Tag: Monetary Policy

How Will the Fed React to Another High Inflation Report?

In a recent podcast we discussed what actions the Fed may take if inflation continues to run well above the Fed’s 2 percent target. We are likely a step closer to finding out with the release this morning (April 10) by the Bureau of Labor Statistics (BLS) of data on the consumer price index (CPI) for March. The inflation rate measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.5 percent, slightly higher than expected (as indicated here and here). As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, the same as in January.

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 values seem to confirm that inflation, while still far below its peak in mid-2022, has been running somewhat higher than it did during the last months of 2023. Headline CPI inflation in March was 4.6 percent (down from 5.4 percent in February) and core CPI inflation was 4.4 percent (unchanged from February). It’s worth bearing in mind that the Fed’s inflation target is measured using the personal consumption expenditures (PCE) price index, not the CPI. But CPI inflation at these levels is not consistent with PCE inflation of only 2 percent.

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. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices and in services prices not included including housing rent. Some economists believe that the rent component of the CPI isn’t well measured and can be volatile, so it’s worthwhile to look at inflation in service prices not including rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023. Inflation in service prices increased from 5.8 percent in February to 6.6 percent in March . Inflation in service prices not including housing rent was even higher, increasing from 7.5 percent in February to 8.9 percent in March. Such large increases in the prices of services, if they were to continue, wouldn’t be consistent with the Fed meeting its 2 percent inflation target.

Finally, some economists and policymakers look at median inflation to gain insight into the underlying trend in the inflation rate. 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, although median inflation declined in March, it was still high at 4.3 percent. Median inflation is volatile, but the trend has been generally upward since July 2023.

Financial investors, who had been expecting that this CPI report would show inflation slowing, reacted strongly to the news that, in fact, inflation had ticked up. As of late morning, the Dow Jones Industrial Average had decline by nearly 500 points and the S&P 5o0 had declined by 59 points. (We discuss the stock market indexes in Macroeconomics, Chapter 6, Section 6.2 and in Microeconomics and Economics, Chapter 8, Section 8.2.) The following figure from the Wall Street Journal shows the sharp reaction in the bond market as the interest rate on the 10-year Treasury note rose sharply following the release of the CPI report.

Lower stock prices and higher long-term interest rates reflect the fact that investors have changed their views concerning when the Fed’s Federal Open Market Committee (FOMC) will cut its target for the federal funds and how many rate cuts there may be this year. At the start of 2024, the consensus among investors was for six or seven rate cuts, starting as early as the FOMC’s meeting on March 19-20. But with inflation remaining persistently high, investors had recently been expecting only two or three rate cuts, with the first cut occurring at the FOMC’s meeting on June 11-12. Two days ago, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC might not cut its target for the federal funds rate during 2024. Some economists have even begun to speculate that the FOMC might feel obliged to increase its target in the coming months.

After the FOMC’s next meeting on April 30-May 1 first, Chair Powell may provide some additional information on the committee’s current thinking.

NEW! 4/5/24 Podcast – Authors Glenn Hubbard & Tony O’Brien react to the newest Friday Jobs Report for March & discuss next steps for the Economy.

Join authors Glenn Hubbard & Tony O’Brien as they react to the jobs report of over 300K jobs created which was way over expectations of about 200K. They consider the impact of this report as the Fed considers the next steps for the economy. Are we on a glide path for a soft landing at 2% inflation or will the Fed reconsider its long-standing target by adopting a higher 3% target? Glenn and Tony offer interesting viewpoints on where this is headed.

Upward Revision of 2023 Fourth Quarter Real GDP Growth May Add to Fed’s Hesitancy to Raise Fed Funds Target

(Photo courtesy of Lena Buonanno)

The Bureau of Economic Analysis (BEA) has issued its third estimate of real GDP for the fourth quarter of 2023. The BEA now estimates that real GDP increased in the fourth quarter of 2023 at an annual rate of 3.4 percent, an increase from the BEA’s second estimate of 3.2 percent. The BEA noted that: “The update primarily reflected upward revisions to consumer spending and nonresidential fixed investment that were partly offset by a downward revision to private inventory investment.”

As the blue line in the following figure shows, despite the upward revision, fourth quarter growth in real GDP decline significantly from the very high growth rate of 4.9 percent in the third quarter. In addition, two widely followed “nowcast” estimates of real GDP growth in the first quarter of 2024 show a futher slowdown. The nowcast from the Federal Reserve Bank of Atlanta estimates that real GDP will have grown at an annualized rate of 2.1 percent in the first quarter and the nowcast from the Federal Reserve Bank of New York estimates a growth rate of 1.9 percent. (The Atlanta Fed describes its nowcast as “a running estimate of real GDP growth based on available economic data for the current measured quarter.” The New York Fed explains: “Our model reads the flow of information from a wide range of macroeconomic data as they become available, evaluating their implications for current economic conditions; the result is a ‘nowcast’ of GDP growth ….”)

Data on growth in real gross domestic income (GDI), on the other hand, show an upward trend, as indicated by the red line in the figure. As we discuss in Macroeconomics, Chapter 8, Section 8.4 (Economics, Chapter 18, Section 18.4), gross domestic product measures the economy’s output from the production side, while gross domestic income does so from the income side. The two measures are designed to be equal, but they can differ because each measure uses different data series and the errors in data on production can differ from the errors in data on income. Economists differ on whether data on growth in real GDP or data on growth in real GDI do a better job of forecasting future changes in the economy. Accordingly, economists and policymakers will differ on how much weight to put on the fact that while the growth in real GDI had been well below growth in real GDP from the fourth quarter of 2022 to the fourth quarter of 2023, during the fourth quarter of 2023, growth in real GDI was 1.5 percentage points higher than growth in real GDP.

On balance, it seems likely that these data will reinforce the views of those members of the Fed’s policy-making Federal Open Market Committee (FOMC) who were cautious about reducing the target for the federal funds rate until the macroeconomic data indicate more clearly that the economy is slowing sufficiently to ensure that inflation is returning to the Fed’s 2 percent target. In a speech on March 27 (before the latest GDP revisions became available), Fed Governor Christopher Waller reviewed the most recent macro data and concluded that:

“Adding this new data to what we saw earlier in the year reinforces my view that there is no rush to cut the [federal funds] rate. Indeed, it tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2 percent.”

Most other members of the FOMC appear to share Waller’s view.

Another Steady-as-She-Goes FOMC Meeting

Federal Reserve Chair Jerome Powell (Photo from the New York Times)

As always, economists and investors had been awaiting the outcome of today’s meeting of the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) to get further insight into future monetary policy. The expectation has been that the FOMC would begin reducing its target for the federal funds rate, mostly likely beginning with its meeting on June 11-12. Financial markets were expecting that the FOMC would make three 0.25 percentage point cuts by the end of the year, reducing its target range from the current 5.25 to 5.50 percent to 4.50 to 4.75 percent.

There appears to be nothing in the committees statement (found here) or in Powell’s press conference following the meeting to warrant a change in expectations of future Fed policy. The committee’s statement noted that: “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” As Powell stated in his press conference, although the committee found the general trend in inflation data to be encouraging, they would have to see additional months of data that were consistent with their 2 percent inflation target before reducing their target for the federal funds rate.

As we’ve noted in earlier blog posts (here, here, and here), inflation during January and February has been somewhat higher than expected. Some economists and investors had wondered if, as a result, the committee might delay its first cut in the federal funds target range or implement only two cuts rather than three. In his press conference, Powell seemed unconcerned about the January and February data and expected that falling inflation rates of the second half of 2023 to resume.

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 table shows that the committee members made relatively small changes to their projections since their December meeting. Most notable was an increase in the median projection of growth in real GDP for 2024 from 1.4 percent at the December meeting to 2.1 percent at this meeting. Correspondingly, the median projection of unemployment during 2024 dropped from 4.1 percent to 4.0 percent. The key projection of the value of the federal funds rate at the end of 2024 was left unchanged at 4.6 percent. As noted earlier, that rate is consistent with three 0.25 percent cuts in the target range during the remainder of the year.

The SEP also includes a “dot plot.” Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 19 dots, representing the 7 members of the Fed’s Board of Governors and the 12 presidents of the Fed’s district banks. Although only the president of the New York Fed and the presidents of 4 of the 11 district banks are voting members of the committee, all the district bank presidents attend the committee meetings and provide economic projections.

The plots on the far left of the figure represent the projections of each of the 19 members of the value of the federal funds rate at the end of 2024. These dots are bunched fairly closely around the median projection of 4.6 percent. The dots representing the projections for 2025 and 2026 are more dispersed, representing greater uncertainty among committee members about conditions in the future. The dots on the far right represent the members’ projections of the value of the federal funds rate in the long run. As Table 1 shows, the median projected value is 2.6 percent (up slightly from 2.5 percent in December), although the plot indicates that all but one member expects that the long-run rate will be 2.5 percent or higher. In other words, few members expect a return to the very low federal funds rates of the period from 2008 to 2016.

Consumer Price Inflation Comes in Somewhat Higher than Expected

Federal Reserve Chair Jerome Powell (Photo from Bloomberg News via the Wall Street Journal.)

Economists, policymakers, and Wall Street analysts have been waiting for macroeconomic data to confirm that the Federal Reserve has brought the U.S. economy in for a soft landing, with inflation arrving back at the Fed’s target of 2 percent without the economy slipping into a recession. Fed officials have been cautious about declaring that they have yet seen sufficient data to be sure that a soft landing has actually been achieved. Accordingly, they are not yet willing to begin cutting their target for the federal funds rate.

For instance, on March 6, in testifying before the Commitee on Financial Services of the U.S. House of Representatives, Fed Chair Jerome Powell stated that the Fed’s Federal Open Market Committee (FOMC) “does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” (Powell’s statement before his testimony can be found here.)

The BLS’s release today (March 12) of its report on the consumer price index (CPI) (found here) for February indicated that inflation was still running higher than the Fed’s target, reinforcing the cautious approach that Powell and other members of the FOMC have been taking. The increase in the CPI that includes the prices of all goods and services in the market basket—often called headline inflation—was 3.2 percent from the same month in 2023, up slightly from 3.1  In January. (We discuss how the BLS constructs the CPI in Macroeconomics, Chapter 9, Section 19.4, Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 3, Section 13.4.) As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, down slightly from 3.9 percent in January.

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 values are more concerning, as indicated in the following figure. Headline CPI inflation is 5.4 percent (up from 3.7 percent in January) and core CPI inflation is 4.4 percent (although that is down from 4.8 percent in January). The Fed’s inflation target is measured using the personal consumption expenditures (PCE) price index, not the CPI. But CPI inflation at these levels is not consistent with PCE inflation of only 2 percent.

Even more concerning is the path of inflation in the prices of services. As we’ve noted in earlier posts, Chair 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. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices and in services prices not included including housing rent. Some economists believe that the rent component of the CPI isn’t well measured and can be volatile, so it’s worthwhile to look at inflation in service prices not including rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023. Although inflation in service prices declined from January, it was still a very high 5.8 percent in February. Inflation in service prices not including housing rent was even higher at 7.5 percent. Such large increases in the prices of services, if they were to continue, wouldn’t be consistent with the Fed meeting its 2 percent inflation target.

Finally, some economists and policymakers look at median inflation to gain insight into the underlying trend in the inflation rate. 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, although median inflation declined in February, it was still high at 4.6 percent and, although median inflation is volatile, the trend has been generally upward since July 2023.

The data in this month’s BLS report on the CPI reinforces the view that the FOMC will not move to cut its target for the federal funds rate in the meeting next week and makes it somewhat less likely that the committee will cut its target at the following meeting on April 30-May 1.

Surprisingly Strong CPI Report

Photo courtesy of Lena Buonanno.

As we’ve discussed in several blog posts (for instance, here and here), recent macro data have been consistent with the Federal Reserve being close to achieving a soft landing. The Fed’s increases in its target for the federal funds rate have slowed the growth of aggregate demand sufficiently to bring inflation closer to the Fed’s 2 percent target, but haven’t, to this point, slowed the growth of aggregate demand so much that the U.S. economy has been pushed into a recession.

By January 2024, many investors in financial markets and some economists were expecting that at its meeting on March 19-20, the Fed’s Federal Open Market Committee would be cutting its target for the federal funds. However, members of the committee—notably, Chair Jerome Powell—have been cautious about assuming prematurely that inflation had, in fact, been brought under control. In fact, in his press conference on January 31, following the committee’s most recent meeting, Powell made clear that the committee was unlikely to reduce its target for the federal funds rate at its March meeting. Powell noted that “inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain.”

Powell’s caution seemed justified when, on February 2, the Bureau of Labor Statistics (BLS) released its most recent “Employment Situation Report” (discussed in this post). The report’s data on growth in employment and growth in wages, as measured by the change in average hourly earnings, might be indicating that aggregate demand is growing too rapidly for inflation to continue to decline.

The BLS’s release today (February 13) of its report on the consumer price index (CPI) (found here) for January provided additional evidence that the Fed may not yet have put inflation on a firm path back to its 2 percent target. The average forecast of economists surveyed before the release of the report was that the increase in the version of the CPI that includes the prices of all goods and services in the market basket—often called headline inflation—would be 2.9 percent. (We discuss how the BLS constructs the CPI in Macroeconomics, Chapter 9, Section 19.4, Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 3, Section 13.4.) As the following figure shows, headline inflation for January was higher than expected at 3.1 percent (measured by the percentage change from the same month in the previous year), while core inflation—which excludes the prices of food and energy—was 3.9 percent. Headline inflation was lower than in December 2023, while core inflation was almost unchanged.

Although the values for January might seem consistent with a gradual decline in inflation, that conclusion may be misleading. Headline inflation in January 2023 had been surprisingly high at 6.4 percent. Hence, the comparision between the value of the CPI in January 2024 with the value in January 2023 may be making the annual CPI inflation rate seem artificially low. 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 values are more concerning, as indicated in the following figure. Headline CPI inflation is 3.7 percent and core CPI inflation is 4.8 percent.

Even more concerning is the path of inflation in the prices of services. Chair 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. Last summer he stated the point this way:

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices. The figure shows that inflation in services has been above 4 percent in every month since July 2023. Inflation in services was a very high 8.7 percent in January. Clearly such large increases in the prices of services aren’t consistent with the Fed meeting its 2 percent inflation target.

How should we interpret the latest CPI report? First, it’s worth bearing in mind that a single month’s report shouldn’t be relied on too heavily. There can be a lot of volatility in the data month-to-month. For instance, inflation in the prices of services jumped from 4.7 percent in December to 8.7 percent in January. It seems unlikely that inflation in the prices of services will continue to be over 8 percent.

Second, housing prices are a large component of service prices and housing prices can be difficult to measure accurately. Notably, the BLS includes in its measure the implicit rental price that someone who owns his or her own home pays. The BLS calculates that implict rental price by asking consumers who own their own homes the following question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” (The BLS discusses how it measures the price of housing services here.) In practice, it may be difficult for consumers to accurately answer the question if very few houses similar to theirs are currently for rent in their neighborhood.

Third, the Fed uses the personal consumption expenditures (PCE) price index, not the CPI, to gauge whether it is achieving its 2 percent inflation target. The Bureau of Economic Analysis (BEA) includes the prices of more goods and services in the PCE than the BLS includes in the CPI and measures housing services using a different approach than that used by the BLS. Although inflation as measured by changes in the CPI and as measured by changes in the PCE move roughly together over long periods, the two measures can differ significantly over a period of a few months. The difference between the two inflation measures is another reason not to rely too heavily on a single month’s CPI data.

Despite these points, investors on Wall Street clearly interpreted the CPI report as bad news. Investors have been expecting that the Fed will soon cut its target for the federal funds rate, which should lead to declines in other key interest rates. If inflation continues to run well above the Fed’s 2 percent target, it seems likely that the Fed will keep its federal funds target at its current level for longer, thereby slowing the growth of aggregate demand and raising the risk of a recession later this year. Accordingly, the Dow Jones Industrial Average declined by more than 500 points today (February 13) and the interest rate on the 10-year Treasury note rose above 4.3 percent.

The FOMC has more than a month before its next meeting to consider the implications of the latest CPI report and the additional macro data that will be released in the meantime.

Surprisingly Strong Jobs Report

Photo courtesy of Lena Buonanno.

This morning of Friday, February 2, the Bureau of Labor Statistics (BLS) issued its “Employment Situation Report” for January 2024.  Economists and policymakers—notably including the members of the Fed’s Federal Open Market Committee (FOMC)—typically focus on the change in total nonfarm payroll employment as recorded in the establishment, or payroll, survey. That number gives what is generally considered to be the best gauge of the current state of the labor market.

Economists surveyed in the past few days by business news outlets had expected that growth in payroll employment would slow to an increase of between 180,000 and 190,000 from the increase in December, which the BLS had an initially estimated as 216,00. (For examples of employment forecasts, see here and here.) Instead, the report indicated that net employment had increased by 353,000—nearly twice the expected amount. (The full report can be found here.)

In this previous blog post on the December employment report, we noted that although the net increase in employment in that month was still well above the increase of 70,000 to 100,000 new jobs needed to keep up with population growth, employment increases had slowed significantly in the second half of 2023 when compared with the first.

That slowing trend in employment growth did not persist in the latest monthly report. In addition, to the strong January increase of 353,000 jobs, the November 2023 estimate was revised upward from 173,000 jobs to 182,000 jobs, and the December estimate was substantially revised from 216,000 to 333,000. As the following figure from the report shows, the net increase in jobs now appears to have trended upward during the last three months of 2023.

Economists surveyed were also expecting that the unemployment rate—calculated by the BLS from data gathered in the household survey—would increase slightly to 3.8 percent. Instead, it remained constant at 3.7 percent. As the following figure shows, the unemployment rate has been remarkably stable for more than two years and has been below 4.0 percent each month since December 2021. The members of the FOMC expect that the unemployment rate during 2024 will be 4.1 percent, a forcast that will be correct only if the demand for labor declines significantly over the rest of the year.

The “Employment Situation Report” also presents data on wages, as measured by average hourly earnings. The growth rate of average hourly earnings, measured as the percentage change from the same month in the previous year, had been slowly declining from March 2022 to October 2023, but has trended upward during the past few months. The growth of average hourly earnings in January 2024 was 4.5 percent, which represents a rise in firms’ labor costs that is likely too high to be consistent with the Fed succeeding in hitting its goal of 2 percent inflation. (Keep in mind, though, as we note in this blog post, changes in average hourly earnings have shortcomings as a measure of changes in the costs of labor to businesses.)

Taken together, the data in today’s “Employment Situation Report” indicate that the U.S. labor market remains very strong. One implication is that the FOMC will almost certainly not cut its target for the federal funds rate at its next meeting on March 19-20. As Fed Chair Jerome Powell noted in a statement to reporters after the FOMC earlier this week: “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. We will continue to make our decisions meeting by meeting.” (A transcript of Powell’s press conference can be found here.) Today’s employment report indicates that conditions in the labor market may not be consistent with a further decline in price inflation.

It’s worth keeping several things in mind when interpreting today’s report.

  1. The payroll employment data and the data on average hourly earnings are subject to substantial revisions. This fact was shown in today’s report by the large upward revision in net employment creation in December, as noted earlier in this post.
  2. A related point: The data reported in this post are all seasonally adjusted, which means that the BLS has revised the raw (non-seasonally adjusted) data to take into account normal fluctuations due to seasonal factors. In particular, employment typically increases substantially during November and December in advance of the holiday season and then declines in January. The BLS attempts to take into account this pattern so that it reports data that show changes in employment during these months holding constant the normal seasonal changes. So, for instance, the raw (non-seasonally adjusted) data show a decrease in payroll employment during January of 2,635,000 as opposed to the seasonally adjusted increase of 353,000. Over time, the BLS revises these seasonal adjustment factors, thereby also revising the seasonally adjusted data. In other words, the BLS’s initial estimates of changes in payroll employment for these months at the end of one year and the beginning of the next should be treated with particular caution.
  3. The establishment survey data on average weekly hours worked show a slow decline since November 2023. Typically, a decline in hours worked is an indication of a weakening labor market rather than the strong labor market indicated by the increase in employment. But as the following figure shows, the data on average weekly hours are noisy in that the fluctuations are relatively large, as are the revisons the BLS makes to these data over time.

4. In contrast to today’s jobs report, other labor market data seem to indicate that the demand for labor is slowing. For instance, quit rates—or the number of people voluntarily leaving their jobs as a percentage of the total number of people employed—have been declining. As shown in the following figure, the quit rate peaked at 3.0 percent in November 2021 and March 2022, and has declined to 2.2 percent in December 2023—a rate lower than just before the beginning of the Covid–19 pandemic.

Similarly, as the following figure shows, the number of job openings per unemployed person has declined from a high of 2.0 in March 2022 to 1.4 in December 2023. This value is still somewhat higher than just before the beginning of the Covid–19 pandemic.

To summarize, recent data on conditions in the labor market have been somewhat mixed. The strong increases in net employment and in average hourly earnings in recent months are in contrast with declining average number of hours worked, a declining quit rate, and a falling number of job openings per unemployed person. Taken together, these data make it likely that the FOMC will be in no hurry to cut its target for the federal funds rate. As a result, long-term interest rates are also likely to remain high in the coming months. The following figure from the Wall Street Journal provides a striking illustration of the effect of today’s jobs report on the bond market, as the interest rate on the 10-year Treasury note rose above 4.0 percent for the first time in more than a month. The interest rate on the 10-year Treasury note plays an important role in the financial system, influencing interest rates on mortgages and corporate bonds. 

FOMC Meeting: Steady as She Goes

Federal Reserve Chair Jerome Powell (Photo from the New York Times.)

This afternoon, Wednesday, January 31, the Federal Reserve’s Federal Open Market Committee (FOMC) held the first of its eight scheduled meetings during 2024. As we noted in a recent post, macroeconomic data have been indicating that the Fed is close to achieving its goal of bringing the U.S. economy in for a soft landing—reducing inflation down to the Fed’s 2 percent target without pushing the economy into a recession. But as we also noted in that post, it was unlikely that at this meeting Fed Chair Jerome Powell and the other members of the FOMC would declare victory in their fight to reduce inflation from the high levels it reached during 2022.

In fact, in Powell’s press conference following the meeting, when asked directly by a reporter whether he believed that the economy had made a safe landing, Powell said that he wasn’t yet willing to draw that conclusion. Accordingly, the committee kept its target range for the federal funds rate unchanged at 5.25 percent to 5.50 percent. This was the fifth meeting in a row at which the FOMC had left the target unchanged. Although some policy analysts expect that the FOMC might reduce its federal funds rate target at its next meeting in March, the committee’s policy statement made that seem unlikely:

“In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

Powell reinforced the point during his press conference by stating it was unlikely that the committee would cut the target rate at the next meeting. He noted that:

“The economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured. The economic outlook is uncertain, and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer, if appropriate.”

Powell highlighted a couple of areas of potential concern. The Fed gauges its progress towards achieving its 2 percent inflation goal using the percentage change in the personal consumption expenditures (PCE) price index. As we noted in a recent post, PCE inflation has declined from a high of 7.1 percent in June 2022 to 2.9 percent in December 2023. But Powell noted that PCE inflation in goods has followed a different path from PCE inflation in services, as the following figure shows.

Inflation during 2022 was much greater in the prices of goods than in the prices of services, reflecting the fact that supply chain disruptions caused by the pandemic had a greater effect on goods than on services. Inflation in goods has been less than 1 percent every month since June 2023 and has been negative in three of those months. Inflation in services peaked in February 2023 at 6.0 percent and has been declining since, but was still 3.9 percent in December. Powell noted that the very low rates of inflation in the prices of goods probably aren’t sustainable. If inflation in the prices of goods increases, the Fed may have difficulty achieving its 2 percent inflation target unless inflation in the prices of services slows.

Powell also noted that the most recent data on the employment cost index (ECI) had been released the morning of the meeting. The ECI is compiled by the Bureau of Labor Statistics and is published quarterly. It measures the cost to employers per employee hour worked. The BLS publishes data that includes only wages and salaries and data that includes, in addition to wages and salaries, non-wage benefits—such as contributions to retirement accounts or health insurance—that firms pay workers. The figure below shows the percentage change from the same month in the previous year for the ECI including just wages and salaries (blue line) and for the ECI including all compensation (red line). Although ECI inflation has declined significantly from its peak in he second quarter of 2022, in the fourth quarter of 2023, both measures of ECI inflation were above 4 percent. Wages increasing at that pace may not be consistent with a 2 percent rate of price inflation.

Powell’s tone at his news conference (which can be watched here) was one of cautious optimism. He and the other committee members expect to be able to cut the target for the federal funds rate later this year but remain on guard for any indications that the inflation rate is increasing again.

A Mixed Employment Report

Photo courtesy of Lena Buonanno.

During the last few months of 2023, the macroeconomic data has generally been consistent with the Federal Reserve successfully bringing about a soft landing: Inflation returning to the Fed’s 2 percent target without the economy entering a recession. On the morning of Friday, January 5, the Bureau of Labor Statistics (BLS) issued its latest “Employment Situation Report” for December 2023.  The report was generally consistent with the economy still being on course for a soft landing, but because both employment growth and wage growth were stronger than expected, the report makes it somewhat less likely that the Federal Reserve’s Federal Open Market Committee (FOMC) will soon begin reducing its target for the federal funds rate. (The full report can be found here.)

Economists and policymakers—notably including the members of the FOMC—typically focus on the change in total nonfarm payroll employment as recorded in the establishment, or payroll, survey. That number gives what is generally considered to be the best gauge of the current state of the labor market.

The report indicated that during December there had been a net increase of 216,000 jobs.  This number was well above the expected gain of 160,000 to 170,000 jobs that several surveys of economists had forecast (see here, here, and here). The BLS revised downward by a total of 71,000 jobs its previous estimates for October and November, somewhat offsetting the surprisingly strong estimated increase in net jobs for December.

The following figure from the report shows the net increase in jobs each month since December 2021. Although the net number of jobs created has trended up from September to December, the longer run trend has been toward slower growth in employment. In the first half of 2023, an average of 257,000 net jobs were created per month, whereas in the second half of 2023, an average of 193,000 net jobs were created per month. Average weekly hours worked have also been slowly trending down, from 34.6 hours per week in January to 34.3 hours per week in December.

Economists surveyed were also expecting that the unemployment rate—calculated by the BLS from data gathered in the household survey—would increase slightly. Instead, it remained constant at 3.7 percent. As the following figure shows, the unemployment rate has been below 4.0 percent each month since December 2021. The members of the FOMC expect that the unemployment rate during 2024 will be 4.1 percent. (The most recent economic projections of the members of the FOMC can be found here.)

Although the employment data indicate that conditions in the labor market are easing in a way that may be consistent with inflation returning to the Fed’s 2 percent target, the data on wage growth are so far sending a different message. Average hourly earnings—data on which are collected in the establishment survey—increased by 4.1 percent in December compared with the same month in 2022. This rate of increase was slightly higher than the 4.0 percent increase in November. The following figure shows movements in the rate of increase in average hourly earnings since January 2021.

In his press conference following the FOMC’s December 13, 2023 meeting, Fed Chair Jerome Powell noted that increases in wages at 4 percent or higher were unlikely to result in inflation declining to the Fed’s 2 percent goal:

“So wages are still running a bit above what would be consistent with 2 percent inflation over a long period of time. They’ve been gradually cooling off. But if wages are running around 4 percent, that’s still a bit above, I would say.”

The FOMC’s next meeting is on January 30-31. At this point it seems likely that the committee will maintain its current target for the federal funds. The data in the latest employment report make it somewhat less likely that the committee will begin reducing its target at its meeting on March 19-20, as some economists and some Wall Street analysts had been expecting. (The calendar of the FOMC’s 2024 meetings can be found here.)

Another Employment Report Consistent with a Soft Landing

Photo courtesy of Lena Buonanno.

In recent months, the macroeconomic data has generally been consistent with the Federal Reserve successfully bringing about a soft landing: Inflation returning to the Fed’s 2 percent target without the economy entering a recession. The Bureau of Labor Statistics’ latest Employment Situation Report, released on the morning of Friday, December 8,  was consistent with this trend. (The full report can be found here.)

Economists and policymakers—notably including the members of the Federal Reserve’s Federal Open Market Committee (FOMC)—typically focus on the change in total nonfarm payroll employment as recorded in the establishment, or payroll, survey. That number gives what is generally considered to be the best gauge of the current state of the labor market.

The report indicated that during November there had been a net increase of 199,000 jobs.  This number was somewhat above the expected gain of 153,000 jobs Reuters news service reported from its survey of economists and just slightly above an expected gain of 190,000 jobs the Wall Street Journal reported from a separate survey of economists. The BLS revised downward by 35,000 jobs its previous estimate for September. It left its estimate for October unchanged.  The following figure from the report shows the net increase in jobs each month since November 2021.

Because the BLS often substantially revises its preliminary estimates of employment from the establishment survey, it’s important not to overinterpret data for a single month or even for a few months. But general trends in the data can give useful information on changes in the state of the labor market. The estimate for November is the fourth time in the past six months that employment has increased by less than 200,000. Prior to that, employment had increased by more than 200,000 every month since January 2021.

Although the rate of job increases is slowing, it’s still above the rate at which new entrants enter the labor market, which is estimated to be roughly 90,000 people per month. The additional jobs are being filled in part by increased employment among people aged 25 to 54—so-called prime-age workers. (We discuss the employment-population ratio in Macroeconomics, Chapter 9, Section 9.1, Economics, Chapter 19, Section 9.1, and Essentials of Economics, Chapter 13, Section 13.1.) As the following figure shows, the employment-population ratio for prime-age workers remains above its level in early 2020, just before the spread of the Covid–19 pandemic in the United States.

The estimated unemployment rate, which is collected in the household survey, was down slightly from 3.9 percent to 3.7 percent. A shown in the following figure, the unemployment rate has been below 4 percent every month since February 2022.

The Employment Situation Report also presents data on wages, as measured by average hourly earnings. The growth rate of average hourly earnings, measured as the percentage change from the same month in the previous year, continued its gradual decline, as shown in the following figure. As a result, upward pressure on prices from rising labor costs is easing. (Keep in mind, though, as we note in this blog post, changes in average hourly earnings have shortcomings as a measure of changes in the costs of labor to businesses.)

Taken together, the data in the latest employment report indicate that the labor market is becoming less tight, reflecting a gradual slowing in U.S. economic growth. The data are consistent with the U.S. economy approaching a soft landing. It’s still worth bearing in mind, of course, that, as Fed Chair Jerome Powell continues to caution, there’s no certainty that inflation won’t surge again or that the U.S. economy won’t enter a recession.