Tag: Real final sales to private domestic purchasers

Mixed PCE Inflation Report and Slowing Growth Provides Murky Outlook for the Fed

Image generated by ChatGTP-4o

Today (June 27), the BEA released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report. 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 headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2016, with inflation measured as the percentage change in the PCE from the same month in the previous year. In May, headline PCE inflation was 2.3 percent, up from 2.2 percent in April. Core PCE inflation in May was 2.7 percent, up from 2.6 percent in April. Headline PCE inflation was equal to the forecast of economists surveyed, while core PCE inflation was slightly higher than forecast.

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 increased in from 1.4 percent in April to 1.6 percent in May. Core PCE inflation also increased from 1.6 percent in April to 2.2 percent in May. So, both 1-month PCE inflation estimates are close to the Fed’s 2 percent target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so we shouldn’t attempt to draw wider conclusions from one month’s data. In addition, these data likely don’t capture fully the higher prices likely to result from the tariff increases the Trump administration announced on April 2.

Fed Chair Jerome Powell has frequently noted that inflation in non-market services can skew PCE inflation. Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices fall, the prices of financial services included in the PCE price index also fall. Powell has argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 2.1 percent in May, up from 1.9 percent in April. Core market-based PCE inflation was 2.4 percent in May, up from 2.3 percent in April. So, both market-based measures show similar rates of inflation in May as the total measures do. In the following figure, we look at 1-month inflation using these measures. The 1-month inflation rates are both lower than the 12-month rates. One-month headline market-based inflation was 1.5 percent in May, down from 2.3 percent in April. One-month core market-based inflation was 2.1 percent in May, down from 2.7 percent in April. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate.

Earlier this week, the BEA released a revised estimate of real GDP growth during the first quarter of 2025—January through March. The BEA’s advance estimate, released on April 30, was that real GDP fell by 0.3 percent in the first quarter, measured at an annual rate. (We discussed the BEA’s advance estimate in this blog post.) The BEA’s revised estimate is that real GDP fell by 0.5 percent in the first quarter. The following figure shows the current estimated rates of real GDP growth in each quarter beginning in 2021.

As we noted in our post discussing the advance estimate, one way to strip out the effects of imports, inventory investment, and government purchases—which can all be volatile—is to look at real final sales to private domestic purchasers, which includes only spending by U.S. households and firms on domestic production. According to the advance estimate, real final sales to private domestic purchasers increased by 3.0 percent in the first quarter of 2025. According to the revised estimate, real final sales to private domestic purchasers increased by only 1.9 percent in the first quarter, down from 2.9 percent growth in the fourth quarter of 2024. These revised data indicate that economic growth likely slowed in the first quarter.

In summary, this week’s data provide some evidence that the inflation rate is getting close to the Fed’s 2 percent annual target and that economic growth may be slowing. Do these data make it more likely that the Fed’s policymaking Federal Open Market Committee (FOMC) will cut its target for the federal funds rate relatively soon? 

Investors who buy and sell federal funds futures contracts still expect that the FOMC will leave its federal funds rate target unchanged at its next meetings on July 29–30 and September 16–17. Investors expect that the committee will cut its target at its October 28–29 meeting. (We discuss the futures market for federal funds in this blog post.) There remains a possibility, though, that future macroeconomic data releases, such as the June employment data to be released on July 3, may lead the FOMC to cut its target rate sooner.

Real GDP Growth Slows in the Fourth Quarter, While PCE Inflation Remains Above Target

Image generated by ChatGTP-4o illustrating GDP

Today (January 30), the Bureau of Economic Analysis (BEA) released its advance estimate of GDP for the fourth quarter of 2024. (The report can be found here.) The BEA estimates that real GDP increased at an annual rate of 2.3 percent in the fourth quarter—October through December. That was down from the 3.1 percent increase in real GDP in the third quarter. On an annual basis, real GDP grew by 2.5 percent in 2024, down from 3.2 percent in 2023. A 2.5 percent growth rate is still well above the Fed’s estimated long-run annual growth rate in real GDP of 1.8 percent. The following figure shows the growth rate of real GDP (calculated as a compound annual rate of change) in each quarter since the first quarter of 2021.

Personal consumption expenditures increased at an annual rate of 4.2 percent in the fourth quarter, while gross private domestic investment fell at a 5.6 annual rate. As we discuss in this blog post, Fed Chair Jerome Powell’s preferred measure of the growth of output is growth in real final sales to private domestic purchasers. This measure of production equals the sum of personal consumption expenditures and gross private fixed investment. By excluding exports, government purchases, and changes in inventories, final sales to private domestic purchasers removes the more volatile components of gross domestic product and provides a better measure of the underlying trend in the growth of output.

The following figure shows growth in real GDP (the blue line) and in real final sales to private domestic purchasers (the red line) with growth measured as compound annual rates of change. Measured this way, in the fourth quarter of 2024, real final sales to private domestic producers increased by 3.2 percent, well above the 2.3 percent increase in real GDP. Growth in real final sales to private domestic producers was down from 3.4 percent in the third quarter, while growth in real GDP was down from 3.1 percent in third quarter. Overall, using Powell’s preferred measure, growth in production seems strong.

This BEA report also includes 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 (the blue line) and the core PCE (the red line)—which excludes food and energy prices—since the beginning of 2016. (Note that these inflation rates are measured using quarterly data and as percentage changes from the same quarter in the previous year to match the way the Fed measures inflation relative to its 2 percent target.) Inflation as measured by PCE was 2.4 percent, up slightly from 2.3 percent in the third quarter. Core PCE, which may be a better indicator of the likely course of inflation in the future, was 2.8 percent in the fourth quarter, unchanged since the third quarter. As has been true of other inflation data in recent months, these data show that inflation has declined greatly from its mid-2022 peak while remaining above the Fed’s 2 percent target.

This latest BEA report doesn’t change the consensus view of the overall macroeconomic situation: Production and employment are growing at a steady pace, while inflation remains stubbornly above the Fed’s target.

FOMC Holds Rate Target Steady While Hinting at a Cut at the September Meeting

Image of “Federal Reserve Chair Jerome Powell speaking at a podium” generated by GTP-4o.

At the conclusion of its July 30-31 meeting, the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) voted unamiously to leave its target range for the federal funds rate unchanged at 5.25 percent to 5.5 percent. (The statement the FOMC issued following the meeting can be found here.)

In the statement Fed Chair Jerome Powell read at the beginning of his press conference after the meeting, Powell appeared to be repeating a position he has stated in speeches and interviews during the past month:

“We have stated that we do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2 percent. The second-quarter’s inflation readings have added to our confidence, and more good data would further strengthen that confidence. We will continue to make our decisions meeting by meeting.”

But in answering questions from reporters, he made it clear that—as many economists and Wall Street investors had already concluded—the FOMC was likely to reduce its target for the federal funds rate at its next meeting on September 17-18. Powell noted that recent data were consistent with the inflation rate continuing to decline toward the Fed’s 2 percent annual target. Powell summarized the consensus from the discussion among committee members as being that “the time was approaching for cutting rates.”

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 resulting 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 100 percent to the FOMC cutting its federal funds rate target at this meeting. Investors assign a probability of 89.0 percent that the committee will cut its target by 0.25 percentage point and a probability of 11.0 percent that the commitee will cut its target by 0.50 percentage point. When asked at his press conference whether the committee had given any consideration to making a 0.50 percentage point cut in its target, Powell said that it hadn’t.

Powell stated that the latest data on wage increases had led the committee to conclude that the labor market was no longer a source of inflationary pressure. The morning of the press conference, the Bureau of Labor Statistics (BLS) released its latest report on the Employment Cost Index (ECI). 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).

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. In contrast, the ECI holds the mix of occupations constant. The ECI does have the drawback that it is only available quarterly whereas the AHE is available monthly.

The following figure shows the percentage change in the ECI for all civilian workers from the same quarter in the previous year. 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 4.3 percent in the first quarter of 2024 to 4.2 percent in the second quarter of 2024. The rate of increase in compensation also declined slightly from 4.2 percent to 4.1 percent. As the figure shows, both measures continued their declines from the peak of wage inflation during the second quarter of 2022. In his press conference, Powell said that the this latest ECI report was a little better than the committee had expected.

Finally, Powell noted that the committee saw no indication that the U.S. economy was heading for a recession. He observed that: “The labor market has come into better balance and the unemployment rate remains low.” In addition, he said that output continued to grow steadily. In particular, he pointed to growth in real final sales to private domestic purchasers. This macro variable equals the sum of personal consumption expenditures and gross private fixed investment. By excluding exports, government purchases, and changes in inventories, final sales to private domestic purchasers removes the more volatile components of gross domestic product and provides a better measure of the underlying trend in the growth of output.

As the following figure shows, this measure of output has grown at an annual rate of more than 2.5 percent in each of the last three quarters. Output expanding at that rate is indicative of an economy that is neither overheating nor heading toward a recession.

At this point, unless macro data releases are unexpectedly strong or weak during the next six weeks, it seems nearly certain that at its September meeting the FOMC will reduce its target range for the federal funds rate by 0.25 percentage point.