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New PCE Data Show Inflation Slowing

Image generated by GTP-4o of people shopping.

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

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

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

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation fell sharply in November to 1.5 percent from 2.8 percent in October. Core PCE inflation also fell from 3.2 percent in October to 1.4 percent in November. Although both 12-month PCE inflation and 12-month core PCE inflation remained above the Fed’s 2 percent annual inflation target, 1-month PCE inflation and 1-month core PCE inflation dropped to well below the inflation target. But the usual caution applies that data from one month shouldn’t be overly relied on; it’s far too soon to draw the conclusion that inflation is likely to remain below the 2 percent target in future months.

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

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

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

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

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

As Expected, 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 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.

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.

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 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.

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.