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Surprisingly Strong Jobs Report

Image created by ChatGTP=4o of workers on an automobile assembly line.

We noted in a blog post earlier this week that although the preliminary estimate from the Bureau of Economic Analysis (BEA) indicated that real GDP had declined during the first quarter of 2025, the report didn’t provide a clear indication that the U.S. economy was in recession. This morning (May 2), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for April. The data in the report also show no sign that the U.S. economy is in a recession. Although there have been many stories in the media about businesspeople becoming increasingly pessimistic, we don’t yet see it in the employment data. We should add two caveats, however: 1. The effects of the large tariff increases the Trump Administration announced on April 2 are likely not reflected in the data from this report, and 2. at the beginning of a recession the data in the jobs report can be subject to large revisions.

The jobs report has two estimates of the change in employment during the month: one estimate from the establishment survey, often referred to as the payroll survey, and one from the household survey. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and Federal Reserve policymakers believe that employment data from the establishment survey provide a more accurate indicator of the state of the labor market than do the household survey’s employment data and unemployment data. (The groups included in the employment estimates from the two surveys are somewhat different, as we discuss in this post.)

According to the establishment survey, there was a net increase of 177,000 jobs during April. This increase was well above the increase of 135,000 that economists surveyed had forecast. Somewhat offsetting this unexpectedly large increase was the BLS revising downward its previous estimates of employment in February and March by a combined 58,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure from the jobs report shows the net change in payroll employment for each month in the last two years.

The unemployment rate was unchanged to 4.2 percent in April. As the following figure shows, the unemployment rate has been remarkably stable over the past year, staying between 4.0 percent and 4.2 percent in each month since May 2024. In March, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.4 percent.

As the following figure shows, the monthly net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. As measured by the household survey, there was a net increase of 436,000 jobs in April, following an increase of 201,000 jobs in March. As an indication of the volatility in the employment changes in the household survey note the very large swings in net new jobs in January and February. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. This month, however, both surveys showed net jobs increasing. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)

The household survey has another indication of continuing strength in the labor market. The employment-population ratio for prime age workers—those aged 25 to 54—increased from 80.4 percent in March to 80.7 percent in April. The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is above what the ratio was in any month during the period from January 2008 to January 2020.

It remains unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in total federal government employment of 9,000 in April. However, the BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.” It’s possible that as more federal employees end their period of receiving severance pay, future jobs reports may find a more significant decline in federal employment. To this point, the decline in federal employment has been too small to have a significant effect on the overall labor market.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.8 percent in April, which is unchanged from the March increase.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic. The April, the 1-month rate of wage inflation was 2.0 percent, down from 3.4 percent in March. If the 1-month increase in AHE is sustained, it would contribute to the Fed’s achieving its 2 percent target rate of price inflation.

Today’s jobs report leaves the situation facing the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) largely unchanged. Looming over monetary policy, however, is the expected effect of the Trump Administration’s unexpectedly large tariff increases. As we note in this blog post, a large unexpected increase in tariffs results in an aggregate supply shock to the economy. In terms of the basic aggregate demand and aggregate supply model that we discuss in Macroeconomics, Chapter 13 (Economics, Chapter 23), an unexpected increase in tariffs shifts the short-run aggregate supply curve (SRAS) to the left, increasing the price level and reducing the level of real GDP.

One indication of expectations of future changes in the target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) The data from the futures market indicate that, despite the potential effects of the surprisingly large tariff increases, investors don’t expect that the FOMC will cut its target for the federal funds rate at its May 6–7 meeting. As shown in the following figure, investors assign a 98.2 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at that meeting.

It’s a different story if we look at the end of the year. As the following figure shows, investors now expect that by the end of the FOMC’s meeting on December 9-10, the committee will have implemented at least three 0.25 percentage point (25 basis points) cuts in its target range for the federal funds rate. Investors assign a probability of 75.9 percent that the target range will end the year at 3.50 percent to 3.75 percent or lower. At their March meeting, FOMC members projected only two 25 basis point cuts this year—but that was before the announcement of the unexpectedly large tariff increases.

How the economy will fare for the remainder of the year depends heavily on what happens with respect to tariffs. News today that China and the United States may be negotiating lower tariff rates has contributed to rising stock prices. The following figure from the Wall Street Journal shows movements in the S&P stock index over the past year. The index declined sharply on April 2, following President Trump’s announcement of the tariff increases. As of 2 pm today, the S&P index has risen above its value on April 1, meaning that it has recovered all of the losses since the announcement of the tariff increases. The increase in stock prices likely indicates that investors expect that the tariff increases will end up being much smaller than those originally announced and that the chances of a recession happening soon are lower than they appeared to be on April 2.

Surprisingly Strong Jobs Report

Image generated by ChatGTP4-o

As we’ve noted in earlier posts, according to the usually reliable GDPNow forecast from the Federal Reserve Bank of Atlanta, real GDP in the first quarter of 2025 will decline by 2.8 percent. This morning (April 4), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for March. The data in the report show no sign that the U.S. economy is in a recession. We should add two caveats, however: 1. The effects of the unexpectedly large tariff increases announced this week by the Trump Administration are not reflected in the data from this report, and 2. at the beginning of a recession the data in the jobs report can be subject to large revisions.

According to the establishment survey, there was a net increase of 228,000 jobs during March. This increase was well above the increase of 140,000 that economists had forecast. Somewhat offsetting this unexpectedly large increase was the BLS revising downward its previous estimates of employment in January and February by a combined 48,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure from the jobs report shows the net change in payroll employment for each month in the last two years.

The unemployment rate rose slightly to 4.2 percent in March from 4.1 percent in February. As the following figure shows, the unemployment rate has been remarkably stable in recent months, staying between 4.0 percent and 4.2 percent in each month since May 2024. In March, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.4 percent.

As the following figure shows, the monthly net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. As measured by the household survey, there was a net increase of 201,000 jobs in March, following a sharp decrease of 588,000 jobs in February. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. This month, however, both surveys showed roughly the same net job increase. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)

One concerning sign in the household survey is the fall in the employment-population ratio for prime age workers—those aged 25 to 54. The ratio declined from 80.5 percent in February to 80.4 percent in March. Although the prime-age employment-population is still high relative to the average level since 2001, it’s now well below the high of 80.9 percent in mid-2024. Continuing declines in this ratio would indicate a significant softening in the labor market.

It’s unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in total federal government employment of 4,000 in March. However, the BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.” It’s possible that as more federal employees end their period of receiving severance pay, future jobs reports may find a more significant decline in federal employment.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic. The March 1-month rate of wage inflation was 3.0 percent, up from 2.7 percent in February. Whether measured as a 12-month increase or as a 1-month increase, AHE is still increasing somewhat more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

Taken by itself, today’s jobs report leaves the situation facing the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) largely unchanged. There are some indications that the economy may be weakening, as shown by some of the data in the jobs report and by some of the data incorporated by the Atlanta Fed in its pessimistic nowcast of first quarter real GDP. But the Fed hasn’t yet brought inflation down to its 2 percent annual target.

Looming over monetary policy is the fallout from the Trump Administration’s implementation of unexpectedly large tariff increases. As we note in this blog post, a large unexpected increase in tariffs results in an aggregate supply shock to the economy. In terms of the basic aggregate demand and aggregate supply model that we discuss in Macroeconomics, Chapter 13 (Economics, Chapter 23), an unexpected increase in tariffs shifts the short-run aggregate supply curve (SRAS) to the left, increasing the price level and reducing the level of real GDP.

The effect of the tariffs poses a dilemma for the Fed. With inflation still running above the 2 percent annual target, additional upward pressure on the price level is unwelcome news. The dramatic decline in both stock prices and in the interest rate on the 10-Treasury note indicate that investors are concerned that the tariffs increases may push the U.S. economy into a recession. The FOMC can respond to the threat of a recession by cutting its target for the federal funds rate, but doing so runs the risk of pushing inflation higher.

In a speech today, Fed Chair Jerome Powell stated the following:

“We have stressed that it will be very difficult to assess the likely economic effects of higher tariffs until there is greater certainty about the details, such as what will be tariffed, at what level and for what duration, and the extent of retaliation from our trading partners. While uncertainty remains elevated, it is now becoming clear that the tariff increases will be significantly larger than expected. The same is likely to be true of the economic effects, which will include higher inflation and slower growth. The size and duration of these effects remain uncertain. While tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could be more persistent. Avoiding that outcome would depend on keeping longer-term inflation expectations well anchored, on the size of the effects, and on how long it takes for them to pass through fully to prices. Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem.”

One indication of expectations of future cuts in the target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) The data from the futures market indicate that, despite the potential effects of the surprisingly large tariff increases, investors don’t expect that the FOMC will cut its target for the federal funds rate at its May 6–7 meeting. As shown in the following figure, investors assign a 58.4 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at that meeting.

It’s a different story if we look at the end of the year. As the following figure shows, investors now expect that by the end of the FOMC’s meeting on December 9-10, the committee will have implemented at least four 0.25 percentage point (25 basis points) cuts in its target range for the federal funds rate. Investors assign a probability of 75.8 percent that the target range will end the year 3.25 percent to 3.50 percent or lower. At their March meeting, FOMC members projected only two 25 basis point cuts this year—but that was before the announcement of the unexpectedly large tariff increases.

Strong Jobs Report with No Sign of Recession

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In a post earlier this week, we noted that according to the usually reliable GDPNow forecast from the Federal Reserve Bank of Atlanta, real GDP in the first quarter will decline by 2.8 percent. (The forecast was updated yesterday on the basis of additional data releases to a slightly less pessimistic –2.4 percent decline.) This morning (March 7), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for February. The data in the report show no sign that the U.S. economy is in a recession. We should add the caveat, however, that at the beginning of a recession the data in the jobs report can be subject to large revisions.

The jobs report has two estimates of the change in employment during the month: one estimate from the establishment survey, often referred to as the payroll survey, and one from the household survey. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and Federal Reserve policymakers believe that employment data from the establishment survey provide a more accurate indicator of the state of the labor market than do either the employment data or the unemployment data from the household survey. (The groups included in the employment estimates from the two surveys are somewhat different, as we discuss in this post.)

According to the establishment survey, there was a net increase of 151,000 jobs during February. This increase was below the increase of 160,000 that economists had forecast. The previously reported increase for December was revised upward, while the previously reported increase for January was revised downward. The net change in jobs, taking the revisions for those two months together, was 2,000 lower than originally estimated. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure from the jobs report shows the net change in payroll employment for each month in the last two years.

The unemployment rate rose slightly to 4.1 percent in February from 4.0 percent in January. As the following figure shows, the unemployment rate has been remarkably stable in recent months, staying between 4.0 percent and 4.2 percent in each month since May 2024. Last December, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.3 percent.

As the following figure shows, the net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. The net change in jobs as measured by the household survey for February showed a sharp decrease of 588,000 jobs following a very large increase of 2,234,000 jobs in January. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. The difference was particularly dramatic this month. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)

Another concerning sign in the household survey is the fall in the employment-population ratio for prime age workers—those aged 25 to 54. The ratio declined from 80.7 percent in January to 80.5 percent in February. Although the employment-population is still high relative to the average level since 2001, it’s now well below the high of 80.9 percent in mid-2024. Continuing declines in this ratio would indicate a significant softening in the labor market.

It’s unclear how many federal workers have been laid off since the Trump Administration took office. The household survey shows a decline in total federal government employment of 10,000 in February. The household survey was conducted in the week that included February 12, so, it’s possible that next month’s jobs report may find a more significant decline.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 4.0 percent in February, up slightly from 3.9 percent in January.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic. The February 1-month rate of wage inflation was 3.4 percent, a decline from the surprisingly high 5.2 percent rate in December. Whether measured as a 12-month increase or as a 1-month increase, AHE is still increasing somewhat more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

Today’s jobs report leaves the situation facing the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) largely unchanged. There are some indications that the economy may be weakening, as shown by some of the data in the jobs report and by some of the data incorporated by the Atlanta Fed in its pessimistic nowcast of first quarter real GDP. But the Fed hasn’t yet brought inflation down to its 2 percent annual target. In addition, it’s unclear how the Trump Administration’s policies—particularly with respect to tariff increases—might affect the economy. Speaking today at an event at the University of Chicago, Fed Chair Jerome Powell observed the following:

“Looking ahead, the new Administration is in the process of implementing significant policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation. It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy. While there have been recent developments in some of these areas, especially trade policy, uncertainty around the changes and their likely effects remains high. As we parse the incoming information, we are focused on separating the signal from the noise as the outlook evolves. We do not need to be in a hurry, and are well positioned to wait for greater clarity.”

The likeliest outcome is that the FOMC will keep its target for the federal funds rate unchanged, perhaps for several meetings, unless additional data are released that clearly show the economy to be weakening.

One indication of expectations of future cuts in the target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) The data from the futures market indicates that investors don’t expect that the FOMC will cut its target for the federal funds rate at either its March 18–19 or May 6–7 meetings. As shown in the following figure, only at the FOMC’s June 17–18 meeting do investors assign a greater than 50 percent probability to the committee cutting its target. As of this afternoon, investors assign a probability of only 19.2 percent to the FOMC keeping its target unchanged at 4.25 percent to 4.50 percent at that meeting. They assign a probability of 80.8 percent to the committee cutting its target rate by at least 0.25 percentage point (25 basis points) at that meeting.

Strong Jobs Report in the Context of Annual Revisions to the Establishment and Household Surveys

Photo courtesy of Lena Buonanno

This morning (February 7), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for January. This report was particularly interesting because it includes data reflecting the annual benchmark revision to the establishment, or payroll, survey and the annual revision of the household survey data to match new population estimates from the Census Bureau.

According to the establishment survey, there was a net increase of 143,000 jobs during January. This increase was below the increase of 169,000 to 175,000 that economists had forecast in surveys by the Wall Street Journal and bloomberg.com. The somewhat weak increase in jobs during January was offset by upward revisions to the initial estimates for November and December. The previously reported increases in employment for those months were revised upward by a total of 100,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”)

The BLS also announced the results of its annual revision of the payroll employment data benchmarked to March 2024. The revisions are mainly based on data from the Quarterly Census of Employment and Wages (QCEW). The data in payroll survey are derived from a sample of 300,000 establishments, whereas the QCEW is based on a much more comprehensive count of workers covered by state unemployment insurance programs. The revisions indicated that growth in payroll employment between March 2023 and March 2024 had been overstated by 598,000 jobs. Although large in absolute scale, the revisions equal only 0.4 percent of total employment. In addition, as we discussed in this blog post last August, initially the BLS had estimated that the overstatement in employment gains during this period was an even larger 818,000 jobs. (The BLS provides a comprehensive discuss of its revisions to the establishment employment data here.)

The following table shows the revised estimates for each month of 2024, based on the new benchmarking.

The BLS also revised the household survey data to reflect the latest population estimates from the census bureau. Unlike with the establishment data, the BLS doesn’t adjust the historical household data in light of the population benchmarking. However, the BLS did include two tables in this month’s jobs report illustrating the effect of the new population benchmark. The following table from the report shows the effect of the benchmarking on some labor market data for December 2024. The revision increases the estimate of the civilian noninstitutional population by nearly 3 million, most of which is attributable to an increase in the estimated immigrant population. The increase in the estimate of the number of employed workers was also large at 2 million. (The BLS provides a discussion of the effects of its population benchmarking here.)

The following table shows how the population benchmarking affects changes in estimates of labor market variables between December 2024 and January 2025. The population benchmarking increases the net number of jobs created in January by 234,000 and reduces the increase in the number of persons unemployed by 142,000.

As the following figure shows, the unemployment rate, as reported in the household survey, decreased from 4.1 percent in December to 4.0 percent in January. The figure shows that the unemployment rate has fluctuated in a fairly narrow range over the past year.

The establishment survey also includes data on average hourly earnings (AHE). As we’ve noted in previous posts, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. AHE increased 4.1 percent in January, which was unchanged from the December increase. By this measure, wage growth is still somewhat higher than is consistent with annual price inflation running at the Fed’s target of 2 percent.

There isn’t much in today’s jobs report to change the consensus view that the Fed’s policymaking Federal Open Market Committee (FOMC) will leave its target for the federal funds rate unchanged at its next meeting on March 18-19. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 91.5 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent at the March meeting. Investors assign a probability of only 8.5 percent to the FOMC cutting its target range by 25 basis points at that meeting.

As Expected, the FOMC Leaves Its Target for the Federal Funds Rate Unchanged

Federal Reserve Chair Jerome Powell at a press conference following a meeting of the FOMC (photo from federalreserve.gov)

Members of the Fed’s Federal Open Market Committee (FOMC) had signaled that the committee was likely to leave its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent at its meeting today (January 29), which, in fact, was what they did. As Fed Chair Jerome Powell put it at a press conference following the meeting:

“We see the risks to achieving our employment and inflation goals as being roughly in balance. And we are attentive to the risks on both sides of our mandate. … [W]e do not need to be in a hurry to adjust our policy stance.”

The next scheduled meeting of the FOMC is March 18-19. It seems likely that the committee will also keep its target rate constant at that meeting. Although at his press conference, Powell noted that “We’re not on any preset course.” And that “Policy is well-positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.” The statement the committee released after the meeting showed that the decision to leave the target rate unchanged was unanimous.

The following figure shows, for the period since January 2010, the upper bound (the blue line) and lower bound (the red line) for the FOMC’s target range for the federal funds rate and the actual values of the federal funds rate (the green line) during that time. Note that the Fed is successful in keeping the value of the federal funds rate in its target range.

A week ago, President Donald Trump in a statement to the World Economic Forum in Davos, Switzerland noted his intention to take actions to reduce oil prices. And that “with oil prices going down, I’ll demand that interest rates drop immediately.” As we noted in this recent post about Fed Governor Michael Barr stepping down as Fed Vice Chair for Supervision, there are indications that the Trump administration may attempt to influence Fed monetary policy.

In his press conference, Powell was asked about the president’s statement and responded that he had “No comment whatever on what the president said.” When asked whether the president had spoken to him about the need to lower interest rates, Powell said that he “had no contact” with the president. Powell stated in response to another question that “I’m not going to—I’m not going to react or discuss anything that any elected politician might say ….”

As we noted earlier, it seems likely that the FOMC will leave its target for the federal funds rate unchanged at its meeting on March 18-19. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 82.0 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent at the March meeting. Investors assign a probability of only 18.0 percent to the committee cutting its target range by 25 basis points at that meeting.

Unexpectedly Strong Jobs Report

Last September the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) cut its target for the federal funds rate by 0.50 percentage point (50 basis points. Many economists and policymakers expected the FOMC to continue cutting its federal funds rate target at meetings through 2025. (We discussed the September target cut in this blog post.) The FOMC cut its target by 25 basis points at both its November and December 2024 meetings. But by the December meeting, it had become clear that the inflation rate was not falling as quickly to the Fed’s 2 percent target as the committee members had hoped. As FOMC’s staff economists put it, there had been “upward surprises” in inflation data. According to the minutes of the December meeting, several members of the committee believed that “upside risks to the inflation outlook had increased.”

As a result, it seemed likely that the FOMC would leave its target for the federal funds rate unchanged at its next meeting on January 28-29. This conclusion was reinforced this morning (January 10) when the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for December. The report indicates that the labor market is stronger than expected.

Economists who had been surveyed by the Wall Street Journal had forecast that payroll employment, as reported in the establishment survey, would increase by 155,000. The BLS reported that payroll employment in December had increased by 256,000, well above expectations. The unemployment rate—which is calculated from data in the household survey—was 4.1 percent, down slightly from 4.2 percent in November. The following figure, taken from the BLS report, shows the net changes in employment for each month during the past two years.

As the following figure shows, the net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. The net change in jobs as measured by the household survey for December also showed a strong increase of 478,000 jobs following a decline of 273,000 jobs in November. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. But in December the two surveys were sending the same signal of rapid employment growth. (In this blog post, we discuss the differences between the employment estimates in the household survey and the employment estimates in the establishment survey.)

The employment-population ratio for prime age workers—those aged 25 to 54—also increased, as shown in the following figure, to 80.5 percent in December from 80.4 percent in November. Although the employment-population is below its recent high of 80.9 percent, it remains high relative to levels seen since 2001.

As the following figure shows, the unemployment rate, which is also reported in the household survey, decreased slightly to 4.1 percent in December from 4.2 percent in November. The unemployment rate has been remarkably stable over the past two years, varying only 0.2 percentage point above or below 4.0 percent.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage that it is available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.9 percent in December, down slightly from 4.0 percent in November.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic. The December 1-month rate of wage inflation was 3.4 percent, a decline from the 4.9 percent rate in November. Whether measured as a 12-month increase or as a 1-month increase, AHE is still increasing somewhat more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

Given these data from the jobs report, it seems unlikely that the FOMC will reduce its target range for the federal funds rate at its next meeting. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 97.3 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent, at its next meeting. Investors assign a probability of only 2.7 percent of the committee cutting its target range by 25 basis points at that meeting.

As the following figure shows, investors also expect the FOMC to keep its target range unchanged at its meeting on March 18-19, although there is greater uncertainty. Investors assign:

A 74.0 percent probability that the FOMC keeps its target range for the federal funds rate unchanged
A 25.4 percent probability that the committee cuts its target range by 25 basis points
A 0.6 percent probability that the committee cuts its target range by 50 basis points

New PCE Data Show Inflation Slowing

Image generated by GTP-4o of people shopping.

As we discussed in this blog post on Wednesday, the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) voted to reduce its target for the federal funds rate by 0.25 percentage point. After the meeting, the committee released its “Summary of Economic Projections” (SEP). The SEP showed that the committee’s forecasts of the inflation rate as measured by the personal consumption expenditures (PCE) price index for this year and next year are both higher than the committee had forecast in September, when the last SEP was released. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.

This morning (December 20), the BEA released monthly data on the PCE price index as part of its “Personal Income and Outlays” report for November.

The following figure shows PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in November PCE inflation was 2.4 percent, up from 2.3 percent in October. Core PCE inflation in November was 2.8 percent, unchanged from October. Both PCE inflation and core PCE inflation were slightly lower than the expectations of economists surveyed before the data were released.

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 fell sharply in November to 1.5 percent from 2.8 percent in October. Core PCE inflation also fell from 3.2 percent in October to 1.4 percent in November. Although both 12-month PCE inflation and 12-month core PCE inflation remained above the Fed’s 2 percent annual inflation target, 1-month PCE inflation and 1-month core PCE inflation dropped to well below the inflation target. But the usual caution applies that data from one month shouldn’t be overly relied on; it’s far too soon to draw the conclusion that inflation is likely to remain below the 2 percent target in future months.

Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University as another way of measuring the underlying trend in inflation. If we listed the inflation rate for each individual good or service included in the PCE, 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. The following figure from the Federal Reserve Bank of Cleveland includes, along with PCE inflation (the green line) and core PCE inflation (the blue line), median PCE inflation (the orange line). All three inflation rates are measured over 12 months. Median PCE inflation in November was 3.1 percent, unchanged from October.

In his press conference earlier this week, Fed Chair Jerome Powell noted that: “we’ve had recent high readings from non-market services.” Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices rise, the prices of financial services included in the PCE price index also rise. Powell argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month inflation (the blue line) and 1-month inflation (the red line) for market-based PCE, excluding the prices of food and energy. (The BEA explains the market-based PCE measure here.)

These measures of inflation tell a similar story to the measures considered earlier: 12-month inflation continues to run above the Fed’s 2 percent inflation target, while 1-month inflation slowed significantly in November and is below the 2 percent target. By this measure 12-month inflation was unchanged in November at 2.4 percent, while 1-month inflation declined from 2.5 percent in October to 1.4 percent in November.

To summarize, the less volatile 12-month measures of inflation show it to be persistently above the Fed’s target, while the more volatile 1-month measures show inflation to have fallen below target. If the FOMC were to emphasize the 1-month measures, we might expect them to continue cutting the target for the federal funds rate at the committee’s next meeting on January 28-29. The more likely outcome is that, unless other macroeconomic data that are released between now and that meeting indicate a significant strengthening or weakening of the economy, the committee will leave its target for the federal funds rate unchanged. (The BEA’s next release of monthly PCE data won’t occur until January 31, which is after the FOMC meeting.)

Investors who buy and sell federal funds futures contracts expect that the FOMC will leave its federal funds rate target unchanged at its next meeting. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, investors assign a probability of 91.4 percent to the FOMC leaving its target for the federal funds rate at the current range of 4.25 percent to 4.50. Investors assign a probability of only 8.6 percent to the FOMC cutting its target by 0.25 percentage point.

Latest PCE Inflation Data Indicate that Fed May Struggle to Achieve a Soft Landing

An image generated by GTP-4o of people shopping

This morning (November 27), the BEA released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report for October. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. This month’s data indicates that progress towards the Fed’s target may have stalled.

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 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in October, PCE inflation (the blue line) was 2.3 percent, up from 2.1 percent in September. Core PCE inflation (the red line) in October was 2.8 percent, up from 2.7 percent in September. Both PCE inflation and core PCE inflation were in accordance with the expectations of economists surveyed.

One reason that PCE inflation has been lower than core PCE inflation in recent months is that PCE inflation has been held down by falling energy prices, as shown in the following figure. Energy prices have been falling over the last three months and were down 5.9 percent in October. It seems unlikely that falling energy prices will persist.

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 rose in October to 2.9 percent from 2.1 percent in September. Core PCE inflation rose from 3.2 percent in September to 3.3 percent in October. Because core inflation is generally a better measure of the underlying trend in inflation, both 12-month and 1-month core PCE inflation indicate that inflation may still run well above the Fed’s 2 percent target in coming months. But the usual caution applies that data from one month shouldn’t be overly relied on.

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 core inflation, excluding the price of housing services as well as the prices of food and energy (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 and in housing.

Inflation in services remained high, increasing from 3.7 percent in September to 3.9 percent in October. Core inflation, measured by excluding housing as well as food and energy, increased from 2.1 percent in September to 2.4 percent in October.

Some Fed watchers have suggested that higher inflation readings may lead he Fed’s policymaking Federal Open Market Committee (FOMC) to leave its target for the federal funds rate unchanged at its next meeting on December 17-18. As of today, however, investors who buy and sell federal funds futures contracts are still expecting that the FOMC will reduce its target by 0.25 percent (25 basis points) at its next meeting. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, investors assign a probability of 70 percent to the FOMC cutting its target for the federal funds rate from the current range of 4.50 percent to 4.75 percent to a range of 4.25 percent to 4.50 percent. Investors assign a probability of only 30 percent to the FOMC leaving its target unchanged.

Since the FOMC began increasing the target for the federal funds rate in the spring of 2022, economists have discussed three possible outcomes of the Fed’s monetary policy:

A hard landing, with the economy only returning to the Fed’s 2 percent inflation target if the U.S. economy experiences a recession
A soft landing, with the economy returning to 2 percent inflation without experiencing a recession.
No landing, with the economy not experiencing a recession but with inflation remaining persistently above the Fed’s 2 percent target.

With GDP and employment data showing no indication that a recession will begin soon and with today’s data showing inflation—while having declined substantially from its mid-2022 peak—remaining above the Fed’s 2 percent target, the chances of the no landing outcome seem to be increasing.

Surprisingly Strong Jobs Report

The “Employment Situation” report (often referred to as the “jobs report”), released monthly by the Bureau of Labor Statistics (BLS), is always closely followed by economists and policymakers because it provides important insight in the current state of the U.S. economy. The jobs report for August, which was released in early September, showed signs that the labor market was cooling. The report played a role in the decision by the Fed’s policy-making Federal Open Market Committee to cut its target for the federal funds rate by 0.50 percentage point (50 basis points) at its meeting on September 17-18. A 0.25 percentage point (25 basis points) cut would have been more typical.

In a press conference following the meeting, Fed Chair Jerome Powell explained that one reason that the Fed’s policy-making Federal Open Market Committee (FOMC) cut its for the federal funds rate by 50 basis points rather than by 25 basis points was the state of the labor market: “In the labor market, conditions have continued to cool. Payroll job gains averaged 116,000 per month over the past three months, a notable step-down from the pace seen earlier in the year.”

The September jobs report released this morning (October 4) indicates that conditions in the labor market appear to have turned around. The jobs report has two estimates of the change in employment during the month: one estimate from the establishment survey, often referred to as the payroll survey, and one from the household survey. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and policymakers at the Federal Reserve believe that employment data from the establishment survey provides a more accurate indicator of the state of the labor market than do either the employment data or the unemployment data from the household survey. (The groups included in the employment estimates from the two surveys are somewhat different, as we discuss in this post.)

Economists surveyed by the Wall Street Journal and by Bloomberg had forecast a net increase in payroll employment of 150,000 and an unchanged unemployment rate of 4.2 percent. The BLS reported a higher net increase of 250,000 jobs and a tick down of the unemployment rate to 4.1 percent. In addition, the BLS revised upward its estimates of the employment increases in July and August by a total of 72,000. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure, taken from the BLS report, shows the net changes in employment for each month during the past two years.

What had seemed from the BLS’s initial estimates to be slow growth in employment from April to June has been partly reversed by revisions. With the current estimates, employment has been increasing since July at a pace that should reduce any concerns that U.S. economy is on the brink of a recession.

As the following figure shows, the net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. The net change in jobs as measured by the household survey increased from 168,000 in August to 430,000 in September. So, in this case the direction of change in the two surveys was the same, with both showing strong increases in the net number of jobs created in September.

As the following figure shows, the unemployment rate, which is also reported in the household survey, decreased slightly for the second month in a row. It declined from 4.2 percent in August to 4.1 percent in September.

The household survey also provides data on the employment-population ratio. The following figure shows the employment-population ratio for prime age workers—those aged 25 to 54. It’s been unchanged since July at 80.9 percent, the higest level since 2001.

The establishment survey also includes data on average hourly earnings (AHE). As we note in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage that it is available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. AHE increased 4.0 percent in September, up from a 3.9 percent increase in August.

The 1-month rate of wage inflation of 4.5 percent in September is a decrease from the 5.6 percent rate in August. Whether measured as a 12-month increase or as a 1-month increase, AHE is increasing more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

What effect will this jobs report likely have on the FOMC’s actions at its final two meetings of the year on November 6-7 and December 17-18? Some investors were expecting that the FOMC would cut its target for the federal funds rate by 50 basis points at its next meeting, matching the cut at its September meeting. This jobs report makes it seem more likely that the FOMC will cut its target by 25 basis points.

One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 97.4 percent to the FOMC cutting its target for the federal funds rate by 25 basis points percentage point at its next meeting and a probability of 2.6 percent to the FOMC leaving its target unchanged at a range of 4.75 percent to 5.00 percent. Investors see effectively no chance of a 50 basis point cut at the next meeting.

Financial Markets Correctly Forecast Today’s 0.50% Cut in the Federal Funds Rate Target

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

In a blog post yesterday (September 17), we noted that trading on the CME’s federal funds futures market indicated that investors assigned a probability of 63 percent to the Federal Open Market Committee (FOMC) announcing today a 0.50 percentage point (50 basis points) cut to its target range for the federal funds rate and a probability of 37 percent to a 0.25 percentage point (25 basis points) cut. (100 basis points equals 1 percentage point.) The forecast proved correct when the FOMC announced this afternoon that it was cutting its target range to 4.75 percent to 5.00 percent, from the range of 5.25 percent to 5.50 percent that had been in place since July 2023.

Congress has given the Fed a dual mandate to achieve maximum employment and price stability. In March 2022, the FOMC began responding to the surge in inflation that had begun in the spring of 2021 by raising its target for the federal funds rate. Up through its July 2024 meeting, the FOMC had been focused on the risk that the inflation rate would remain above the Fed’s target inflation rate of 2 percent. In the statement released after today’s meeting, the committee stated that it “has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”

In a press conference following the meeting, Fed Chair Jerome Powell indicated that with inflation close to the 2 percent target and the labor market continuing to cool “by any measure,” the committee judged that it was time to begin normalizing its target range for the federal funds rate. Powell said that: “The U.S. economy is in a good place and our action is intended to keep it there.” When asked by a reporter whether the committee cut its target by 50 basis points today to catch up for not having cut its target at its July meeting, Powell responded that: “We don’t think we’re behind [on cutting the target range]. We think this [50 basis point cut] will keep us from falling behind.”

At the conclusion of each meeting, the committee holds a formal vote on its target for the federal funds rate. The vote today was 15-1, with Governor Michelle Bowman casting the sole negative vote. She stated that she would have preferred a 25 basis point cut. Dissenting votes have been rare in recent years.

How much lower will the federal funds target range go? Typically at the FOMC’s December, March, June, and September meetings, the committee releases a “Summary of Economic Projections” (SEP), which presents median values of the committee members’ forecasts of key economic variables. The following table is from the SEP released after today’s meeting.

Looking at the values under the heading “Median” on the left side of the table, the median projection for the federal funds rate at the end of the 2024 is 4.4 percent. That projection signals that the committee will likely cut its target range by 25 basis points at each of its two remaining meetings on November 6-7 and December 17-18. The median projection for the federal funds rate at the end of 2025 is 3.4 percent, implying four additional 25 basis points cuts. In the long run, the median projection of the committee is that the federal funds rate will be 2.9 percent, which is somewhat higher than the 2.5 percent rate that the committee had projected at its December 2019 meeting before the start of the Covid pandemic.

Committee members project that the unemployment rate will end the year at 4.4 percent, up from the 4.2 percent rate in August. They expect that the unemployment rate will be 4.2 percent in the long run. The long run unemployment rate is ofter referred to as the natural rate of unemployment. (We discuss the natural rate of unemployment in Macroeconomics, Chapter 9, Section 9.2 and Economics, Chapter 19, Section 19.2.)

The median projection of the committe members is that at the end of 2024 the inflation rate, as measured by the percentage change in the personal consumption expenditures (PCE) price index, will be 2.3 percent, slightly above the Fed’s target rate. Inflation will also run slightly above the Fed’s target in 2025 at 2.1 percent before retuning to 2 percent by the end of 2026. The median projections of the inflation rate at the ends of 2024 and 2025 are lower than the median projections in the SEP that was released after the FOMC meeting on June 11-12.