The BLS announced that the CPI increased 2.18% on annualized basis (the BLS reported 0.2% on a monthly basis) in September after increasing 2.27% in August. The year over year measures came in at 2.41% for September after a 2.59% increase in August. While this is apparently good news, in earlier posts we have remarked that the monthly number is too volatile and the year over year number does not respond very quickly to changes in trend. Unfortunately, our preferred trend measure has increased to 1.98% in September after increasing 1.87% in August, thus moving in the wrong direction compared to the monthly and year over year measures. It should be noted, however, that our measure is just below the Fed’s 2% target.
The CPI saw big declines in energy, falling 1.9% over the month and 6.8% year over year. Fuel oil fell 6.0% over the month and 22.4% year over year. It is well known that both food and energy prices are quite volatile so that looking at core (excluding food and energy) may be a better indicator. While the year over year number changed little, both the monthly and trend measures saw a significant bounce, rising to 3.81% (was 3.42% in August) and 3.05% (was 2.68% in August), respectively.
Perhaps an easier way to see the changes is in the bar graph below where it becomes more evident for our trend measure that the last few months have been going in the wrong direction.
Another piece of data came out this morning: initial jobless claims popped up 258,000, its highest reading since August of 2023. This increase in jobless claims will make Fed decision-making a bit more problematic as they balance inflation vs. the labor market.
The BLS announced that payroll employment increased 254,000 in September (plus 72,000 in upward revisions over the previous two months), solidly beating the “forecasts” that hovered around 150,000. Before the report many had talked about the slowing of the labor market, such as this from CNBC:
September’s jobs picture is expected to look a lot like August’s — a gradual slowdown in hiring from earlier this year, a modest increase in wages and a labor market that is looking a lot like many policymakers had hoped it would.
Well, looks like policy makers didn’t get what they hoped for! In fact it looks more like a gradual increase in hiring over the past four months. The private sector led the charge, increasing 223,000, the second highest reading since May of 2023.
Private sector service jobs increased 202,000 with health services and social assistance rising 71,700 and leisure and hospitality jumping up 78,000, the highest since January, 2023. Declines were seen in manufacturing of both durable goods, down 3,000 and non-durable goods down 4,000.
Average hours of work fell from 34.3 to 34.2, so that total hours of work fell 1.5%. Average hourly earnings climbed to $35.36 from $35.23. The growth in hourly earnings continues to outpace CPI inflation, meaning real wages are rising.
The household survey shows an employment increase of 430,000 and the number of unemployed persons fell 281,000. The labor force increased 150,000. The unemployment rate declined from 4.22% to 4.05%. Curiously, in its press release, the Bureau of Labor Statistics said that the unemployment rate was little changed between August and September.
Earlier this week, the Job Openings and Labor Turnover Survey (JOLTS) was released and showed little change in job openings, hires and separations. There are still more job openings than the number of unemployed persons.
Overall, the labor market continues to defy the press who seem to be constantly trying to show the economy is softening. No signs here. What will this do to the outlook for the Fed’s next steps? The labor market is also at odds with the Fed, at least in terms of their last statement,
Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.
Looking at the very first graph on this post, one can see that job gains have been increasing over the past several months and the unemployment rate actually fell this month. With the strong GDP numbers and this strong labor market outcome it may shift the thinking that inflation pressures could/might/will be increasing. Was the recent 50bp cut too much too soon?
The Bureau of Economic Analysis announced that the price index for personal consumption expenditures (PCE) increased 1.09%, on an annualized basis, in August following a 1.85% increase in July. The year over year reading came in at 2.2% following 2.7% in July. Our preferred measure of “trend” inflation continues to fall and came in at 1.65% after a 1.92% in July.
The Fed tends to put more weight on the core PCE, the PCE excluding food and energy (PCEX). Over the month the BEA shows an annualized 1.58% increase. The year over year reading came in at 2.68%, slightly higher than the 2.65% reading in July. Our trend measure for August is 2.12% following a 2.39% reading for July.
The two main components of the PCE price index, goods and services, show much different behavior. The annualized goods component for August was -1.82% and the services component was 2.46%. This has been roughly the pattern for all the year over year and trend measures over the past few months.
Fed Governor Christopher Waller was recently interviewed on CNBC, and was quoted as saying that PCE price inflation for August would be “very low” and that “inflation is softening much faster than I thought”. Our measure of trend core PCE inflation is still above the FOMC’s 2% target. Granted, monetary policy is said to operate with long and variable lags. Still, for the purposes of Fed credibility and keeping inflation expectations in check, it might have been a good idea to have waited until inflation was well and truly contained. Indeed, the FOMC commented in the July 31 statement:
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.
Looking at the PCEX graph above all of the measures were moving sustainably to the 2% target starting in 2023, however, there was a bounce in those measures in late 2023 and early 2024. Moreover, the real side of the economy is strong. While concern has been expressed regarding the unemployment rate, by historic standards it’s still rather low. It strikes us as premature to declare “mission accomplished.”
The Bureau of Labor Statistics announced that the consumer price index (CPI) increased 0.2% over the month on a seasonally adjusted basis. On an annualized basis, the CPI increased 2.27%, up 0.41 percentage points from July’s 1.88%. The year over year reading was 2.59% which is down 0.33 points from the 2.92% recorded in July. One way to think about the fall in the year-over-year inflation rate is that it’s the average of the current and past 11 months’ monthly inflation rates. Consequently, the decline in the year-over-year inflation rate can be attributed to dropping the 6.32% monthly inflation rate from August 2023 while adding the lower 2.27% for August 2024. Our preferred trend measure came in at 1.87%. While the trend number looks pretty good on the surface at 1.87% it has been creeping up over the last few months: 1.58% in June, 1.68% in July and now 1.87% in August.
The core (ex food and energy, CPIX) measures tell a slightly worse story, with the annualized number hitting 3.42%, the year over year up 3.26% and our trend measure up 2.68%. There were very large declines in the monthly numbers for energy products: gasoline down 0.6%, fuel oil down 1.9% and energy services down 0.9%. Used cars and trucks also saw a large decline of 1.0%.
Chairman Powell has all but promised “Christmas in September” in the form of a cut in the Fed funds rate. Moreover, given the relationship between the CPI measures and the Fed’s preferred Personal Consumption Expenditure core measure means that this measure of inflation will likely show an increase when it’s released in a couple of weeks. While the unemployment rate has been creeping up, real output growth has been robust. (If the US is deemed in some dire situation with a 4.2% unemployment rate, pity Canadians with their 6.6% rate) In our humble opinions, the current inflation data do not warrant such a cut, much less the 50 basis point cut hoped for by some commentators.
On September 6, the Bureau of Labor Statistics released its employment report for August. According to the Establishment Survey, the US economy added 142 thousand jobs in August. In addition, the previous two months were revised down, -61 in June and -25 in July. The Household Survey put the gain at 168 thousand jobs.
From the Establishment Survey, the leisure and hospitality sector added 46 thousand jobs; construction 34 thousand jobs; and health care 30 thousand jobs. Sectors losing jobs were led by manufacturing (24 thousand) and retail trade (11 thousand).
Average weekly hours rose from 34.2 to 34.3 so that total hours of work increased by 4.7%. Average hourly earnings increased 0.4%, from $35.07 to $35.21.
The unemployment rate, derived from the Household Survey, fell marginally, from 4.25% to 4.22%. (The headline numbers are touting a decline from 4.3% to 4.2%.) However, a broader measure of the unemployment rate which includes marginally attached individuals rose between July and August, from 7.8% to 7.9%.
Policy Implications
Is strength or weakness in the eye of the beholder? Or rather, in the data of the beholder?
Given the signaling from members of the FOMC, it’s pretty clear that the committee will lower the Federal funds rate at its next meeting later in September. Speculation is growing that the committee may deliver a 50 basis point reduction rather that `just’ a 25 point reduction. The case for a more aggressive loosening of monetary policy lies on the real side of the economy. Where does this weak real side show up? Maybe in the employment numbers reported above. Yet, the same report shows a slight decline in the unemployment rate and a 48 thousand decline in the number unemployed. The labor force increased by 120 thousand. As mentioned above, wage growth was fairly strong and total hours increased substantially. Second quarter real GDP growth was revised up from 2.8% to 3.0%. Considering that US population growth is running around 0.5% per year, real per capita output growth for the second quarter is around 2.5% which is well above its long run average. Meanwhile, while PCE inflation has fallen, it is still a bit above the FOMC’s 2% target.
The Bureau of Economic Analysis (BEA) announced that the personal consumption expenditures (PCE) price index increased 0.2% over the month. Using the price index numbers (found here in Table 5) of 123.378 for July and 123.187 for June, the annualized increase is 1.88%, up somewhat from the June reading of 0.73%. The year over year measure increased 2.50% in July after increasing 2.47% in June. Our trend measure increased 1.81% in July and 1.78% in June.
The Fed’s preferred measure, the PCE less food and energy (core PCE) in July increased 1.95% on an annualized basis, down slightly from the June reading of 1.97%. Our trend measure also saw a decline from June, 2.28% from 2.44%.
Inflation pressures have moderated and our preferred trend measure of core PCE inflation has been falling over the past four months. At the same time, real Personal Consumption Expenditures increased 4.62% on an annualized basis in July compared to a 3.20% increase in June. The bottom line is that inflation is now close to the Fed’s 2.0% target with seemingly no big effect on the real side of the economy. We don’t see anything in this report that should change the outlook for an upcoming rate cut.
The BLS’s CPI report for July saw increases in month-over-month CPI inflation (from -0.67% to 1.88%) and core CPI inflation (from 0.78% to 2%). Granted, the June inflation rates were quite low, and the July rates are within the mythical 2% range. Meanwhile, on a year-over-year basis, CPI inflation fell (from 2.98% to 2.92%) as did core CPI inflation (from 3.28% to 3.21%). Our measure of trend CPI inflation rose from 1.58% to 1.68%; trend core CPI inflation fell from 2.46% to 2.31%.
Policy Implications
The Fed’s preferred measure of inflation is core PCE inflation rather than the CPI or core CPI inflation. The PCE is a broader measure than the CPI and removing the more volatile food and energy is a better way to track where inflation is heading. For example, this month fuel oil rose 0.9% over the month while piped gas services fell 0.7% over the month. Nonetheless, the CPI report provides a (noisy) signal of what can be expected from the PCE when it is released in a couple of weeks time. The figure below shows that our measures of trend core CPI and trend core PCE inflation generally move together, albeit not lock-step. It would not be too surprising to see July trend core PCE inflation come in lower than its June value of 2.6%.
The likely case for a cut in the Fed funds rate is that core PCE inflation is trending towards the Fed’s 2% target (even if it isn’t actually at 2%) along with real side weakness (witness the stock market’s reaction to the July employment gains). All of this with an eye to executing a “soft landing” (getting inflation under control without a inducing a recession).
The BLS announced that employment rose by a very subdued 114,000 according to the establishment survey, 97,000 of which came from the private sector. The bulk of the increase came from Health Care and Social Assistance sector, increasing 64,000. Moreover, there were 29,000 fewer employees over the past two months than reported earlier, as May was revised down 2,000 and June revised down 27,000.
Average hours of work fell from 34.3 to 34.2. Given the weak increase in private sector employment and the decline in average hours meant that total hours of work fell about 2.6%.
To be sure, the July employment report is disappointing. The figure below plots the change in nonfarm payroll employment since 1947. To this figure, we’ve added a red dot when the change in employment was at most 114,000 (as in the most recent jobs report), and the economy was in an expansion. (We’ve excluded a few months around the start of the pandemic because these employment changes were so extreme.) The bottom line is that the US has often had weak job reports in the midst of expansions. The point being that looking only at one monthly report may be very misleading. Indeed the Fed has mentioned this in other contexts:
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.
July 31 FOMC Statement
The unemployment rate, based on the household survey, rose to 4.25% from 4.05% in the previous month. Digging deeper into the unemployment data reveals that much of the increase in the unemployment rate in 2024 has been due to a combination of workers losing jobs, and workers reentering the labor market, the labor force grew by 420,000. Keep in mind that reentry may be an artifact of the rules for counting an individual as unemployed which includes a notion of active job search. According to the jobs report, in July there were 4.6 million individuals who were not in the labor force but who want a job, an increase of 346,000. When these marginally attached individuals are included in the ranks of the unemployed, the unemployment rate is nearly 8%, not the official 4.3%.
Once again there are many in the media showing the possibility that the economy is heading toward a recession. Note: definitionally, it has to be true that if we are currently not in a recession we are heading toward one since recessions do frequently occur (but have become much less frequent, see the recessions graph below. At any one time there are usually both positive and negative signs. For example, how much weight should one put on a one month decline? Or a one day decline in the stock market? Jeremy Piger uses data to infer the probability the economy is in a recession, as of July 26, the probability that we were in a recession in June was 0.26%. That said, there will be inflation reports before the next FOMC meeting, but at this point it looks more likely there will be a rate cut in September, barring any large increases in inflation.
On July 25 the BEA announced that the advance estimate of real GDP increased 2.8% in Q2 on an annualized basis. The gains were fairly widespread, except for residential and non-residential structures, that fell 1.4% and 3.3%, respectively. Personal consumption expenditures, PCE, increased 2.3% and was the largest contributor to overall growth, at 1.57 percentage points.
PCE price index
On July 26, the BEA announced that the personal consumption expenditures, PCE, price index increased 0.95% on an annualized basis. Our preferred trend measure came in at 1.9%.
The Fed’s preferred measure, the PCE ex food and energy came in at 2.2% on an annualized basis while our trend measure came in at 2.6% and has continued to fall for the last 5 months.
As we have mentioned many times before, we believe our trend measure better captures the path of inflation and, more importantly, implications for Fed policy. For example, the annualized monthly change was higher in June, 2.2%, than in May, 1.5%. It seems pretty obvious that the Fed will not change its current stance on policy given this one month blip.
Policy Discussion
No doubt, there will be a lot of chatter about whether the FOMC should lower the Fed funds rate at its July 30-31 meeting, or wait until September. Or something else. To wade through all this, it helps to have a framework to organize thoughts about the incoming data. Arguably, the so-called Taylor rule has the broadest acceptance in the economics-policy profession. Briefly, the Taylor rule says that the Federal funds rate should be set as: (a) the natural real interest rate plus (b) the target inflation rate (2%) with (c) an upward adjustment when actual inflation exceeds target and (d) a downward adjustment reflecting slack on the real side of the economy. Typically, this slack is measured by either the output gap, or the unemployment rate gap. It’s easiest to understand why one of these gaps is included in the Taylor rule by thinking about what happens when there’s a negative gap. In the case of the unemployment rate, the idea is the demand for labor is high. Consequently, either firms will have to offer higher wages, or workers have more bargaining power and can command higher wages. Either way, these nominal wage channels put upward pressure on prices through some sort of “cost push” channel. This could be as simple as firms pricing using a constant markup over their (marginal) costs. In the case of a negative output gap, the story is that demand is outstripping supply, and firms find it easier to raise their prices. Returning to the Taylor rule, the idea is that these gaps reflect future inflationary pressures, and that the FOMC should respond now to head off future inflation.
There’s a lot of wiggle room in the Taylor rule. First, one needs an estimate of the natural real interest rate. The Atlanta Fed’s Taylor rule calculator provides eight (8!) choices for the real interest rate, currently ranging from 0.7% to 2.5%. That said, a given measure of the real interest rate does not change much over time.
Second, how to think about the deviation of inflation from target? As mentioned above, we like our trend measure which has moved down in 2024. The Taylor rule would, then, prescribe a lower Fed funds rate. But that prescription depends on the FOMC having religiously followed the Taylor rule over the past few years — which it almost certainly hasn’t. Nonetheless, some commentators may suggest that it’s time to start lowing the Fed funds rate since PCE inflation has come down in 2024.
Third, how to measure real-side slack? The output gap is given by potential output less actual output. The problem here is the nebulous concept of “potential” output. The fact that FRED has a potential GDP series is of no comfort. (“Fake data!”) To be absolutely clear, the output gap is a made-up number. Similarly, the unemployment rate gap is the difference between the “natural unemployment rate” and the actual unemployment rate. Some may substitute NAIRU (the non-accelerating inflation rate of unemployment) for natural unemployment rate, but it’s the same basic idea. As with the output gap, there’s the problem of measuring the natural unemployment rate. (“More fake data!”) Between the output gap and the unemployment rate gap, the Atlanta Fed provides 18 (yes, 18!) measures of real-side slack. What’s does the Taylor rule say should be happening with the Fed funds rate based on recent real-side data? Currently, estimates of the output gap are positive: there’s slack in the economy which tends to push down the Taylor rule’s prescription for the Fed funds rate. The strong growth in the second quarter is likely to cut the size of this gap (unless of course, potential output is revised!) which calls for a higher Fed funds rate. On the other hand, the unemployment rate has increased, and so the unemployment rate gap has increased which, through the Taylor rule, would call for a lower Fed funds rate.
TLDR: Inflation is coming down; the Taylor rule dictates a lower Fed funds rate. The output gap has narrowed; raise the Fed funds rate. The unemployment gap increased; lower the Fed funds rate.
So, here is the rub, even with the most widely used model at hand, it offers little guidance as to what to do next. Indeed, there is way too much wiggle room to come to a coherent and consistent policy recommendation.
The June CPI numbers point to lower inflation. On an annualized month-over-month basis, CPI inflation fell from 0.07% to -0.67%; core CPI inflation dropped from 1.97% to 0.78%. The year-over-year measures recorded more modest declines, from 3.25% to 2.98% for CPI and 3.41% to 3.28% for core CPI. As we have emphasized in past posts, the monthly inflation rate is quite volatile while the annual inflation rate is slow to reflect changes in trend. For June, our measure of trend CPI inflation plunged by 1.1 percentage point to 1.58% while trend core CPI inflation fell 0.8 percentage point to 2.46%
Policy Implications
In about two weeks, the PCE deflator for June will be released. If our trend core PCE inflation falls by the same 0.8 percentage points that core CPI inflation fell, then trend core PCE inflation will sit at 1.8% – comfortably below the Fed’s 2% target. Alternatively, CPI inflation tends to run about 0.5 percentage points higher than PCE inflation. On this basis, one might expect our trend core PCE inflation for June to come in at 2.1% – just outside the Fed’s 2% target. Chairman Powell’s testimony earlier this week raised expectations of a rate cut this year, although the chairman was silent regarding the timing. Given the declines of the recent numbers, it appears that the Fed has pretty much achieved its longer run inflation goal. The real side of the economy seems to have been mostly unaffected by the rapid increases in the fed funds rate. The FOMC next meets July 30-31. As this stage, the question is: will the FOMC lower its policy rate at the end of July, or wait until September? The debate will probably hinge on what are the potential costs of cutting rates in July, if any? Stay tuned.
