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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.

Headline CPI Inflation Is Higher in December but Core Inflation Is Lower than Expected

Image generated by GTP-4o illustrating inflation

On January 15, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the green line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.9 percent in December—up from 2.7 percent in November.
The core inflation rate, which excludes the prices of food and energy, was 3.2 percent in December—down from 3.3 percent in November.

Headline inflation was slightly above and core inflation was slightly below what economists surveyed had expected.

In the following figure, 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. Calculated as the 1-month inflation rate, headline inflation (the blue line) jumped from 3.8 percent in November to 4.8 percent in December. Core inflation (the green line) decreased from 3.8 percent in November to 2.7 percent in December.

Overall, considering 1-month and 12-month inflation together, the most favorable news is the low value of the 1-month core inflation rate. The most concerning news is a sharp increase in 1-month headline inflation, which brought that measure to its highest reading since February 2024. On balance, this month’s CPI report doesn’t do much to challenge the conclusion of other recent inflation reports that progress on lowering inflation has slowed or, possibly, stalled. So, the probability of a “no landing” outcome, with inflation remaining above the Fed’s target for an indefinite period, seems to have at least slightly increased.

Of course, it’s important not to overinterpret the data from a single month. The figure shows that 1-month inflation is particularly volatile. Also note that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI, to evaluate whether it is hitting its 2 percent annual inflation target.

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or a house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but in December it was still high at 4.6 percent. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—fell from 4.1 percent in November to 3.1 percent in December.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation 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.
Trimmed mean inflation drops the 8 percent of goods and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure shows that 12-month median inflation (the red line) declined slightly from 3.9 percent in November to 3.8 percent in December. Twelve-month trimmed mean inflation (the blue line) was unchanged at 3.2 percent for the fifth month in a row.

The following figure shows 1-month median and trimmed mean inflation. One-month median inflation rose from 2.8 percent in November to 3.6 percent in December. One-month trimmed mean inflation fell slightly from 3.3 percent in November to 3.2 percent in December. These data provide confirmation that (1) CPI inflation at this point is likely running higher than a rate that would be consistent with the Fed achieving its inflation target, and (2) that progress toward the target has slowed.

What are the implications of this CPI report for the actions the FOMC may take at its next meeting on January 28-29? The stock market rendered a quick verdict, as the following figure from the Wall Street Journal shows. As soon as the market opened on Wednesday morning, all three of the most widely followed stock market indexes jumped—as indicated by the vertical segments in the figure. Investors seem to be focusing on core CPI inflation being lower than expected, which should increase the probability that the FOMC will cut its target for the federal funds rate at either its March or May meeting. Lower inflation and lower interest rates would be good news for stock prices.

Investors who buy and sell federal funds futures contracts still do not expect that the FOMC will cut its target for the federal funds rate at its next meeting, as indicated by the following figure. (We discuss the futures market for federal funds in this blog post.) Today, investors assign a probability of 93.7 percent to the FOMC leaving its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent at its January 28-29 meeting, and a probability of only 2.7 percent to the committee cutting its target range by 0.25 percentage point (25 basis points).

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.

As Expected, FOMC Cuts Target for the Federal Funds Rate by 0.25 Percentage Point

Federal Reserve Chair Jerome Powell speaks at a press conference following a meeting of the Federal Open Market Committee. (Photo from federalreserve.gov)

Members of the Fed’s Federal Open Market Committee (FOMC) had signaled that the committee was likely to cut its target range for the federal funds rate by 0.25 percentage point (25 basis points) at its meeting today (December 18). As we noted in this recent post, investors had overwhelming expected a cut of this size. Although the committee followed through with a 25 basis point cut, Fed Chair Jerome Powell noted in a press conference following the meeting that it was a “closer call” than were the two earlier cuts this year. The statement the committee released after the meeting showed that only one member—Beth M. Hammack, president of the Federal Reserve Bank of Cleveland—ended up voting against the decision to cut the target rate.

In his press conference, Powell noted that although there were some indications that the labor market has weakened, the committee believed that unemployment was likely to remain near the natural rate. The committee also saw real GDP increasing at a steady rate. Powell stated that he was optimistic about the economy and that “I expect another good year next year.” The main obstacle to the committee fulfilling its dual mandate for full employment and price stability is that inflation remains persistently above the Fed’s target of a 2 percent annual inflation rate.

After the meeting, the committee also released a “Summary of Economic Projections” (SEP)—as it typically does at its March, June, September, and December meetings. The SEP 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 forecasts mirror the points that Powell made in his news conference:

Committee members now forecast that GDP will be higher in 2024, and that the unemployment rate will be lower, than they had forecast in September.
Committee members now forecast that both personal consumption expenditures (PCE) price inflation and core PCE inflation will be slightly higher in 2024 than they had forecast in September.
Most notably, whereas in September committee members had forecast that PCE inflation would be 2.1 percent in 2025, they now forecast it will be 2.5 percent—notably higher. And committee members now forecast that inflation will not fall to the Fed’s 2 percent target until 2027, rather than 2026.
Finally, committee members now project that the federal funds rate will end 2025 50 basis points lower than it is now, rather than 100 basis points lower. In other words, committee members ares now forecasting only two 25 basis point cuts in the target next year rather than the four cuts they had forecast in September.

In his press conference, Powell noted that the main reason that PCE inflation remains high is that inflation in the prices of housing services has been running high, as have the prices of some other services. Noting that monetary policy affects the economy “with long and variable lags,” Powell stated that he believes that inflation is still on track to fall to the 2 percent target.

Given that inflation has been running closer to 2.5 percent and that the committee expects the inflation rate will still be 2.5 percent next year, a reporter asked Powell if the committee had considered the possibility of accepting a 2.5 percent inflation rate in the long run. Powell replied that: “No. We’re not going to settle for [2.5 percent inflation].” He stated that a 2 percent inflation rate is what the Fed “owes the public.”

Finally, Powell indicated that the committee would have to take into account the effects of the incoming Trump Administration’s fiscal policy actions—particularly tariff increases—when they occur. President Trump has stated that he would like to see interest rates decline more quickly, so the committee may face criticism for keeping the target for the federal funds rate higher next year than they had originally intended.

As Expected, CPI Inflation Is Higher in November as the Fed Struggles to Hit Its Inflation Target.

Image generated by GTP-4o illustrating inflation.

On December 11, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the red line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.7 percent—up from 2.6 percent in October.
The core inflation rate, which excludes the prices of food and energy, was unchanged at 3.3 percent for the fourth month in a row.

Both headline inflation and core inflation were the same as economists surveyed by the Wall Street Journal had expected.

In the following figure, 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. Calculated as the 1-month inflation rate, headline inflation (the blue line) increased sharply from 3.0 percent in October to 3.8 percent in November. Core inflation (the red line) increased from 3.4 percent in October to 3.8 percent in November.

The relatively high rates of core inflation in both the 12-month and 1-month measures are concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. It’s important not to overinterpret the data from a single month, although this is the fourth month in a row that core inflation has been above 3 percent. (Note, that 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.)

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but in November it was at a still high 4.8 percent. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—fell from 4.7 percent in October to 4.1 percent in November.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation 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.
Trimmed mean inflation drops the 8 percent of good and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure is from the Federal Reserve Bank of Cleveland. It shows that median inflation (the orange line) fell from 4.1 percent in October to 3.9 percent in November. Trimmed mean inflation (the blue line) was unchanged at 3.2 percent for the fourth month in a row. These data provide confirmation that (1) core CPI inflation at this point is likely running higher than a rate that would be consistent with the Fed achieving its inflation target, and (2) that progress toward the target has slowed.

Will this persistence in inflation above the Fed’s 2 percent target cause the FOMC to hold constant its target range for the federal funds rate? Investors who buy and sell federal funds futures contracts still expect that the FOMC will cut its target for the federal funds rate by 0.25 percentage point at its next meeting on December 17-18. (We discuss the futures market for federal funds in this blog post.) The following figure shows that today these investors assign a probability of 94.7 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of only 5.3 percent to the committee leaving its target unchanged at its current range of 4.50 percent to 4.75 percent.

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.

Latest CPI Report Indicates That the Fed May Have Trouble Guiding the Economy the Last 1,000 Feet to a Soft Landing

Image illustrating inflation generated by GTP-4o.

On November 13, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the red line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.6 percent—up from 2.4 percent in September.
The core inflation rate, which excludes the prices of food and energy, was unchanged at 3.3 percent for the third month in a row.

Both headline inflation and core inflation were the values that economists surveyed by the Wall Street Journal had expected.

In the following figure, 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. Calculated as the 1-month inflation rate, headline inflation (the blue line) increased from 2.2 percent in September to 3.0 percent in October. Core inflation (the red line) fell from 3.8 percent in September to 3.4 percent in October.

Overall, considering 1-month and 12-month inflation together, the U.S. economy may still be on course 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. However, progress on lowering inflation may have slowed or, possibly, stalled. The relatively high rates of core inflation in both the 12-month and 1-month measures are concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. It’s important not to overinterpret the data from a single month, although this is the third month in a row that core inflation has been above 3 percent. (Note, that 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.)

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but increased in October to 4.9 percent from 4.8 percent in September. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—increased sharply from 2.7 percent in September to 4.7 percent in October.

Chair Powell and the other members of the FOMC have been expecting that the inflation in shelter would continue to decline. For instance, in his press conference following the last FOMC meeting on November 7, Powell stated that:

“What’s going on there is, you know, market rents, newly signed leases, are experiencing very low inflation. And what’s happening is older—you know, leases that are turning over are taking several years to catch up to where market leases are; market rent leases are. So that’s just a catch-up problem. It’s not really reflecting current inflationary pressures, it’s reflecting past inflationary pressures.”

The recent uptick in shelter inflation may concern FOMC members as they consider whether, and by how much, to cut their target for the federal funds rate at their next meeting on December 17-18. Bear in mind, though, that shelter has a weight of only 15 percent in the PCE price index that the Fed uses to gauge whether it is hitting its 2 percent inflation target in contrast with the 33 percent weight that shelter has in the CPI.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation 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.
Trimmed mean inflation drops the 8 percent of good and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure is from the Federal Reserve Bank of Cleveland. It shows that median inflation (the orange line) was unchanged in October at 4.1 percent. Trimmed mean inflation (the blue line) was also unchanged at 3.2 percent. These data provide confirmation that (1) core CPI inflation at this point is likely running at least slightly higher than a rate that would be consistent with the Fed achieving its inflation target and (2) that progress toward the target has slowed.

Will this persistence in inflation above the Fed’s 2 percent target cause the FOMC to hold constant its target range for the federal funds rate? Investors who buy and sell federal funds futures contracts expect that the FOMC will cut still cut its target for the federal funds rate by 0.25 percentage point at its December meeting. (We discuss the futures market for federal funds in this blog post.) The following figure that today these investors assign a probability of 75.7 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of 24.3 percent to the committee leaving its target unchanged at a range of 4.50 percent to 4.75 percent.

Fed Tries to Thread the Needle with Today’s 0.25% Cut in the target Federal Funds Rate

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

The Federal Reserve’s policymaking Federal Open Market Committee (FOMC) concluded its meeting today (November 7) after considering a mixed batch of macroeconomic data. As we noted in this blog post, the most recent jobs report showed a much smaller increase in payroll employment than had been expected. However, the effects of hurricanes and strikes on the labor market made the data in the report difficult to interpret. Real GDP growth during the third quarter of 2024, while relatively strong, was slower than expected. Finally, as we discuss in this post, inflation has been running above the Fed’s 2 percent annual target with wages also growing faster than is consistent with 2 percent price inflation.

Congress has given the Fed a dual mandate of achieving maximum employment and price stability. If FOMC members had been most concerned about lower-than-expected real GDP growth and some weakening in the labor market, the likely course would have been to cut the target range for the federal funds rate by 0.50 percentage point (50 basis points) from its current range of 4.75 percent to 5.00 percent to a range of 4.25 percent to 4.50 percent.

If the committee had been most concerned about inflation remaining above target, the likely course would have been to leave the target range for the federal funds rate unchanged. Instead, the committee split the difference by reducing the target range by 25 basis points. As we noted near the end of this blog post, financial markets had been expecting a 25 basis point cut. At the conclusion of each meeting, the committee holds a formal vote on its target for the federal funds rate. The vote today was unanimous.

In a press conference following the meeting, Fed Chair Jerome Powell noted that: “We see the risks to achieving our employment and inflation goals as being roughly in balance, and we are attentive to the risks to both sides of our mandate.” Powell also indicated his confidence that the committee would succeed in staying on what he labeled the “middle path” that monetary policy needs to follow: “We know that reducing policy restraint too quickly could hinder progress on inflation. At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment …. Policy is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.”

With respect to the effect of the macroeconomic policies of the incoming Trump Administration, Powell noted that the Fed doesn’t comment on fiscal policy nor did he consider it appropriate to comment in any way on the recent election. He stated that the committee would wait to see new policies enacted before considering their consequences for monetary policy. When asked by a reporter whether he would leave the position of Fed chair if asked to do so by someone in the Trump Administration, Powell answered “no.” When asked whether he believes the president has the power to remove a Fed chair before the end of the chair’s term, Powell again answered “no.” (Most legal scholars believe that, according to the Federal Reserve Act, a president can’t remove a Fed chair because of policy disagreements, but only “for cause.” See Macroeconomics, Chapter 17, Section 17.4/Economics, Chapter 27, Section 27.4 for more on this topic.)