CPI inflation for February (released a couple of weeks ago) brought the prospect of lower PCE defaltor inflation. It didn’t happen. On a year-over-year basis, PCE inflation barely changed, increasing from 2.52% (January) to 2.54% (February). While the annualized month-over-month rate fell, from 4.12% to 4.01%, our measure of trend rose from 3.06% to 3.38%.
Similarly, core PCE inflation (that is, excluding food and energy) rose in February: the monthly rate from 3.64% (January) to 4.47% (February); the annual rate from 2.66% to 2.79%. Our measure of trend core PCE popped up from 2.72% to 3.37%.
Core measures of PCE inflation have moved away from the FOMC’s 2% target. On the basis of these numbers, it seems unlikely that the Fed will be delivering interest rate cuts in the next few months.
PCE inflation for goods (durable plus non-durable) had been subdued for the past couple of years, actually falling for seven out of the last ten months. Recently, however, goods price inflation has been climbing and is now the highest since 2022. Service price inflation has been high and is climbing, nearly hitting 4% from January to February.
The BLS announced that the CPI rose 2.62% on an annualized basis, the lowest reading since August, 2024. Year over year inflation came in at 2.81%. Our preferred trend measure of inflation was 3.62%. The report offers some good news given the CPI spike in January. The biggest decline came from energy commodities (gasoline and fuel oil), down 10.1% on an annualized basis, down 3.17% year over year; however, our trend measure rose 8.53% due to outsized increases in January (13.8%) and February (17.9%). Energy prices are extremely volatile as can be seen in the magnitude of the scale in the energy graph.
Given the volatility mentioned above, policy makers often remove food (including the price of eggs) and energy from the index, namely, core CPI. The monthly core number fell from 5.49% to 2.75% on an annualized basis, and from 3.29% to 3.14% year over year. Our trend measure fell from 5.85% to 3.49%.
While there is a small sigh of relief given January’s spike in inflation, the core numbers are still solidly above the Fed’s 2% target. Moreover, these numbers from February do not reflect the recent tariff measures put in place and may take many months before we see any price effects. Looking at future inflation expectations, however, reveals a marked increase in prices. The breakeven inflation rate represents a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities and 5-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 5 years, on average.
Meeting next week, the Fed will almost surely stay the course with no change in rates as they wait to see how current policies play out over the next few months.
The Bureau of Labor Statistics Establishment Survey recorded an increase in employment of 151 thousand for February. This increase is only slightly below the average for the previous 12 months. Another way to think about the February number: it exceeds 6 of the previous 12 month employment gains.
While government employment rose by 11 thousand jobs in February, federal government employment dropped by 10 thousand.
The household survey from the BLS press release indicated a decline in the labor force participation rate (62.6% to 62.4%) and an employment-to-population ratio decline (60.1% to 59.9%). The report showed a slight increase in the unemployment rate, from 4.01% in January to 4.14% in February. For the most part, the unemployment rate has hovered around 4.1% for the last 8 months.
Although the unemployment rate has been trending up over the past year or so, keep in mind that it is, historically, quite low.
The headlines say that PCE (personal consumption expenditure) inflation fell in January. This is a case of “Yes, but …”. In particular, it is true that the year-over-year PCE inflation rates fell from 2.6% (December 2024) to 2.5% (January 2025) in the case of overall PCE inflation, and from 2.86% to 2.64% for core PCE inflation (that is, excluding food and energy). Looks like the Fed is doing a great job. However, the annualized month-over-month inflation rates jumped from 3.56% to 3.98% (PCE), and from 2.52% to 3.47% (core PCE).
How can we reconcile these divergent patterns to the year-over-year and month-over-month inflation rates? As we have previously explained, the year-over-year inflation rate is roughly the average of the past 12 month-over-month inflation rates. For example, the year-over-year inflation rate for December 2024 is the average of the 12 month-over-month inflation rates in 2024. Similarly, the January 2025 year-over-year inflation rate is the average of the 12 month-over-month rates running from February 2024 through to January 2025. As a result, every month the calculation for the year-over-year inflation rate adds in to this average the current month reading of the month-over-month inflation rate while simultaneously dropping out the monthly rate from 13 months ago. With all of this in mind, for core PCE inflation, the year-over-year rate for January 2025 added in the January 2025 month-over-month rate (3.47%) while dropping the January 2024 rate (6.14%). In this case, the year-over-year rate for January 2025 fell not because of a particularly favorable month-over-month rate for January 2025, but because of an especialy high rate for January 2024!
It is for reasons like this that we developed our measure of trend inflation. Without getting into the details, our measure of trend inflation is a “constant gain” measure of the average month-over-month inflation rates: it applies a constant weight to the current month-over-month rate, with the remaining weight applied to the previous month’s reading of the trend. Our measure of trend PCE inflation rose from 2.52% (December 2024) to 3% (January 2025) while our measure of trend core PCE inflation rose from 2.4% to 2.76%.
Another desirable feature of our trend inflation measure is that it responds reasonably quickly to changes in underlying trend inflation. Visually, we can see that the month-over-month inflation rates have trended up over the last half year. Our measure of trend reflects what can be seen in the data. While the year-over-year inflation rates will eventually also reflect such a change in underlying trend, it will take nearly a year to fully reflect the change in trend. In 2021, inflation rose sharply and the Fed appeared to be asleep at the switch. In particular, our trend measure was rising pretty quickly during 2020 and moved over the 2% target by midyear while the year over year measure stayed below 2% throughout the year and into 2021. One can only hope that the Fed learned something from its earlier mistake.
The Bureau of Labor Statistics (BLS) announced that the Consumer Price Index (CPI) for all items rose 0.5% over the month or 5.75% on an annualized basis. This is the largest increase since August of 2023. The year-over-year increase was 3.00%. Our preferred trend measure rose 4.12% on an annualized basis. As the graph below shows, all of the measures have been inching up over the past few months.
Removing food and energy from the index, the core measure, increased 5.49%, the highest reading since April of 2023. The year-over-year number increased 3.29% and the trend measure was up 3.85%.
No matter how one slices it, the inflation numbers are not moving in the right direction. The rise in prices was broad-based, the only major category that decreased over the month was apparel. Later this month, the FOMC’s preferred measure of inflation, core PCE, will be released. There’s a high correlation between CPI and PCE inflation, and it seems unlikely that this measure of inflation will near the committee’s 2% target.
Fed Chair Powell began his testimony to the House Financial Services Committee this morning and will likely have a tough time given the broad based spike in prices. Needless to say, this does not bode well for an easing of interest rates in the near term.
The BLS announced that the establishment survey revealed a 143,000 increase in employment in January, 111,000 of that came from private payrolls. Moreover, all of the private employment increase came from the service sector as the goods producing sector had a net of zero. November was revised up by 49,000 and December by 51,000.
Average hours worked in January fell to 34.1 hours. Apart from the pandemic, the last time it was 34.1 was back in April of 2010. With the 111,000 increase in private employment and the reduction in average hours of work, total hours worked also fell.
Average hourly earnings for private workers rose 0.5% over the month (5.9% on an annual basis). Using various inflation measures, real hourly earnings have been steadily rising over the past couple of years.
The household survey indicated that the labor force participation rate increased from 62.5% to 62.6% and the employment to population ratio increased from 60.0% to 60.1%. The unemployment rate fell from 4.08% to 4.01%.
An article in the New York Times suggested that the jobs report would be “confusing” due to massive revisions owing to an annual process that reconciles the differences between the establishment and household surveys. Our reading: not so much. There was no revision to the household survey employment numbers. While establishment survey employment was revised down some 610,000 as of December 2024, the level of employment was around 159 million. While 610,000 would be a massive change on a monthly basis, that’s not the right way to think about the revision since the revisions are spread over many months. A better way to think about the revision: the level of employment in December was revised down roughly 0.4%. The figure below shows substantial downward revisions in January and March 2024, and similarly large upward revisions for November and December.
On Tuesday, the BLS released the job openings and labor turnover summary (JOLTS). The job openings rate fell somewhat but hires and separations changed little.
On Thursday, the BLS released data on productivity and costs. Growth in productivity fell from 2.3% in 2024Q3 to 1.2% in 2024Q4. Most of this decline can be attributed to a fall in output growth (from 3.6% to 2.3%). Growth in hours worked also fell, from 1.3% to 1.0%.
The labor market, as always, has some ups and downs in the underlying components. Job growth was so-so and both the labor force participation rate and employment to population ratio rose. Average hourly earnings show strong growth. However, average hours of work and total hours fell as did productivity. These reports do not really alter the “wait and see” approach outlined by the FOMC after their recent meeting.
2024 ended on a strong note as the BEA announced that real GDP increased 2.4% on a seasonally adjusted annual rate, lower than the very strong previous two quarters, but still above the long term trend. Over the year, GDP increased 2.8% following a 2.9% increase in 2023.
Personal consumption expenditures led the way, increasing 4.2%. Investment went the opposite direction, declining 5.6%.
One useful way to look at this data is to decompose the growth in output into contributions by its constituent parts. By way of example, the contribution of consumption, 2.9%, is given by the growth rate of consumption (4.2% in 2024Q4) weighted by the share of consumption (69%). Comparing across the third and fourth quarters, one can see that the contribuiton of consumption rose, from 2.5 percentage points to 2.9 points while that of investment fell from 0.1 points to -1.0 points. At the same time, the contribution of exports went from 1.1 points in the third quarter to a drag of 0.1 points in the fourth; in contrast, imports were exerted a 1.7 point drag in the third quarter but contributed a positive 0.1 points in the fourth.
The PCE price index was released today and, much like the CPI released earlier this month, delivered mixed signals. Inflation as measured by the PCE price index jumped to its highest level since April of 2024, increasing 3.11% on a seasonally adjusted annualized basis. Removing the highly volatile food and energy categories, the increase was only 1.89%, the second consecutive month below the FOMC’s 2.0% target. Our preferred trend measure revealed a similar pattern, with the PCE trend rising 2.36% (highest since last April) but the PCE core measure fell to its lowest level since December of 2023, 2.17%.
The Department of Labor released weekly initial claims for unemployment, falling 16,000 to 207,000, indicating that the labor market continues a strong performance.
Are we there yet?
We all know that the Fed looks at core PCE inflation. Less clear is whether they look at the month-to-month inflation rate, or year-over-year rate. Over the past three months, our trend measure has moved down towards the Fed’s 2% target, but: the same could be said of June to August of 2024, and our trend measure is still above target. There is still (some) work to be done on the inflation front. Fortunately, the real side of the economy continues its strong showing. Earlier this week the FOMC decided to keep rates as they were:
Recent indicators suggest that economic activity has continued to expand at a solid pace. The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid. Inflation remains somewhat elevated.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 4-1/4 to 4-1/2 percent.
The BLS announced that the CPI rose 4.82% on an annualized, seasonally adjusted basis, the highest reading since last February, and an increase of a full percentage point compared to November. The year over year reading increased from 2.73% to 2.90% and our preferred trend measure increased from 2.81% to 3.48%. The surge, however, came largely from energy commodities (fuel oil and gasoline) rising 4.3% over the month, 66.5% annualized!! The extreme volatility of energy and food is the main reason the BLS also reports the CPI ex food and energy, likely a better measure of underlying inflation.
The CPI core measure (ex food and energy) plunged from an annualized 3.76% in November to 2.73% in December. The year over year number fell from 3.30% to 3.25% and our trend measure fell from 3.37% to 3.16%.
The following graph shows the extreme volatility of energy prices, often rising or falling 50% or more in a month. Food prices are also volatile, but no where near that of energy.
PCE inflation for December will be available in just over two weeks. Given the overlap in the goods and services in the CPI and PCE deflator, the CPI provides a useful signal of the likely direction for PCE inflation. Clearly, the signal from this CPI report is mixed: Overall CPI inflation rose between November and December while core CPI inflation fell. Since the policymakers on the FOMC focus on core inflation measures, perhaps the CPI report is good news: we may be in for a moderate decline in core PCE inflation. Stay tuned.
As reported by the Bureau of Labor Statistics (BLS), according to the Establishment Survey, nonfarm payroll employment rose by 256 thousand jobs in December — well in excess of expectations of 165 thousand new jobs reported by Bloomberg. The BLS noted that December’s job gains exceeded the average monthly gain for 2024 of 186 thousand.
Sectors receiving particular attention by the BLS were: health care added 46 thousand jobs in December (lower than the average of 57 thousand jobs per month in 2024), government gained 33 thousand jobs (down from the 2024 average of 37 thousand), social assistance was up 23 thousand (compared to an average of18 thousand per month in 2024), and retail trade accrued 43 thousand additional jobs in December after losing 29 thousand jobs in November (for the year, retail trade was essentially unchanged).
The household survey showed an increase in employment of 478,000 and a decrease in unemployed persons of 235,000. The employment to population ratio increased to 60% and the participation remained at 62.5%. The unemployment rate fell from 4.23% to 4.09%.
Although the overall labor force participation rate is still much lower than its peak in the late 1990’s, the rate for prime-age workers is close to it’s all-time high.
With a decline in the number of unemployed persons and a recent increase in job openings, we continue to see more openings than persons searching for jobs, meaning jobs are, in some sense, plentiful.
These stronger than expected labor market gains cast more doubt on the potential for future declines in the Fed Funds rate, as indicated in their December 18 announcement:
In considering the extent and timing of additional 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.
Indeed, if the next inflation report shows no real progress in moving toward the 2% target, it is quite likely, in our view, that the Fed should take a pause while they wait for more incoming signals.
Mostly bad news on the inflation front: The Fed’s favorite measure of inflation, core PCE inflation, ticked up from 2.79% in October to 2.82% in November, measured on a year-over-year basis. The good news, such as it is, is that the one-month inflation rate rose at an annual rate of 1.39%, down from 3.19% in October. Of course, regular readers know that these month-to-month inflation rates are volatile. Looking over the past 12 months, this is only the second time that the monthly inflation rate has been below the Fed’s 2% target; in fairness, there were a couple of months when inflation exceeded target by less than 0.1 percentage points. Our trend measure of inflation fell from 2.77% in October to 2.31% in November.
Year-over-year PCE inflation also rose, from 2.31% in October to 2.44% in November while the annualized monthly inflation rate dropped from 2.78 to 1.55%. Our trend measure fell from 2.20% to 1.98%.
In our earlier post on November CPI inflation, we made the case for the FOMC to leave the Fed funds rate unchanged. Not surprisingly, the committee didn’t listen to us, lowering the Fed funds rate by 25 basis points instead. The real side of the economy continues to show strength: Earlier this week, third quarter GDP growth was revised up, from 2.8% to 3.1%; and the labor market shows few signs of weakness. Indeed, Cleveland Fed President Hammack dissented, remarking
Economic growth has been strong, and the labor market is healthy. Broad measures of financial conditions have eased, and business sentiment remains robust. Monetary policy has played an important role in bringing PCE inflation down considerably from its peak of 7.2 percent in the summer of 2022. Despite these positive developments, inflation remains elevated, and recent progress in returning inflation to 2 percent has been uneven.
When we worked within the Federal Reserve System, we knew that holding the line on inflation was job one. Thus far, the FOMC has done a bang-up job of reducing inflation without causing much, if any, of a slowdown. Finishing the job will probably require somewhat tighter monetary policy. This was evident in the recent statement and projections showing the likelihood of fewer cuts over the coming year. So, it seems the FOMC realizes that inflation is not where they wish it to be and they certainly cannot deny that the real side continues to show strength. In terms of future policy, a pause in lowering rates is the right course of action at this time.
