Tag: PCE inflation

Latest PCE Inflation Data Indicate that Fed May Struggle to Achieve a Soft Landing

An image generated by GTP-4o of people shopping

This morning (November 27), the BEA released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report for October. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. This month’s data indicates that progress towards the Fed’s target may have stalled.

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in October, PCE inflation (the blue line) was 2.3 percent, up from 2.1 percent in September. Core PCE inflation (the red line) in October was 2.8 percent, up from 2.7 percent in September. Both PCE inflation and core PCE inflation were in accordance with the expectations of economists surveyed.

One reason that PCE inflation has been lower than core PCE inflation in recent months is that PCE inflation has been held down by falling energy prices, as shown in the following figure. Energy prices have been falling over the last three months and were down 5.9 percent in October. It seems unlikely that falling energy prices will persist.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation rose in October to 2.9 percent from 2.1 percent in September. Core PCE inflation rose from 3.2 percent in September to 3.3 percent in October.  Because core inflation is generally a better measure of the underlying trend in inflation, both 12-month and 1-month core PCE inflation indicate that inflation may still run well above the Fed’s 2 percent target in coming months. But the usual caution applies that data from one month shouldn’t be overly relied on.

The following figure shows other ways of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and core inflation, excluding the price of housing services as well as the prices of food and energy (the blue line). Fed Chair Jerome Powell and other members of the Federal Open Market Committee (FOMC) have said that they are concerned by the persistence of elevated rates of inflation in services and in housing.

Inflation in services remained high, increasing from 3.7 percent in September to 3.9 percent in October. Core inflation, measured by excluding housing as well as food and energy, increased from 2.1 percent in September to 2.4 percent in October.

Some Fed watchers have suggested that higher inflation readings may lead he Fed’s policymaking Federal Open Market Committee (FOMC) to leave its target for the federal funds rate unchanged at its next meeting on December 17-18. As of today, however, investors who buy and sell federal funds futures contracts are still expecting that the FOMC will reduce its target by 0.25 percent (25 basis points) at its next meeting. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, investors assign a probability of 70 percent to the FOMC cutting its target for the federal funds rate from the current range of 4.50 percent to 4.75 percent to a range of 4.25 percent to 4.50 percent. Investors assign a probability of only 30 percent to the FOMC leaving its target unchanged.

Since the FOMC began increasing the target for the federal funds rate in the spring of 2022, economists have discussed three possible outcomes of the Fed’s monetary policy:

  1. A hard landing, with the economy only returning to the Fed’s 2 percent inflation target if the U.S. economy experiences a recession
  2. A soft landing, with the economy returning to 2 percent inflation without experiencing a recession.
  3. No landing, with the economy not experiencing a recession but with inflation remaining persistently above the Fed’s 2 percent target.

With GDP and employment data showing no indication that a recession will begin soon and with today’s data showing inflation—while having declined substantially from its mid-2022 peak—remaining above the Fed’s 2 percent target, the chances of the no landing outcome seem to be increasing.

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

Photo courtesy of Lena Buonanno.

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

The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.  The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in September PCE inflation (the blue line) was 2.1 percent, down from 2.3 percent in August. Core PCE inflation (the red line) in September was 2.7 percent, which was unchanged from August. PCE inflation was in accordance with the expectations of economists surveyed by the Wall Street Journal, but core inflation was higher than expected.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation rose in September to 2.1 percent from 1.4 percent in August. Core PCE inflation rose from 1.9 percent in August to 3.1 percent in June.  Because core inflation is generally a better measure of the underlying trend in inflation, both 12-month and 1-month core PCE inflation indicate that inflation may still run above the Fed’s 2 percent target in coming months. But the usual caution applies that data from one month shouldn’t be overly relied on.

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

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

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

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

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

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

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

Real GDP Growth Comes in Slightly Below Expectations, Inflation Is Below Target, and the Labor Market Shows Some Weakening

Image of GDP generated by GTP-4o

This week, two data releases paint a picture of the U.S. economy as possibly slowing slightly, but still demonstrating considerable strength. The Bureau of Economic Analysis (BEA) released its advance estimate of GDP for the third quarter of 2024. (The report can be found here.) The BEA estimates that real GDP increased by 2.8 percent at an annual rate in the third quarter—July through September. That was down from the 3.0 percent increase in real GDP in the second quarter and below the 3.1 percent that economists surveyed by the Wall Street Journal had expected. The following figure from the BEA report shows the growth rate of real GDP in each quarter since the fourth quarter of 2020.

Two other points to note: In June, the Congressional Budget Office (CBO) had forecast that the growth rate of real GDP in the third quarter would be only 2.1 percent. The CBO forecasts that, over the longer run, real GDP will grow at a rate of 1.7 to 1.8 percent per year. So, the growth rate of real GDP according to the BEA’s advance estimate (which, it’s worth recalling, is subject to potentially large revisions) was above expectations from earlier this year and above the likely long run growth rate.

Consumer spending was the largest contributor to third quarter GDP growth. The following figure shows growth rates of real personal consumption expenditures and the subcategories of expenditures on durable goods, nondurable goods, and services. There was strong growth in each component of consumption spending. The 8.1 percent increase in expenditures on durables was particularly strong. It was the second quarter in a row of strong growth in spending on durables after a decline of –1.8 percent in the first quarter.

Investment spending and its components were a more mixed bag, as shown in the following figure. Investment spending is always more volatile than consumption spending. Overall, gross private domestic investment increased at a slow rate of 0.3 percent—the slowest rate since a decline in the first quarter of 2023. Residential investment decreased by 5.1 percent, reflecting difficulties in residential construction due to mortgage interest rates remaining high. Business fixed investment grew 3.1 percent, powered by an increase of 11.1 percent in spending on business equipment. Spending on structures—such as factories and office buildings—had increased rapidly over the past two years before slowing to a 0.2 percent increase in the second quarter and a decline of 4.0 percent in the fourth quarter.

The GDP report also contained data on the private consumption expenditure (PCE) price index, which the FOMC uses to determine whether it is achieving its goal of a 2 percent inflation rate. The following figure shows inflation as measured using the PCE and the core PCE—which excludes food and energy prices—since the beginning of 2016. (Note that these inflation rates are measured using quarterly data and as compound annual rates of change.) Despite the strong growth in real GDP, inflation as measured by PCE was only 1.5 percent, below the 2.5 percent increase in the second quarter and below the Federal Reserve’s 2.0 percent inflation target. Core PCE, which may be a better indicator of the likely course of inflation in the future, declined to 2.2 percent in the third quarter from 2.8 percent in the second quarter. The third quarter increase was slightly above the rate that economists surveyed by the Wall Street Journal had expected.

This week, the Bureau of Labor Statistics (BLS) released its “Job Openings and Labor Turnover” (JOLTS) report for September 2024. The report provided data indicating some weakening in the U.S. labor market. The following figure shows the rate of job openings. The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days and the rate of job openings as the number of job openings divided by the number of job openings plus the number of employed workers, multiplied by 100. The 4.9 percent job opening rate in September continued the slow decline from the peak rate of 7.4 percent in March 2022. The rate is also slightly below the rate during late 2018 and 2019 before the Covid pandemic.

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows a slow decline from a peak of more than 2 job openings per unemployed person in the spring of 2022 to 1.1 job openings per employed person in September 2024, somewhat below the levels in 2019 and early 2020, before the pandemic. Note that the number is still above 1.0, indicating that the demand for labor is still high, although no higher than during the strong labor market of 2019.

Finally, note from the figure that over the period during which the BLS has been conducting the JOLTS survey, the rate of job openings has declined just before and during recessions. Does that fact indicate that the decline in the job opening rate in recent months is signaling that a recession is likely to begin soon? We can’t say with certainty, particularly because the labor market was severely disrupted by the pandemic. The decline in the job openings rate since 2022 is more likely to reflect the labor market returning to more normal conditions than a weakening in hiring that signals a recession is coming.

To summarize these data:

  1. Real GDP growth is strong, although below what economists had been projecting.
  2. Inflation as measured by the PCE is below the Fed’s 2 percent target, although core inflation remains slightly above the target.
  3. The job market has weakened somewhat, although there is no strong indication that a recession will happen in the near future.

Latest PCE Report Shows Inflation Continuing to Fall

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

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

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

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

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

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

Financial Markets Correctly Forecast Today’s 0.50% Cut in the Federal Funds Rate Target

Federal Reserve Chair Jerome Powell (Photo from federalreserve.gov)

In a blog post yesterday (September 17), we noted that trading on the CME’s federal funds futures market indicated that investors assigned a probability of 63 percent to the Federal Open Market Committee (FOMC) announcing today a 0.50 percentage point (50 basis points) cut to its target range for the federal funds rate and a probability of 37 percent to a 0.25 percentage point (25 basis points) cut. (100 basis points equals 1 percentage point.) The forecast proved correct when the FOMC announced this afternoon that it was cutting its target range to 4.75 percent to 5.00 percent, from the range of 5.25 percent to 5.50 percent that had been in place since July 2023.

Congress has given the Fed a dual mandate to achieve maximum employment and price stability. In March 2022, the FOMC began responding to the surge in inflation that had begun in the spring of 2021 by raising its target for the federal funds rate. Up through its July 2024 meeting, the FOMC had been focused on the risk that the inflation rate would remain above the Fed’s target inflation rate of 2 percent. In the statement released after today’s meeting, the committee stated that it “has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”

In a press conference following the meeting, Fed Chair Jerome Powell indicated that with inflation close to the 2 percent target and the labor market continuing to cool “by any measure,” the committee judged that it was time to begin normalizing its target range for the federal funds rate. Powell said that: “The U.S. economy is in a good place and our action is intended to keep it there.” When asked by a reporter whether the committee cut its target by 50 basis points today to catch up for not having cut its target at its July meeting, Powell responded that: “We don’t think we’re behind [on cutting the target range]. We think this [50 basis point cut] will keep us from falling behind.”

At the conclusion of each meeting, the committee holds a formal vote on its target for the federal funds rate. The vote today was 15-1, with Governor Michelle Bowman casting the sole negative vote. She stated that she would have preferred a 25 basis point cut. Dissenting votes have been rare in recent years.

How much lower will the federal funds target range go? Typically at the FOMC’s December, March, June, and September meetings, the committee releases a “Summary of Economic Projections” (SEP), which presents median values of the committee members’ forecasts of key economic variables. The following table is from the SEP released after today’s meeting.

Looking at the values under the heading “Median” on the left side of the table, the median projection for the federal funds rate at the end of the 2024 is 4.4 percent. That projection signals that the committee will likely cut its target range by 25 basis points at each of its two remaining meetings on November 6-7 and December 17-18. The median projection for the federal funds rate at the end of 2025 is 3.4 percent, implying four additional 25 basis points cuts. In the long run, the median projection of the committee is that the federal funds rate will be 2.9 percent, which is somewhat higher than the 2.5 percent rate that the committee had projected at its December 2019 meeting before the start of the Covid pandemic.

Committee members project that the unemployment rate will end the year at 4.4 percent, up from the 4.2 percent rate in August. They expect that the unemployment rate will be 4.2 percent in the long run. The long run unemployment rate is ofter referred to as the natural rate of unemployment. (We discuss the natural rate of unemployment in Macroeconomics, Chapter 9, Section 9.2 and Economics, Chapter 19, Section 19.2.)

The median projection of the committe members is that at the end of 2024 the inflation rate, as measured by the percentage change in the personal consumption expenditures (PCE) price index, will be 2.3 percent, slightly above the Fed’s target rate. Inflation will also run slightly above the Fed’s target in 2025 at 2.1 percent before retuning to 2 percent by the end of 2026. The median projections of the inflation rate at the ends of 2024 and 2025 are lower than the median projections in the SEP that was released after the FOMC meeting on June 11-12.

Latest PCE Report Indicates that Inflation May Be Approaching the Fed’s Target

The result when asking GTP-4o to generate “an image illustrating inflation.”

Inflation, as measured by changes in the personal consumption expenditures (PCE) price index, continued a slow decline that began in March. (The Fed uses annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.) On August 30, the Bureau of Economic Analysis (BEA) released its “Personal Income and Outlays” report for July, which contains monthly PCE data.

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in July PCE inflation (the blue line) was 2.5 percent, the same as in June. Core PCE inflation (the red line) in July was 2.6 percent, which was also unchanged from June.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation rose in July to 1.7 percent from 0.7 percent in July—although higher in July, inflation was below the Fed’s 2 percent target in both months. Core PCE inflation was 2.0 percent in July, which was unchanged from June. These data indicate that inflation has been at or below the Fed’s target for the last three months.

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

Inflation using the trimmed mean measure was 2.7 percent in July (calculated as a 12-month inflation rate), down only slightly from 2.8 percent in June—and still above the Fed’s target inflation rate of 2 percent. Inflation in services remained high in July at 3.7 percent, although down from 3.9 percent in June.

On balance, taking together these various measures, inflation seems on track to return to the Fed’s 2 percent target. As we noted in this earlier post, last week in a speech at the Federal Reserve Bank of Atlanta’s monetary policy symposium in Jackson Hole, Wyoming , Fed Chair Jerome Powell all but confirmed that the the Fed’s policy-maiking Federal Open Market Committee (FOMC) will cut its target for the federal funds rate at its next meeting on September 17-18. There was nothing in this latest PCE report to reduce the likelihood of the FOMC cutting its target at that meeting by an expected 0.25 percent point from a range of 5.25 percent to 5.50 percent to a range of 5.00 percent to 5.25 percent. There also is nothing in the report that would increase likelihood that the committee will cut its target by 0.50 percentage point, as many investors expected following the weak employment report released by the Bureau of labor Statistics (BLS) at the beginning of August. (We discuss this report and the reaction among investors in this post.)

Latest PCE Report Shows Inflation Continues to Ease

Federal Reserve Chair Jerome Powell at a press conference following a meeting of the Federal Open Market Committee (Photo from federal reserve.gov)

Inflation in 2024 is a tale of two quarters. During the first quarter of 2024, inflation ran higher than expected considering the falling inflation rates at the end of 2023. As a result, although at the beginning of the year many economists and Wall Street analysts had expected the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) would cut its target for the federal funds rate at least once in the first half of 2024, the FOMC left its target unchanged.

On July 26, the Bureau of Economic Analysis (BEA) released its “Personal Income and Outlays” report for June. The report includes monthly data on the personal consumption expenditures (PCE) price index. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.  The report confirmed that PCE inflation slowed in the second quarter, bringing it closer to the Fed’s 2 percent target.

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2015 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in June PCE inflation (the blue line) was 2.5 percent, down slightly from PCE inflation of 2.6 percent in May. Core PCE inflation (the red line) in June was also 2.5 percent, which was unchanged from May.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation rose in June to 0.9 percent from 0.4 percent in May—although higher in June, inflation was well below the Fed’s 2 percent target in both months. Core PCE inflation rose from 1.5 percent in May to 2.0 percent in June.  These data indicate that inflation has been at or below the Fed’s target for the last two months.

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 June (calculated as a 12-month inflation rate), down only slightly from 2.9 percent in May—and still above the Fed’s target inflation rate of 2 percent. Inflation in services remained high in June at 3.9 percent, down only slightly from 4.0 percent in May.

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. It now seems likely that the FOMC will soon lower the committee’s target for the federal funds rate, which is currently 5.25 percent to 5.50 percent. Remarks by Fed Chair Powell have been interpreted as hinting as much. The next meeting of the FOMC is July 30-31. What do financial markets think the FOMC will decide at that meeting?

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 July meeting. The chart indicates that investors assign a probability of only 4.7 percent to the FOMC cutting its federal funds rate target by 0.25 percentage point at its July 30-31 meeting and an 95.3 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 an 87.7 percent probability of a 0.25 percentage point cut and a 11.9 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 effectively assigned a zero probability. In other words, investors believe with near certainty that the FOMC will reduce its target for the federal funds rate for the first time since the current round of rate increases ended in July 2023.