCE data for January released in the BEA’s latest “Personal Income and Outlays” report, the PCE inflation data were broadly consistent with the CPI data: Inflation in January increased somewhat from December. The first of the following figures shows PCE inflation and core PCE inflation—which excludes energy and food prices—for the period since January 2015 with inflation measured as the change in PCE from the same month in the previous year.  The second figure shows PCE inflation and core PCE inflation measured as the inflation rate calculated by compounding the current month’s rate over an entire year. (The first figure shows what is sometimes called 12-month inflation and the second figure shows 1-month inflation.)

The two inflation measures are telling markedly different stories: 12-month inflation shows a continuation in the decline in inflation that began in 2022. Twelve-month PCE inflation fell from 2.6 percent in December to 2.4 percent in January. Twelve-month core PCE inflation fell from 2.9 percent in December to 2.8 percent in December. So, by this measure, inflation continues to approach the Fed’s 2 percent inflation target.

One-month PCE and core PCE inflation both show sharp increases from December to January: From 1.4 percent in December to 4.2 percent for 1-month PCE inflation and from 1.8 percent in December to 5.1 percent in January for 1-month core PCE inflation.

The one-month inflation data are bad news in that they may indicate that inflation accelerated in January and that the Fed is, therefore, further away than it seemed in December from hitting its 2 percent inflation target. But it’s important not to overinterpret a single month’s data. Although 1-month inflation is more volatile than 12-month inflation, the broad trend in 1-month inflation had been downwards from mid-2022 through December 2023. It will take at least a more months of data to assess whether this trend has been broken.

Fed officials didn’t appear to be particularly concerned by the news. For instance, according to an article on bloomberg.com, Federal Reserve Bank of Atlanta President Raphael Bostic noted that: “The last few inflation readings—one came out today—have shown that this is not going to be an inexorable march that gets you immediately to 2%, but that rather there are going to be some bumps along the way.” Investors appear to continue to expect that the Fed will cut its target for the federal funds rate at its meeting on June 11-12.

Surprisingly Strong CPI Report

Photo courtesy of Lena Buonanno.

As we’ve discussed in several blog posts (for instance, here and here), recent macro data have been consistent with the Federal Reserve being close to achieving a soft landing. The Fed’s increases in its target for the federal funds rate have slowed the growth of aggregate demand sufficiently to bring inflation closer to the Fed’s 2 percent target, but haven’t, to this point, slowed the growth of aggregate demand so much that the U.S. economy has been pushed into a recession.

By January 2024, many investors in financial markets and some economists were expecting that at its meeting on March 19-20, the Fed’s Federal Open Market Committee would be cutting its target for the federal funds. However, members of the committee—notably, Chair Jerome Powell—have been cautious about assuming prematurely that inflation had, in fact, been brought under control. In fact, in his press conference on January 31, following the committee’s most recent meeting, Powell made clear that the committee was unlikely to reduce its target for the federal funds rate at its March meeting. Powell noted that “inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain.”

Powell’s caution seemed justified when, on February 2, the Bureau of Labor Statistics (BLS) released its most recent “Employment Situation Report” (discussed in this post). The report’s data on growth in employment and growth in wages, as measured by the change in average hourly earnings, might be indicating that aggregate demand is growing too rapidly for inflation to continue to decline.

The BLS’s release today (February 13) of its report on the consumer price index (CPI) (found here) for January provided additional evidence that the Fed may not yet have put inflation on a firm path back to its 2 percent target. The average forecast of economists surveyed before the release of the report was that the increase in the version of the CPI that includes the prices of all goods and services in the market basket—often called headline inflation—would be 2.9 percent. (We discuss how the BLS constructs the CPI in Macroeconomics, Chapter 9, Section 19.4, Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 3, Section 13.4.) As the following figure shows, headline inflation for January was higher than expected at 3.1 percent (measured by the percentage change from the same month in the previous year), while core inflation—which excludes the prices of food and energy—was 3.9 percent. Headline inflation was lower than in December 2023, while core inflation was almost unchanged.

Although the values for January might seem consistent with a gradual decline in inflation, that conclusion may be misleading. Headline inflation in January 2023 had been surprisingly high at 6.4 percent. Hence, the comparision between the value of the CPI in January 2024 with the value in January 2023 may be making the annual CPI inflation rate seem artificially low. If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the values are more concerning, as indicated in the following figure. Headline CPI inflation is 3.7 percent and core CPI inflation is 4.8 percent.

Even more concerning is the path of inflation in the prices of services. Chair Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices. The figure shows that inflation in services has been above 4 percent in every month since July 2023. Inflation in services was a very high 8.7 percent in January. Clearly such large increases in the prices of services aren’t consistent with the Fed meeting its 2 percent inflation target.

How should we interpret the latest CPI report? First, it’s worth bearing in mind that a single month’s report shouldn’t be relied on too heavily. There can be a lot of volatility in the data month-to-month. For instance, inflation in the prices of services jumped from 4.7 percent in December to 8.7 percent in January. It seems unlikely that inflation in the prices of services will continue to be over 8 percent.

Second, housing prices are a large component of service prices and housing prices can be difficult to measure accurately. Notably, the BLS includes in its measure the implicit rental price that someone who owns his or her own home pays. The BLS calculates that implict rental price by asking consumers who own their own homes the following question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” (The BLS discusses how it measures the price of housing services here.) In practice, it may be difficult for consumers to accurately answer the question if very few houses similar to theirs are currently for rent in their neighborhood.

Third, the Fed uses the personal consumption expenditures (PCE) price index, not the CPI, to gauge whether it is achieving its 2 percent inflation target. The Bureau of Economic Analysis (BEA) includes the prices of more goods and services in the PCE than the BLS includes in the CPI and measures housing services using a different approach than that used by the BLS. Although inflation as measured by changes in the CPI and as measured by changes in the PCE move roughly together over long periods, the two measures can differ significantly over a period of a few months. The difference between the two inflation measures is another reason not to rely too heavily on a single month’s CPI data.

Despite these points, investors on Wall Street clearly interpreted the CPI report as bad news. Investors have been expecting that the Fed will soon cut its target for the federal funds rate, which should lead to declines in other key interest rates. If inflation continues to run well above the Fed’s 2 percent target, it seems likely that the Fed will keep its federal funds target at its current level for longer, thereby slowing the growth of aggregate demand and raising the risk of a recession later this year. Accordingly, the Dow Jones Industrial Average declined by more than 500 points today (February 13) and the interest rate on the 10-year Treasury note rose above 4.3 percent.

The FOMC has more than a month before its next meeting to consider the implications of the latest CPI report and the additional macro data that will be released in the meantime.