Tag: Federal funds rate futures

Weaker Than Expected Jobs Report Shakes Up Investors’ Expectations of FOMC Rate Cuts

This morning (August 1), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for July. The data in the report show that the labor market was weaker than expected in July. There have been many stories in the media about firms becoming cautious in hiring as a result of the Trump administration’s tariff increases. Some large firms—including Microsoft, Walt Disney, Walmart, and Proctor and Gamble—have announced layoffs. In addition, real GDP growth slowed during the first half of the year. Nevertheless, until today it appeared that employment growth remained strong.

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 only 73,000 nonfarm jobs during July. This increase was below the increase of 1115,000 that economists surveyed by Factset had forecast. In addition, the BLS revised downward its previous estimates of employment in May and June by a combined 258,000 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 nonfarm payroll employment for each month in the last two years. The figure shows the striking deceleration in job growth during the second quarter of this year.

The unemployment rate increased from 4.1 percent in June to 4.2 percent in July, which is the same rate as economists surveyed had forecast. 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 June, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.5 percent. The unemployment rate would have to rise significantly in the second half of the year for that forecast to be accurate.

Each month, the Federal Reserve Bank of Atlanta estimates how many net new jobs are required to keep the unemployment rate stable. Given a slowing in the growth of the working-age population due to the aging of the U.S. population and a sharp decline in immigration, the Atlanta Fed currently estimates that the economy would have to create 111,573 net new jobs each month to keep the unemployment rate stable at 4.2 percent. If this estimate is accurate, continuing monthly net job increases of 73,000 would result in a slowly rising unemployment rate.

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 decrease of 260,000 jobs in July, following an increase of 93,000 jobs in June. 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, which was the case this month. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)

The household survey has another important labor market indicator: the employment-population ratio for prime age workers—those aged 25 to 54. In July the ratio declined to 80.4 percent from 80.7 percent in June. The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is still above what the ratio was in any month during the period from January 2008 to November 2019. Further declines in the prime-age employment-population ratio would be a strong indication of a softening labor market.

It is still unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in federal government employment of 12,000 in June and a total decline of 84,000 since the beginning of February 2025. 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 report a larger 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 3.9 percent in July, up from an increase of 3.8 percent in June.

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. In July, the 1-month rate of wage inflation was 4.0 percent, up from 3.0 percent in June. If the July rate of wage inflation is sustained, it would complicate the Fed’s task of achieving its 2 percent target rate of price inflation. But one month’s data from such a volatile series may not accurately reflect longer-run trends in wage inflation.

What effect might today’s jobs report have on the decisions of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) with respect to setting its target for the federal funds rate? One indication of expectations of future changes in the FOMC’s 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.) Yesterday, as we noted in a blog post, investors assigned a 60.8 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at its September 16–17 meeting. As the following figure shows, there has been a sharp change in investors’ expectations. As of this morning, investors are assigning a 78.9 percent probability to the committee cutting its target by 0.25 percentage point (25 basis points) to a range of 4.00 percent to 4.25 percent.

There is a similarly dramatic change in investors’ expectations of the target range for the federal funds rate following the FOMC’s October 28–29 meeting. As the following figure shows, investors now assign a probability of 57.3 percent to the committee lowering its target range to 3.75 percent to 4.00 percent at that meeting. Yesterday, investors assigned a probability of only 13.7 percent to that outcome.

PCE Inflation Comes in Higher Than Expected

Image generated by ChatGTP-4o

Yesterday, in this blog post, we discussed the quarterly data on inflation as measured by changes in the personal consumption expenditures (PCE) price index. Today (July 31), the Bureau of Economic Analysis (BEA) released monthly data on the PCE price index as part of its “Personal Income and Outlays” report. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.

The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2017, with inflation measured as the percentage change in the PCE from the same month in the previous year. In June, headline PCE inflation was 2.6 percent, up from 2.4 percent in May. Core PCE inflation in June was 2.8 percent, unchanged from May. Headline PCE inflation was higher than the forecast of economists surveyed, while core PCE inflation was the same as forecast.

The following figure shows headline 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, headline PCE inflation jumped from 2.0 percent in May to 3.4 percent in June. Core PCE inflation increased from 2.6 percent in May to 3.1 percent in June. So, both 1-month PCE inflation estimates are well above the Fed’s 2 percent target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so we shouldn’t attempt to draw wider conclusions from one month’s data. In addition, these data likely don’t capture fully the higher prices likely to result from the tariff increases the Trump administration has implemented, including those in trade agreements that have only been announced in the past few days.

Fed Chair Jerome Powell has frequently noted that inflation in non-market services can skew PCE inflation. 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 fall, the prices of financial services included in the PCE price index also fall. Powell has 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 headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 2.3 percent in June, up from 2.1 percent in May. Core market-based PCE inflation was 2.6 percent in June, up from 2.4 percent in May. So, both market-based measures show similar rates of inflation in June as the total measures do. In the following figure, we look at 1-month inflation using these measures. The 1-month inflation rates are both higher than the 12-month rates. One-month headline market-based inflation soared to 3.9 percent in June from 1.6 percent in May. One-month core market-based inflation also increased sharply to 3.6 percent in June from 2.2 percent in May. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate. Still, looking at 1-month inflation gives us a better look at current trends in inflation, which these data indicate is rising significantly.

Is the increase in inflation attributable to the effects of tariffs? At this point, it’s too early to tell, particularly since, as noted earlier, all tariff increases have not yet been implemented. We can note, though, that the effect of tariffs are typically seen in goods prices, rather than in service prices because tariffs are levied primarily on imports of goods. As the following figure shows, one-month inflation in goods prices jumped from 0.9 percent in May to 4.8 percent in June, while one-month inflation in services prices increased only from 2.5 percent in May to 2.8 percent in June.

Finally, we noted in a blog post yesterday that investors trading federal funds rate futures assigned a 55.0 percent probability to the Federal Open Market Committee leaving its target for the federal funds rate unchanged at its meeting on September 16–17. With today’s PCE report showing higher than expected inflation, that probability has increased to 60.8 percent.