Federal funds rate target – Page 6 – HubbardOBrienEconomics.com Blog

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 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.)

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 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 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.

Did the Federal Funds Futures Market Accurately Forecast the Size of the Rate Cut?

Image generated by GTP-4o “illustrating interest rates.”

Tomorrow (September 18) at 2 p.m. EDT, the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) will announce its target for the federal funds rate. It’s been clear since Fed Chair Jerome Powell’s speech on August 23 at the Kansas City Fed’s annual monetary policy symposium held in Jackson Hole, Wyoming that the FOMC would cut its target for the federal funds rate at its meeting on September 17-18. (We discuss Powell’s speech in this blog post.)

The only suspense has been over the size of the cut. Traditionally, the FOMC has raised or lowered its target for the federal funds rate in 0.25% (or 25 basis points) increments. Occasionally, however, either because economic conditions are changing rapidly or because the committee concludes that it has been adjusting its target too slowly (“fallen behind the curve” is the usual way of putting it) the committee makes 0.50% (50 basis points) changes to its target.

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

The following figure summarizes the implied probabilities from federal funds rate futures trading of the FOMC cutting its target by 25 basis points (the orange bars) or 50 basis points (the blue bars) at tomorrow’s meeting. The probabilities on four days are shown—today, yesterday, one week ago, and one month ago.

The figure shows how sentiment among investors has changed over the past month. On August 16, investors assigned a 75 percent probability of a 25 basis point cut in the target range and only a 25 percent probability of a 50 basis point cut. Yesterday and today, investor sentiment has swung sharply toward expecting a 50 basis point cut. Why the shift? As the Fed attempts to fulfill its dual mandate of maximum employment and price stability, it’s focus since the spring of 2022 had been on bringing inflation back down to its 2 perecent target. But as the unemployment rate has slowly risen, output growth has cooled, and more consumers are delinquent on their auto loan and credit card payments, some members of the committee now believe that the committee made a mistake in not cutting the target range by 25 basis points at its last meeting at the end of July. For these members, a 50 basis point cut tomorrow would bring the changes in the target range back on track.

How well did investors in the federal funds futures market forecast the FOMC’s decision? If you are reading this after 2 p.m. EDT on September 18, you’ll know the answer.

Mixed CPI Inflation Report Sets the Stage for Fed Rate Cut

Image illustrating inflation generated by GTP-4o.

Today (September 11), the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). This report is the last one that will be released before the Fed’s policy-making Federal Open Market Committee (FOMC) holds its next meeting on September 17-18.

As the following figure shows, the inflation rate for August measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 2.6 percent down from 2.9 percent in July. Core inflation (the red line)—which excludes the prices of food and energy—increased slightly to 3.3 percent in August from 3.2 percent in July. Headline inflation was slightly below what economists surveyed by the Wall Street Journal had expected, while core inflation was slightly higher.

As the following figure shows, if we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—we see that both headline and core inflation increased. Headline inflation (the blue line) increased from 1.8 percent in July to 2.3 percent in August. Core inflation (the red line) jumped from 2.0 percent in July to 3.4 percent in August. Overall, we can say that, taking 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—but the increase in 1-month inflation is concerning. Of course, as always, it’s important not to overinterpret the data from a single month. (Note, also, 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 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 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 reversed the decline that began in the spring of 2023, rising from 5.0 percent in July to 5.2 percent August. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—increased from 4.6 percent in July to 5.2 percent in August, continuing an increase that began in June. The increase in 1-month inflation in shelter may concern the members of the FOMC, as may, to a lesser extent, the increase in 12-month inflation in shelter. Shelter has a smaller weight of 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. But persistent shelter inflation in the 5 percent range would make a soft landing more difficult.

Finally, in order to get a 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 higherst inflation rates and the 8 percent of goods and services with the lowest inflation rates.

As the following figure (from the Federal Reserve Bank of Cleveland) shows, median inflation (the orange line) declined slightly from 4.3 percent in July to 4.2 percent in August. Trimmed mean inflation (the blue line) also declined slightly from 3.3 in July to 3.2 percent in August. These data provide confirmation that core CPI inflation is likely running higher than a rate that would be consistent with the Fed achieving its inflation target.

For the past few weeks Fed officials have been indicating that the FOMC is likely to cut its target for the federal funds at its next meeting on Septembe 17-18. Investors who buy and sell federal funds futures contracts expect that the FOMC will cut its target for the federal funds rate by 0.25 percentage point from the current range of 5.50 percent to 5.25 percent. (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 85.0 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point at its next meeting and a probability of only 15.0 percent that the cut will be 0.50 percentage point.

The FOMC has to balance the risk of leaving its target for the federal funds rate at its current level for too long—increasing the risk of slowing demand so much that the economy slips into recession—against the risk of cutting its target too soon—increasing the risk that inflation persists above the Fed’s 2 percent target. We’ll see at the committee’s next meeting how Fed Chair Jerome Powell and the other members assess the current state of the economy as they consider when and by how much to cut their target for the federal funds rate.

Unexpectedly Weak Employment Report; Beware the Sahm Rule?

Earlier this week, as we discussed in this blog post, the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) voted to leave its target for the federal funds rate unchanged. In his press conference following the meeting, Fed Chair Jerome Powell stated that: “Overall, a broad set of indicators suggests that conditions in the labor market have returned to about where they stood on the eve of the pandemic—strong but not overheated.”

This morning (August 2), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often referred to as the “jobs report”) for July, which indicates that the labor market may be weaker than Powell and the other members of the FOMC believed it to be when they decided to leave their target for the federal funds rate unchanged.

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.)

According to the establishment survey, there was a net increase of 114,000 jobs during July. This increase was below the increase of 175,000 to 185,000 that economists had forecast in surveys by the Wall Street Journal and bloomberg.com. The following figure, taken from the BLS report, shows the monthly net changes in employment for each month during the past two years.

The previously reported increases in employment for April and May were revised downward by 29,000 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.”) As we’ve discussed in previous posts (most recently here), downward revisions to the payroll employment estimates are particularly likely at the beginning of a recession, although this month’s adjustments were relatively small.

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 in the establishment survey. The net change in jobs as measured by the household survey declined from 116,000 in June to 67,000 in June. So, in this case the direction of change in the two surveys was the same—a decline in the increase in the number of jobs.

As the following figure shows, the unemployment rate, which is also reported in the household survey, increased from 4.1 percent to 4.3 percent—the highest unemployment rate since October 2021. Although still low by historical standards, July was the fifth consecutive month in which the unemployment rate increased. It is also higher than the unemployment rate just before the pandemic. The unemployment rate was below 4 percent most months from mid-2018 to early 2020.

Some economists and policymakers have been following the Sahm rule, named after Claudia Sahm Chief Economist for New Century Advisors and a former Fed economist. The Sahm rule, as stated on the site of the Federal Reserve Bank of St. Louis is: “Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3 [measure]) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.” The following figure shows the values of this indicator dating back to March 1949.

So, according to this indicator, the U.S. economy is now at the start of a recession. Does that mean that a recession has actually started? Not necessarily. As Sahm stated in an interview this morning, her indicator is a historical relationship that may not always hold, particularly given how signficantly the labor market has been affected during the last four years by the pandemic.

As we noted in a post earlier this week, investors who buy and sell federal funds futures contracts assigned a probability of 11 percent that the FOMC would cut its target for the federal funds rate by 0.50 percentage point at its next meeting. (Investors in this market assigned a probability of 89 percent that the FOMC would cut its target by o.25 percentage point.) Today, investors dramatically increased the probability to 79.5 percent of a 0.50 cut in the federal funds rate target, as shown in this figure from the CME site.

Investors on the stock market appear to believe that the probability of a recession beginning before the end of the year has increased, as indicated by sharp declines today in the stock market indexes.

The next scheduled FOMC meeting isn’t until September 17-18. The FOMC is free to meet in between scheduled meetings but doing so might be interpreted as meanng that economy is in crisis, which is a message the committee is unlikely to want to send. It would likely take additional unfavorable reports on macro data for the FOMC not to wait until September to take action on cutting its target for the federal funds rate.