U.S. Economic Snapshot

By Paul Gomme and Peter Rupert

The Bureau of Labor Statistics announced that the CPI rose 0.2% on a seasonally adjusted basis in October. Our own calculation using the level of the price index, shows an increase of 0.24% over the month or 2.97% on an annualized basis, up from an annualized 2.18% in September. The year over year increase was 2.58% in October, increasing from the 2.41% reading in September. Our preferred annualized trend measure also increased, from 1.98% in September to 2.31% in October.

Removing food and energy from the index shows a slight drop in the annualized number, from 3.81% in September to 3.42% in October. The year over year saw almost no change, 3.26% to 3.30%. Our trend measure rose from 3.06% to 3.18%. More importantly, our trend measure has been increasing every month since June.

The main reason that “core” inflation is used by the Fed and others is due to the fact that food and energy prices are very volatile and so are removed from the index. However, food and energy are large parts of the expenditure of households. So when households are looking at the prices of things they buy, obviously, food and energy play a large role. Food is roughly 13% of the total expenditures in an average urban budget and energy is a bit over 6%. The largest expenditure category is shelter at about 37%. While one can pick and choose what to take out, many of the measures have also shown increases, but others have not. For example, take food prices. The price index shot up quickly during/after Covid but the growth of prices has come down but have started to rise more recently.

The CPI for services also increased during and after Covid and have since come down but again have started to creep up.

The bottom line is that inflation has come down over the past year or so, but many indicators are showing signs of increasing prices. So, it seems surprising that some Fed officials, namely Kashkari stated that inflation is moving in the right direction and Logan said that “progress on inflation has been broad based,” although Logan was speaking about the PCE, see our commentary about the PCE here.

Solid Output Growth in the Third Quarter

According to the advance estimate for third quarter real GDP, output growth slowed marginally, from 3.0% to 2.8% on a seasonally adjusted annualized rate. Real personal consumption expenditures increased 3.7%. Investment expenditures were weak, growing at 0.3%. Government consumption expenditures and investment grew at 5.0%, led by federal expenditures that grew at 9.7%, the largest since Q1 of 2021.

To better understand what drove the increase in real GDP, it is useful to look at what contributed to overall growth. To do so, the BEA essentially “weights” the change by the share in output. So, while consumption grew at 3.7% it constitutes about 70% of output. On the other hand, while federal government expenditures grew at 9.7% the share is only about 7% of the total. While consumption, government spending and exports increased their contributions to output growth, investment and imports decreased their contributions with imports being a drag on growth.

A MURKY Inflation Outlook

The recently released Personal Consumption Expenditure (PCE) index data sends a mixed message on inflation. Measured relative to a year ago, inflation is down, either from 2.27% to 2.09% for the PCE, or from 2.72% to 2.65% for core PCE (excluding food and energy). These are the numbers that have been making headlines. However, the monthly annualized inflation rate rose sharply, from 1.39% to 2.13% for the PCE, and from 1.89% to 3.09% for the Fed’s preferred core PCE measure. As we have said many times in the past, the monthly inflation numbers are quite volatile — as seen in the figures below. Meanwhile, the year-over-year measures take many months to reflect a change in trend. Our preferred trend measure splits the difference. By this measure, inflation rose in September, from 1.77% to 1.89% for the PCE, and from 2.26% to 2.53% for core PCE.

An Anemic Jobs Report

Employment in October increased by a scant 12,000 jobs. Indeed, the private sector actually shed 28,000. The labor market was roiled by weather and strikes, making it difficult to understand the stance of the labor market. Many economists “expected” a weaker report, something like 100,000 jobs, but note that the deviation from expected and actual is often quite large. To add to the dismal looking report, there was another 112,000 downward revision over the past two months. Average hours of work remained at 34.3 and average hourly earnings rose $35.33 to $35.46.

The household survey also showed some weakness, but keep the hurricanes and strikes in mind. The labor force fell 220,000 and the participation rate fell to 62.6 from 62.7. The number employed fell by 368,000 and there was a 150,000 increase in the number unemployed. The unemployment rate increased slightly, from 4.05% to 4.15%.

Policy Outlook

The real-side picture is mixed: a strongish GDP report, but a weak employment report. Abstracting from the strike activity affecting the employment numbers, the October reading for the labor market is still feeble, particularly compared to September’s strong report. Core PCE inflation is still running at least half a point above the Fed’s 2% target.

One way to try to make sense of all this is to look at the real Federal funds rate: that is, the nominal rate less inflation. The current target for the Fed funds rate is 4.84%. Core PCE inflation for October was 2.54% using our trend measure, or 2.65% as measured year over year. Consequently, the real Fed funds rate is 2.2-2.3%. Whether or not this value is considered high depends on what one things is the “natural” rate of interest: the rate that would prevail if the economy is operating at potential (full employment), and inflation is stable. If one puts credence in the estimates of the New York Fed, it is. So, then one must ask whether now is the appropriate time to continue loosening monetary policy. The answer to this question depends chiefly on: (1) whether one thinks enough tightening has been applied to bring inflation into a “glide path” to 2%; and (2) whether the real side of the economy is (starting to) display weakness. For our money, inflation is job one for the Fed, and there’s still work to be done.

By Paul Gomme and Peter Rupert

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.

by paul gomme and peter rupert

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.”

By Paul Gomme and Peter Rupert

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).