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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.

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.)

Weaker Than Expected Jobs Report Likely Due to the Effects of Hurricanes and Strikes

Image generated by GTP-4o.

The Bureau of Labor Statistics (BLS) releases the “Employment Situation” report (often called the “jobs report”) monthly. Economists and policymakers follow this report closely because it provides important insight into the current state of the U.S. economy. The October jobs report was released this morning, November 1 As sometimes happens, the data in the report were distorted by unusual events last month, primarily the effects of hurricanes and strikes. The BLS reported the results of its surveys without attempting to correct for these events. With respect to hurricanes, the BLS noted:

“No changes were made to either the establishment or household survey estimation procedures for the October data. It is likely that payroll employment estimates in some industries were affected by the hurricanes; however, it is not possible to quantify the net effect on the over-the-month change in national employment, hours, or earnings estimates because the establishment survey is not designed to isolate effects from extreme weather events. There was no discernible effect on the national unemployment rate from the household survey.”

Economists who participated in various surveys had forecast that payroll employment would increase by 117,500, with the unemployment rate—which is calculated from data in the household survey—being unchanged at 4.1 percent. The forecast of the unemployment rate was accurate, as the BLS reported a 4.1 percent unemployment rate in October. But the BLS reported that payroll employment had increased by only 12,000. In addition, the BLS revised downward its estimates of the employment increases in August and September by a total of 112,000. (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 initially seemed to be particularly strong growth in employment in September, possibly indicating a significant increase in the demand for labor, has been partially reversed by the data revision.

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 October was a decline of 368,000 jobs after an increase of 430,000 jobs in September. So, the story told by the two surveys was similar: significant weakening in the job market. But we need to keep in mind the important qualification that the job market in some areas of the country had been disrupted by unusual events during the month.

Other data in the jobs report told a more optimistic story of conditions in job market. The following figure shows the employment-population ratio for prime age workers—those aged 25 to 54. Although it declined from 80.9 percent to 80.6 percent, it remained high relative to levels seen since 2001.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post yesterday, 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 October, up from a 3.9 percent increase in September.

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 October 1-month rate of wage inflation was 4.5 percent, an increase from the 3.8 percent rate in September. 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.

The Federal Reserve’s policy-making Federal Open Market Committee (FOMC) has its next meeting on November 6-7. What effect will this jobs report likely have on the committee’s actions at that 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 99.8 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point (25 basis points) at its next meeting. Investors see effectively no chance of the committee leaving its target range unchanged at the current 4.75 percent to 5.00 percent or of the committee cutting its target rate by 50 basis point cut.

Investors don’t appear to believe that the acceleration in wage growth indicated by today’s jobs report will cause the FOMC to pause its rate cutting. Nor do they appear to believe that the unexpectedly small increase in payroll employment will cause the committee to cut its target for the federal funds rate by 50 basis points.

New Data on Inflation and Wage Growth Indicate that the Fed Is Still Not Assured of Hitting Its Inflation Target

Photo courtesy of Lena Buonanno.

Yesterday, the Bureau of Economic Analysis (BEA) released quarterly data on the personal consumption expenditures (PCE) price index as part of its advance estimate of third quarter GDP. (We discuss that release in this blog post.) Today, the BEA released monthly data on the PCE as part of its Personal Income and Outlays report. In addition, the Bureau of Labor Statistics (BLS) released quarterly data on the Employment Cost Index (ECI).

The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows 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 September PCE inflation (the blue line) was 2.1 percent, down from 2.3 percent in August. Core PCE inflation (the red line) in September was 2.7 percent, which was unchanged from August. PCE inflation was in accordance with the expectations of economists surveyed by the Wall Street Journal, but core inflation was higher than expected.

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 September to 2.1 percent from 1.4 percent in August. Core PCE inflation rose from 1.9 percent in August to 3.1 percent in June. 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 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.

Turning to wages, as we’ve noted in earlier posts, as a measure of the rate of increase in labor costs, the Fed’s policy-making Federal Open Market Committee (FOMC) prefers the ECI to average hourly earnings (AHE).

The AHE is calculated by adding all of the wages and salaries workers are paid—including overtime and bonus pay—and dividing by the total number of hours worked. As a measure of how wages are increasing or decreasing during a particular period, AHE can suffer from composition effects because AHE data aren’t adjusted for changes in the mix of occupations workers are employed in. For example, during a period in which there is a decline in the number of people working in occupations with higher-than-average wages, perhaps because of a downturn in some technology industries, AHE may show wages falling even though the wages of workers who are still employed have risen. In contrast, the ECI holds constant the mix of occupations in which people are employed. The ECI does have this drawback: It is only available quarterly whereas the AHE is available monthly.

The data released this morning indicate that labor costs continue to increase at a rate that is higher than the rate that is likely needed for the Fed to hit its 2 percent price inflation target. The following figure shows the percentage change in the employment cost index for all civilian workers from the same quarter in 2023. The blue line shows only wages and salaries while the red line shows total compensation, including non-wage benefits like employer contributions to health insurance. The rate of increase in the wage and salary measure decreased from 4.0 percent in the second quarter of 2024 to 3.8 percent in the third quarter. The movement in the rate of increase in compensation was very similar, decreasing from 4.1 percent in the second quarter of 2024 to 3.9 percent in the third quarter.

If we look at the compound annual growth rate of the ECI—the annual rate of increase assuming that the rate of growth in the quarter continued for an entire year—we find that the rate of increase in wages and salaries decreased from 3.4 percent in the second quarter of 2024 to 3.1 percent in the third quarter. Similarly, the rate of increase in compensation decreased from 3.7 percent in the second quarter of 2024 to 3.2 percent in the third quarter. So, this measure indicates that there has been some easing of wage inflation in the third quarter, although, again, we have to use caution in interpreting one quarter’s data.

Some economists and policymakers prefer to look at the rate of increase in ECI for private industry workers rather than for all civilian workers because the wages of government workers are less likely to respond to inflationary pressure in the labor market. The first of the following figures shows the rate of increase of wages and salaries and in total compensation for private industry workers measured as the percentage increase from the same quarter in the previous year. The second figure shows the rate of increase calculated as a compound growth rate.

Both figures show results consistent with the 12-month PCE inflation figures: A decrease in wage inflation during the third quarter compared with the second quarter but with wage inflation still running somewhat above the level consistent with the Fed’s 2 percent price inflation target.

Taken together, the PCE and ECI data released today indicate that the Fed has not yet managed to bring about soft landing—returning inflation to its 2 percent target without pushing the economy into a recession. As we noted in yesterday’s post, although output growth remains strong, there are some indications that the labor market may be weakening. If so, future months may see a further decrease in wage growth that will make it more likely that the Fed will hit its inflation target. The BLS is scheduled to release its “Employment Situation” report for October on Friday, November 1. That report will provide additional data for assessing the current state of the labor market.

CPI Inflation Running Slightly Higher than Expected

Image illustrating inflation generated by GTP-4o.

This morning (October 10), the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). As the following figure shows, the inflation rate for September measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 2.4 percent down from 2.6 percent in August. That was the lowest headline inflation rate since February 2021. Core inflation (the red line)—which excludes the prices of food and energy—was unchanged at 3.3 prcent. Both headline inflation and core inflation were slightly higher than economists surveyed by the Wall Street Journal had expected.

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 headline inflation (the blue line) decreased from 2.3 percent in August to 2.2 percent in September. Core inflation (the red line) increased from 3.4 percent in August to 3.8 percent in September.

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 core inflation is concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. Of course, as always, it’s important not to overinterpret the data from a single month, although this is the second month in a row that core inflation has been well above 3 percent. (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. After rising in August, 12-month inflation in shelter resumed the decline that began in the spring of 2023, falling from 5.2 percent in August to 4.8 percent September. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—declined sharply from 6.4 percent in August to 2.7 percent in September. The members of the FOMC are likely to find the decline in inflation in shelter reassuring as they consider another cut to the target for the federal funds rate at the committee’s next meeting on November 6-7. 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.

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 4.2 percent in August to 4.1 percent in September. Trimmed mean inflation (the blue line) was unchanged at 3.2 percent. These data provide confirmation that 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.

The FOMC cut its target for the federal funds rate by 0.50 percentage point (50 basis points) from 5.50 percent to 5.25 percent to 5.00 percent to 4.75 percent at its last meeting on September 17-18. Some economists and investors believed that the FOMC might cut its target by another 50 basis points at its next meeting on November 6-7. This inflation report makes that outcome less likely. In addition, the release of the minutes from the September 17-18 meeting revealed that a significant number of committee members may have preferred a 25 basis point cut rather than a 50 basis point cut at that meeting:

“However, noting that inflation was still somewhat elevated while economic growth remained solid and unemployment remained low, some participants observed that they would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision.”

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 at its November meeting. (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 80.3 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of 19.7 percent to the committee leaving its target unchanged.

Surprisingly Strong Jobs Report

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

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

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

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

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

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

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

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

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

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

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

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

Latest PCE Report Shows Inflation Continuing to Fall

On September 27, the Bureau of Economic Analysis (BEA) released its “Personal Income and Outlays” report for August, which includes monthly data on the personal consumption expenditures (PCE) price index. Inflation as measured by annual changes in the consumer price index (CPI) receives the most attention in the media, but the Federal Reserve looks instead to inflation as measured by annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, PCE inflation (the blue line) was 2.2 percent in August, down from 2.7 percent in July. Core PCE inflation (the red line) ticked up in August to 2.7 percent from 2.6 percent in July.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation declined from 1.9 percent in July to 1.1 percent in August, well below the Fed’s 2 percent inflation target. Core PCE inflation declined from 1.9 percent in July to 1.6 percent in August. Calculating inflation this way focuses only on the most recent data, and so reinforces the conclusion that inflation has slowed significantly from the higher rates seen at the beginning of this year.

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

Inflation using the trimmed mean measure was 2.7 percent in August (calculated as a 12-month inflation rate), down only slightly from 2.6 percent in July—still above the Fed’s target inflation rate of 2 percent. Inflation in services remained high in August at 3.7 percent, the same as in July.

Today’s data indicate that the economy is still on a path for a soft landing in which the inflation rate returns to the Fed’s 2 percent target without the economy slipping into a recession. Looking forward, both the Federal Bank of Atlanta’s GDPNow forecast and the Federal Reserve Bank of New York’s GDP Nowcast project that real GDP will increase at annual rate of more than 3 percent in the third quarter (which ends in three days). So, at this point there is no indication that the economy is slipping into a recession. The next Employment Situation report will be released on October 4 and will provide more information on the state of the labor market.

Fed Governor Michelle Bowman Explains Her Dissenting Vote at the FOMC Meeting

Federal Reserve Governor Michelle Bowman (Photo from federalreserve.gov)

Federal Reserve Chairs place a high value on consensus, particularly with respect to the decisions of the Federal Open Market Committee (FOMC) setting the target for the federal funds rate. (Note that the chair of the Fed’s Board of Governors also serves as the chair of the FOMC.) As we discuss in Macroeconomics, Chapter 14, Section 14.4 (Economics, Chapter 24, Sectio 24.4), the FOMC has 12 voting members: the 7 members of the Board of Governors, the president of the Federal Reserve Bank of New York, and 4 of the other 11 District Bank presidents, who serve rotating one-year terms.

Decisions by the FOMC in setting the target for the federal funds rate are usually unanimous. Prior to the FOMC meeting on September 17-18, each vote of the committee had been unanimous since Esther George, president of the Federal Reserve Bank of Kansas City cast a dissenting vote at the meeting on June 14-15, 2022. At that meeting, the committee voted to raise its target for the federal funds rate by 0.75 percentage point (75 basis points). George voted against the move because she believed a 0.50 percentage point (50 basis points) increase would have been more appropriate.

At the September 17-18 meeting, Fed Governor Michelle Bowman voted against the decision to reduce the target for the federal funds rate by 50 basis points because she believed a cut of 25 basis point would have been more appropriate. She was the first member of the Board of Governors to cast a dissenting vote at an FOMC meeting since 2005.

Perhaps because it’s unusual for a member of the Board of Governors to dissent from an FOMC decision, Bowman issued a statement explaining her vote. In her statement, Bowman argued that although inflation has declined substantially over the past two years, she was concerned that inflation as measured by the 12-month percentage change in the core personal consumption expenditures (PCE) price index was still 2.5 percent—above the Fed’s target inflation rate of 2 percent: “Although it is important to recognize that there has been meaningful progress on lowering inflation, while core inflation remains around or above 2.5 percent, I see the risk that the Committee’s larger policy action could be interpreted as a premature declaration of victory on our price stability mandate.” (Note that the Fed uses the PCE rather than the core PCE to gauge whether it is hitting its inflation target, but core PCE is generally thought to be a better indicator of the underlying inflation rate.)

Bowman also noted the difficulty of interpreting developments in the labor market: “My reading of labor market data has become more uncertain due to increased measurement challenges and the inherent difficulty in assessing the effects of recent immigration flows.” (We discuss the effects on employment measures of differing estimates of the level of immigration in this blog post.)

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.