Monetary Policy – Page 11 – HubbardOBrienEconomics.com Blog

How Should the Fed Interpret the Monthly Employment Reports?

Jerome Powell arriving to testify before Congress. (Photo from Bloomberg News via the Wall Street Journal.)

Each month the Bureau of Labor Statistics (BLS) releases its “Employment Situation” report. As we’ve discussed in previous blog posts, discussions of the report in the media, on Wall Street, and among policymakers center on the estimate of the net increase in employment that the BLS calculates from the establishment survey.

How should the members of the Fed’s policy-making Federal Open Market Committee interpret these data? For instance, the BLS reported that the net increases in employment in June was 206,000. (Always worth bearing in mind that the monthly data are subject to—sometimes substantial—revisions.) Does a net increase of employment of that size indicate that the labor market is still running hot—with the quantity of labor demanded by businesses being greater than the quantity of labor workers are supplying—or that the market is becoming balanced with the quantity of labor demanded roughly equal to the quantity of labor supplied?

On July 9, in testimony before the Senate Banking Committee indicated that his interpretation of labor market data indicate that: “The labor market appears to be fully back in balance.” One interpretation of the labor market being in balance is that the number of net new jobs the economy creates is enough to keep up with population growth. In recent years, that number has been estimated to be 70,000 to 100,000. The number is difficult to estimate with precision for two main reasons:

There is some uncertainty about the number of older workers who will retire. The more workers who retire, the fewer net new jobs the economy needs to create to accommodate population growth.
More importantly, estimates of population growth are uncertain, largely because of disagreements among economists and demographers over the number of immigrants who have entered the United States in recent years.

In calculating the unemployment rate and the size of the labor force, the BLS relies on estimates of population from the Census Bureau. In a January report, the Congressional Budget Office (CBO) argued that the Census Bureau’s estimate of the population of the United States is too low by about 6 million people. As the following figure from the CBO report indicates, the CBO believes that the Census Bureau has underestimated how much immigration has occurred and what the level of immigration is likely to be over the next few years. (In the figure, SSA refers to the Social Security Administration, which also makes forecasts of population growth.)

Some economists and policymakers have been surprised that low levels of unemployment and large monthly increases in employment have not resulted in greater upward pressure on wages. If the CBO’s estimates are correct, the supply of labor has been increasing more rapidly than is indicated by census data, which may account for the relative lack of upward pressure on wages. If the CBO’s estimates of population growth are correct, a net increase in employment of 200,000, as occured in June, may be about the number necessary to accommodate growth in the labor force. In other words, Chair Powell would be correct that the labor market was in balance in June.

In a recent publication, economists Nicolas Petrosky-Nadeau and Stephanie A. Stewart of the Federal Reserve Bank of San Francisco look at a related concept: breakeven employment growth—the rate of employment growth required to keep the unemployment rate unchanged. They estimate that high rates of immigration during the past few years have raised the rate of breakeven employment growth from 70,000 to 90,000 jobs per month to 230,000 jobs per month. This analysis would be consistent with the fact that as net employment increases have averaged 177,000 over the past three months—somewhat below their estimate of breakeven employment growth—the unemployment rate has increased from 3.8 percent to 4.1 percent.

Latest CPI Report Shows Inflation Continuing to Slow

Image of “a family shopping in a supermarket” generated by ChatGTP 4o.

In testifying before Congress this week, Federal Reserve Chair Jerome Powell indicated that the Fed’s policy-making Federal Open Market Committee (FOMC) was becoming more concerned that it not be too late in reducing its target for the federal funds rate:

“[I]n light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face. Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

Powell also noted that: “more good data would strengthen our confidence that inflation is moving sustainably toward 2 percent.” Today (July 11), Powell received more good data as the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI), which showed a further slowing in inflation.

As the following figure shows, the inflation rate for June measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 3.o percent down from 3.3 percent in May. Core inflation (the red line)—which excludes the prices of food and energy—was 3.3 percent in June, down from 3.4 percent in May.

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—the declines in the inflation rate are much larger. Headline inflation (the blue line) declined from 0.1 percent in May to –0.7 in June—consumer prices fell during June. Core inflation (the red line) declined from 2.0 percent in May to 0.8 percent in June. Overall, we can say that inflation has cooled further in June, bringing the U.S. economy closer to a soft landing—with the annual inflation rate returning to the Fed’s 2 percent target without the economy being pushed into a recession. (Note, though, 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.)

The FOMC has been looking closely at 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 continued its decline that began in the spring of 2023. One-month inflation in shelter declined substantially from 4.9 percent in May to 2.1 percent in June. These values indicate that the price of shelter may no longer be a significant driver of headline inflation.

Finally, in order to get a better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation. Meadin 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, both median inflation (the brown line) and trimmed mean inflation (the blue line) were somewhat higher than either headline CPI inflation or core CPI inflation. One conclusion from these data is that headline and core inflation may be somewhat understating the underlying rate of inflation.

Financial markets are interpreting the most inflation and employment data as indicating that at its meeting on Septembe 17-18 the FOMC is likely to cut its target range for the federal funds rate from the current 5.25 percent to 5.50 to 5.00 percent to 5.25 percent.

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 chart from the CME’s FedWatch Tool shows the current values from trading of federal funds futures.

The probabilities in the chart reflect investors’ predictions of what the FOMC’s target for the federal funds rate will be after the committee’s September meeting. The chart indicates that investors assign a probability of only 8.1 percent to the FOMC leaving its federal funds rate target unchanged at its September meeting, but a 84.6 percent probability of the committee cutting its target by 0.25 percentage point (and a 7.3 percent probability of the committee cutting its target by 0.50 percent age point).

Latest Jobs Report May Indicate the Labor Market Is Weakening

Image generated by ChatGTP 4o.

Recent macroeconomic data have been sending mixed signals about the state of the U.S. economy. The growth in real GDP, industrial production, retail sales, and real consumption spending has been slowing. Growth in employment has been a bright spot—showing steady net increases in job growth above the level necessary to keep up with population growth. Even here, though, as we discuss in a recent blog post, the data may be overstating the actual strength of the labor market.

This morning (July 5), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often referred to as the “jobs report”) for June, which, while seemingly indicating continued strong job growth, also provides some indications that the labor market may be weakening. 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 206,000 jobs during April. This increase was a little above the increase of 1900,000 to 200,000 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 to years.

It’s notable that the previously reported increases in employment for April and May were revised downward by 110,000 jobs, or by about 25 percent. (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), revisions to the payroll employment estimates can be particularly large at the beginning 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 in the establishment survey. The net increase in jobs as measured by the household survey increased from –408,000 in May (that is, employment by this measure fell during May) to 116,000 in June.

Note that the BLS also reports a survey for household employment adjusted to conform to the concepts and definitions used to construct the payroll employment series. After this adjustment, over the past 12 months household employment has increased by 32.5 million less than has payroll employment. Clearly, this is a very large discrepancy and may be indicating that the payroll survey is substantially overstating growth in employment.

The unemployment rate, which is also reported in the household survey, ticked up slightly from 4.0 percent to 4.1 percent. Although still low by historical standards, June was the fourth consecutive month in which the unemployment rate increased.

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 show the percentage change in the AHE from the same month in the previous year. The 3.9 percent increase for June continues a downward trend that began in January and is the smallest increase since June 2021.

The 1-month rate of wage inflation of 3.5 percent in June is a significant decrease from the 5.3 percent rate in May, although it’s unclear whether the decline was an additional sign that the labor market is weakening or reflected the greater volatility in wage inflation when calculated this way.

What effect is today’s job reports likely to have on the Fed’s policy-making Federal Open Market Committee as it considers changes in its target for the federal funds rate? As always, it’s a good idea not to rely too heavily on a single data point—particularly because, as we noted earlier, the establishment survey employment data is subject to substantial revisions. But the Wall Street Journal’s headline that the “Case for September Rate Cut Builds After Slower Jobs Data,” seems likely to be accurate.

Latest PCE Report Shows Inflation Slowing

Chair Jerome Powell and other members of the Federal Open Market Committee (Photo from federalreserve.gov)

On Friday, June 28, the Bureau of Economic Analysis (BEA) released its “Personal Income and Outlays” report for April, 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 change in the PCE from the same month in the previous year. Measured this way, in May PCE inflation (the blue line) was 2.6 percent in May, down slightly from PCE inflation of 2.7 percent in April. Core PCE inflation (the red line) in May was also 2.6 percent, down from 2.8 percent in April.

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 sharply declined from 3.2 percent in April to -0.1 percent in in May—meaning that consumer prices actually fell during May. Core PCE inflation declined from 3.2 percent in April to 1.0 percent in May. This decline indicates that inflation by either meansure slowed substantially in May, but data for a single month should be interpreted with caution.

The following figure shows another way 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 2.8 percent in May (calculated as a 12-month inflation rate), down only slightly from 2.9 percent in April—and still well above the Fed’s target inflation rate of 2 percent. Inflation in services remained high in May at 3.9 percent, down only slightly from 4.0 percent in April.

This month’s PCE inflation data indicate that the inflation rate is still declining towards the Fed’s target, with the low 1-month inflation rates being particularly encouraging. But the FOMC will likely need additional data before deciding to lower the committee’s target for the federal funds rate, which is currently 5.25 percent to 5.50 percent. The next meeting of the FOMC is July 30-31. What do financial markets think the FOMC will decide at that meeting?

The probabilities in the chart reflect investors’ predictions of what the FOMC’s target for the federal funds rate will be after the committee’s July meeting. The chart indicates that investors assign a probability of only 10.3 percent to the FOMC cutting its federal funds rate target by 0.25 percentage point at that meeting and an 89.7 percent probability of the commitee leaving the target unchanged.

In contrast, the following figure shows that investors expect that the FOMC will cut its federal funds rate at the meeting scheduled for September 17-18. Investors assign a 57.9 percent probability of a 0.25 percentage point cut and a 6.2 percent probability of a 0.50 percentage point cut. The committee deciding to leave the target unchanged at 5.25 percent to 5.50 percent is assigned a probability of only 35.9 percent.

What Does the Latest Jobs Report Tell Us about the State of the U.S. Economy?

Image of “people working in a store” generated by ChatGTP 4o.

This morning (June 7), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report for May. Recent government releases of macroeconomic data have indicated that the expansion of the U.S. economy is slowing. For instance, as we noted in this recent post on the JOLTS report, the labor market seems to be normalizing. Real personal consumption expenditures declined from March to April. The Federal Reserve Bank of New York’s Nowcast of real GDP growth during the current quarter declined from 2.74 percent at the end of April to 1.76 percent at the end of May. That decline reflects some weakness in the data series the economists at the New York Fed use to forecast current real GDP growth

In that context, today’s jobs report was, on balance, surprisingly strong. The 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 272,000 jobs during May. This increase was well below the increase of 190,000 that economists had forecast in a survey by the Wall Street Journal and well above the net increase of 165,000 during April. (Bloomberg’s survey of economists yielded a similar forecast of an increase of 180,000.) The increase was also higher than the 232,000 average monthly increase during the past year. The following figure, taken from the BLS report, shows the monthly net changes in employment for each month during the past two years.

The surprising strength in employment growth in establishment survey was not echoed in the household survey, which reported a net decrease of 408,000 jobs. 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, and—as noted earlier—the two surveys are of somewhat different groups. Still, the discrepancy between the two survey was notable.

The unemployment rate, which is also reported in the household survey, ticked up slightly from 3.9 percent to 4.0 percent. This is the first time that the unemployment has reached 4.0 percent since January 2022.

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 show the percentage change in the AHE from the same month in the previous year. The 4.1 percent increase in May was a slight increase from the 4.0 percent increase in April. The increase in the rate of wage inflation is in contrast with the decline in employment and increase in the unemployment rate in the same report.

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 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 4.9 percent in May is a sharp increase from the 2.8 percent rate in April, although it’s unclear whether the increase represents a significant acceleration in wage inflation or is just reflecting the greater volatility in wage inflation when calculated this way.

To answer the question posed in the title to this post, the latest jobs report is a mixed bag that doesn’t send a clear message as to the state of the economy. The strong increase in employment and the increase in the rate of wage growth indicate that economy may not be slowing sufficiently to result in inflation declining to the Federal Reserve’s 2 percent annual target. On the other hand, the decline in employment as measured in the household survey and the tick up in the unemployment rate, along with the data in the recent JOLTS report, indicate that the labor market may be returning to more normal conditions.

It seems unlikely that this jobs report will have much effect on the thinking of the Fed’s policy-making Federal Open Market Committee (FOMC), which has its next meeting next week on June 11-12.

Inflation Cools Slightly in Latest CPI Report

Inflation was running higher than expected during the first three months of 2024, indicating that the trend in late 2023 of declining inflation had been interrupted. At the beginning of the year, many economists and analysts had expected that the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target for the federal funds rate sometime in the middle of the year. But with inflation persisting above the Fed’s 2 percent inflation target, it has become likely that the FOMC will wait until later in the year to start cutting its target and might decide to leave the target unchanged through the remainder of 2024.

Accordingly, economists and policymakers were intently awaiting the report from the Bureau of Labor Statistics (BLS) on the consumer price index (CPI) for April. The report released this morning showed a slight decrease in inflation, although the inflation rate remains well above the Fed’s 2 percent target. (Note that, as we discuss in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), 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.)

The inflation rate for April measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.4 percent—about the same as economists had expected—down from 3.5 percent in March. As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.6 percent in April, down from 3.8 percent in March.

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—the declines in the inflation rate are larger. Headline inflation declined from 4.6 percent in March to 3.8 percent in April. Core inflation declined from 4.4 percent in March to 3.6 percent in April. Note that the value for core inflation is the same whether we measure over 12 months or over 1 month. Overall, we can say that inflation seems to have cooled in April, but it still remains well above the Fed’s 2 percent target.

As has been true in recent months, the path of inflation in the prices of services has been concerning. As we’ve noted in earlier posts, Federal Reserve Chair Jerome Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Powell has been particularly concernd about how slowly the price of housing has been declining, a point he made again in the press conference that followed the most recent FOMC meeting.

The following figure shows the 1-month inflation rate in service prices and in service prices not included including housing rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023, but inflation in service prices slowed markedly from 6.6 percent in March to 4.4 percent in April. Inflation in service prices not including housing rent declined more than 50 percent, from 8.9 percent in March to 3.4 percent in April. But, again, even though inflation in service prices declined in April, as the figure shows, the 1-month inflation in services is volatile and even these smaller increases aren’t yet consistent with the Fed meeting its 2 percent inflation target.

Finally, in order to get a better estimate of the underlying trend in inflation, some economists look at median inflation, which 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. As the following figure shows, at 4.3 percent, median inflation in April was unchanged from its value in March.

Today’s report was good news for the Fed in its attempts to reduce the inflation rate to its 2 percent target without pushing the U.S. economy into a recession. But Fed Chair Jerome Powell and other members of the FOMC have made clear that they are unlikely to begin cutting the target for the federal funds rate until they receive several months worth of data indicating that inflation has clearly resumed the downward path it was on during the last months of 2023. The unexpectedly high inflation data for the first three months of 2024 has clearly had a significant effect on Fed policy. Powell was quoted yesterday as noting that: “We did not expect this to be a smooth road, but these [inflation readings] were higher than I think anybody expected,”

What Can We Conclude from a Weaker than Expected Employment Report?

This morning (May 3), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report for April. The 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 175,000 jobs during April. This increase was well below the increase of 240,000 that economists had forecast in a survey by the Wall Street Journal and well below the net increase of 315,000 during March. The following figure, taken from the BLS report, shows the monthly net changes in employment for each month during the past to years.

The unemployment rate, which is also reported in the household survey, ticked up slightly from 3.8 percent to 3.9 percent. It has been below 4 percent every month since February 2022.

The establishment survey also includes data on average hourly earnings (AHE). As we note in this recent 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 show the percentage change in the AHE from the same month in the previous year. The 3.9 percent value for April continues a downward trend that began in February.

The 1-month rate of wage inflation of 2.4 percent in April is a significant decrease from the 4.2 percent rate in March, although it’s unclear whether the decline was a sign that the labor market is weakening or reflected the greater volatility in wage inflation when calculated this way.

The macrodata released during the first three months of the year had, by and large, indicated strong economic growth, with the pace of employment increases being particularly rapid. Wages were also increasing at a pace above that during the pre-Covid period. Inflation appeared to be stuck in the range of 3 percent to 3.5 percent, above the Fed’s target inflation rate of 2 percent.

Today’s “Employment Situation” report may be a first indication that growth is slowing sufficiently to allow the inflation rate to fall back to 2 percent. This is the outcome that Fed Chair Jerome Powell indicated in his press conference on Wednesday that he expected to occur at some point during 2024. Financial markets reacted favorably to the release of the report with stock prices jumping and the interest rate on the 10-year Treasury note falling. Many economists and Wall Street analysts had concluded that the Fed’s policy-making Federal Open Market Committee (FOMC) was likely to keep its target for the federal funds rate unchanged until late in the year and might not institute a cut in the target at all this year. Today’s report caused some Wall Street analysts to conclude, as the headline of an article in the Wall Street Journal put it, “Jobs Data Boost Hopes of a Late-Summer Rate Cut.”

This reaction may be premature. Data on employment from the establishment survey can be subject to very large revisions, which reinforces the general caution against putting too great a weight one month’s data. Its most likely that the FOMC would need to see several months of data indicating a slowing in economic growth and in the inflation rate before reconsidering whether to cut the target for the federal funds rate earlier than had been expected.

The FOMC Follows the Expected Course in Its Latest Meeting

Chair Jerome Powell at a meeting of the Federal Open Market Committee (photo from federalreserve.gov)

At the beginning of the year, there was an expectation among some economists and policymakers that the Fed’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target range for the federal funds rate at the meeting that ended today (May 1). The Fed appeared to be bringing the U.S. economy in for a soft landing—inflation returning to the Fed’s 2 percent target without a recession occurring.

During the first quarter of 2024, production and employment have been expanding more rapidly than had been expected and inflation has been higher than expected. As a result, the nearly universal expectation prior to this meeting was that the FOMC would leave its target for the federal funds rate unchanged. Some economists and investment analysts have begun discussing the possiblity that the committee might not cut its target at all during 2024. The view that interest rates will be higher for longer than had been expected at the beginning of the year has contributed to increases in long-term interest rates, including the interest rates on the 10-year Treasury Note and on residential mortgage loans.

The statement that the FOMC issued after the meeting confirmed the consensus view:

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.”

In his press conference after the meeting, Fed Chair Jerome Powell emphasized that the FOMC was unlikely to cut its target for the federal funds rate until data indicated that the inflation rate had resumed falling towards the Fed’s 2 percent target. At one point in the press conference Powell noted that although it was taking longer than expected for the inflation rate to decline he still expected that the pace of economic actitivity was likely to slow sufficiently to allow the decline to take place. He indicated that—contrary to what some economists and investment analysts had suggested—it was unlikely that the FOMC would raise its target for the federal funds rate at a future meeting. He noted that the possibility of raising the target was not discussed at this meeting.

Was there any news in the FOMC statement or in Powell’s remarks at the press conference? One way to judge whether the outcome of an FOMC meeting is consistent with the expectations of investors in financial markets prior to the meeting is to look at movements in stock prices during the time between the release of the FOMC statement at 2 pm and the conclusion of Powell’s press conference at about 3:15 pm. The following figure from the Wall Street Journal, shows movements in the three most widely followed stock indexes—the Dow Jones Industrial Average, the S&P 500, and the Nasdaq composite. (We discuss movements in stock market indexes in Macroeconomics and Essentials of Economics, Chapter 6, Section 6.2 and in Economics, Chapter 8, Section 8.2.)

If either the FOMC statement or the Powell’s remarks during his press conference had raised the possibility that the committee was considering raising its target for the federal funds rate, stock prices would likely have declined. The decline would reflect investors’ concern that higher interest rates would slow the economy, reducing future corporate profits. If, on the other hand, the statement and Powell’s remarks indicated that the committee would likely cut its target for the federal funds rate relatively soon, stock prices would likely have risen. The figure shows that stock prices began to rise after the 2 pm release of the FOMC statement. Prices rose further as Powell seemed to rule out an increase in the target at a future meeting and expressed confidence that inflation would resume declining toward the 2 percent target. But, as often happens in the market, this sentiment reversed towards the end of Powell’s press conference and two of the three stock indexes ended up lower at the close of trading at 4 pm. Presumably, investors decided that on reflection there was no news in the statement or press conference that would change the consensus on when the FOMC might begin lowering its target for the federal funds rate.

The next signficant release of macroeconomic data will come on Friday when the Bureau of Labor Statistics issues its employment report for April.

Latest Wage Data Another Indication of the Persistence of Inflation

Photo courtesy of Lena Buonanno.

The latest significant piece of macroeconomic data that will be available to the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) before it concludes its meeting tomorrow is the report on the Employment Cost Index (ECI), released this morning by the Bureau of Labor Statistics (BLS). As we’ve noted in earlier posts, as a measure of the rate of increase in labor costs, the 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 the drawback, that 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 looks only at wages and salaries while the red line is for total compensation, including non-wage benefits like employer contributions to health insurance. The rate of increase in the wage and salary measure decreased slightly from 4.4 percent in the fourth quarter of 2023 to 4.3 percent in the first quarter of 2024. The rate of increase in compensation was unchanged at 4.2 percent in both quarters.

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 increased from 4.3 percent in the fourth quarter of 2023 to 4.5 percent in the first quarter of 2024. Similarly, the rate of increase in compensation increased from 3.8 percent in the third quarter of 2023 to 4.5 percent in the first quarter of 2024.

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.

The first figure shows a slight decrease in the rate of growth of labor costs from the fourth quarter of 2023 to the first quarter of 2024, while the second figure shows a fairly sharp increase in the rate of growth.

Taken together, these four figures indicate that there is little sign that the rate of increase in employment costs is falling to a level consistent with a 2 percent inflation rate. At his press conference tomorrow afternoon, following the conclusion of the FOMC’s meeting, Fed Chair Jerome Powell will give his thoughts on the implications for future monetary policy 0f recent macroeconomic data.

Will the Fed Not Cut Rates at All this Year?

Federal Reserve Vice Chair Philip Jefferson (photo from the Federal Reserve)

Federal Reserve Chair Jerome Powell (photo from the Federal Reserve)

At the beginning of 2024, investors were expecting that during the year the Fed’s policy-making Federal Open Market Committee (FOMC) would cut its target range for the federal funds rate six or seven times. At its meeting on March 19-20 the economic projections of the members of the FOMC indicated that they were expecting to cut the target range three times from its current 5.25 percent to 5.50 percent. But, as we noted in this recent post and in this podcast, macroeconomic data during the first three months of this year indicated that the U.S. economy was growing more rapidly than the Fed had expected and the reductions in inflation that occurred during the second half of 2023 had not persisted into the beginning of 2024.

The unexpected strength of the economy and the persistence of inflation above the Fed’s 2 percent target have raised the issue of whether the FOMC will cut its target range for the federal funds rate at all this year. Earlier this month, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC would not cut its target range this year.

Today (April 16) both Fed Vice Chair Philip Jefferson and Fed Chair Jerome Powell addressed the issue of monetary policy. They gave what appeared to be somewhat different signals about the likely path of the federal funds target during the remainder of this year—bearing in mind that Fed officials never commit to any specific policy when making a speech. Adressing the International Research Forum on Monetary Policy, Vice Chair Jefferson stated that:

“My baseline outlook continues to be that inflation will decline further, with the policy rate held steady at its current level, and that the labor market will remain strong, with labor demand and supply continuing to rebalance. Of course, the outlook is still quite uncertain, and if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer.”

One interpretation of his point here is that he is still expecting that the FOMC will cut its target for the federal funds rate sometime this year unless inflation remains persistently higher than the Fed’s target—which he doesn’t expect.

Chair Powell, speaking at a panel discussion at the Wilson Center in Washington, D.C., seemed to indicate that he believed it was less likely that the FOMC would reduce its federal funds rate target in the near future. The Wall Street Journal summarized his remarks this way:

“Federal Reserve Chair Jerome Powell said firm inflation during the first quarter had introduced new uncertainty over whether the central bank would be able to lower interest rates this year without signs of an economic slowdown. His remarks indicated a clear shift in the Fed’s outlook following a third consecutive month of stronger-than-anticipated inflation readings ….”

An article on bloomberg.com had a similar interpretation of Powell’s remarks: “Federal Reserve Chair Jerome Powell signaled policymakers will wait longer than previously anticipated to cut interest rates following a series of surprisingly high inflation readings.”

Politics may also play a role in the FOMC’s decisions. As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), the Federal Reserve Act, which Congress passed in 1913 and has amended several times since, puts the Federal Reserve in an unusal position in the federal government. Although the members of the Board of Governors are appointed by the president and confirmed by the Senate, the Fed was intended to act independently of Congress and the president. Over the years, Fed Chairs have protected that independence by, for the most part, avoiding taking actions beyond the narrow responsibilites Congress has given to the Fed by Congress and by avoiding actions that could be interpreted as political.

This year is, of course, a presidential election year. The following table from the Fed’s web site lists the FOMC meetings this year. The presidential election will occur on November 5. There are four scheduled FOMC meetings before then. Given that inflation has been running well above the Fed’s target during the first three months of the year, it would likely take at least two months of lower inflation data—or a weakening of the economy as indicated by a rising unemployment rate—before the FOMC would consider lowering its federal funds rate target. If so, the meeting on July 30-31 might be the first meeting at which a rate reduction would occur. If the FOMC doesn’t act at its July meeting, it might be reluctant to cut its target at the September 17-18 meeting because acting close to the election might be interpreted as an attempt to aid President Joe Biden’s reelection.

Although we don’t know whether avoiding the appearance of intervening in politics is an important consideration for the members of the FOMC, some discussion in the business press raises the possibility. For instance, a recent article in the Wall Street Journal noted that:

“The longer that officials wait, the less likely there will be cuts this year, some analysts said. That is because officials will likely resist starting to lower rates in the midst of this year’s presidential election campaign to avoid political entanglements.”

These are clearly not the easiest times to be a Fed policymaker!