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.
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 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 BLS announced that employment in June rose 206,000, about 1/3 of that came from government employment. Downward revisions to the earlier months totaled 111,000.
The service sector saw a 117,000 increase with the health care and social assistance sector increasing 82,400; however the largest decline in the service sector came from temporary help services, falling 48,900 and has been in decline for a over the past year and a half or so.
Average hours of work remained steady at 34.3 and with the 136,000 private sector increase in employment meant only a small increase in total hours of work.
The household survey shows a 116,000 increase in employment. 277,000 more people entered the labor force and the number of unemployed persons increased 162,000. These changes led to an increase in the unemployment rate from 3.96% to 4.05%.
Policy Chatter
The labor market continues to run strong, despite the recent mediocre showing although the unemployment has risen slightly to 4.05%. Inflation has trended down and, depending on the particular measure, is not a great cause for concern. Some are calling for an interest rate cut my the Fed. Indeed, Mark Zandi, Chief Economist at Moody’s, has said that the Fed should lower interest rates since the Fed “has hit their objective.” If they have hit their objective of full employment and low inflation, does it seem reasonable to be lowering, or raising rates, at this time. He does continue by saying that maybe the equilibrium interest rate for the economy could be higher, but he says it is not 5.5%. Obviously this is an issue that the Fed will be dealing with in the near future.
The CPI was unchanged in May according to the BLS release. By any one of the measures, year over year, 3.25%, monthly annualized, 0.69% or our trend measure, 2.70%, CPI inflation is down. The core CPI (ex food and energy) shows a similar pattern.
Food away from home, used cars and trucks and shelter were items with the largest monthly price increases, 0.4%, 0.6% and 0.4%, respectively. The largest declines came from energy commodities, declining 3.6% and a 3.5% decline for the gasoline component.
What to Expect for PCE inflation
As we have discussed in earlier posts, year-over-year inflation measures evolve sluggishly. The reason for this sluggishness is that the year-over-year inflation rate is the 12-month average of month-over-month inflation rates. So, the change in the year-over-year CPI inflation rate equals the month-over-month inflation rate for the current month (the inflation rate being added to the calculation) less the month-over-month inflation rate from 13 months ago (the inflation rate being dropped from the calculation) — all divided by 12. As a result, even if the month-over-month inflation rates started coming in at, say, 2%, it would take nearly 12 months until the year-over-year inflation rate would reflect this new 2% trend.
Instead, consider our trend inflation measure which places a 1/3 weight on the current month-over-month inflation rate, and a 2/3 weight on last month’s trend inflation. Our trend measure of inflation will, necessarily, respond in a more timely fashion to month-over-month inflation rates. Our trend measure of CPI inflation fell by 0.66 percentage points; core inflation by 1.3 percentage points. Similar declines in PCE inflation would result in PCE inflation around 2%, and core PCE inflation around 2.67%. Alternatively, over long periods of time, CPI inflation runs approximately 0.5 percentage points higher than PCE inflation. Subtracting 0.5 percentage points from the May CPI inflation rates suggests PCE inflation of 2.2% for May, and core PCE inflation of 2.8%.
In other words, we expect good news on the PCE inflation front when the data for May is released in a couple of weeks’ time. That said, FOMC members have indicated that they will hold off on rate cuts until they have seen a few months of such positive developments, meaning inflation as measured by the core PCE deflator trending towards 2%. It remains to be seen whether FOMC members will feel pressure to cut rates given that the European Central Bank and the Bank of Canada have already cut their rates.
The FOMC statement came out on the same day as the CPI report and reiterated their earlier view
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.
And so they left the target rate unchanged at 5.25-5.5%. The general statement from the FOMC is that the real economy is still humming along, inflation is not yet revealing the hoped for sustainable decline.
The consumer price index (CPI) rose 3.82% over the month on an annualized basis. While the increase was less than the previous month’s 4.65%, there is still some work to do according to the most recent FOMC announcement:
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.
May 1 FOMC statement
According to our trend measure the CPI fell only slightly, from 4.11% in March to 4.02% in April. The core measure saw a steeper decline, from 4.39% in March to 3.56% in April. Our trend measure of core inflation fell to 3.97% in April compared to 4.17% in March.
All of these measures attempt to remove the highly volatile price movements. Indeed, there is another measure, dubbed Supercore, that contains only services with shelter prices removed. Our trend measure was 2% a year ago but has now climbed to 6.12%
As we have discussed before, the value of looking at CPI inflation is that it gives a hint as to what to expect from the PCE (personal consumption expenditure) inflation that will be released in a couple of weeks. And recall that core PCE inflation is what the FOMC members seem to have their sights on. The good news is that our trend and year-over-year measures of CPI inflation fell by roughly 0.1 percentage points while core CPI inflation fell by around 0.2 percentage points. It would be reasonable to conjecture similar declines in PCE and core PCE inflation. Since our trend measures of these inflation series were 3.5% in March, we’re looking at 3.3 to 3.4% inflation. While inflation is moving in the “right” direction (at least for this one month), inflation is still running well above the Fed’s stated 2% target for core PCE inflation. While today’s news did not rule out a rate cut by the end of the year, it also did little to change anyone’s mind either.
The BLS announced that CPI inflation rose 0.4% from February to March or 4.6% on annual basis. On a year over basis the CPI increased 3.5%. Our preferred measured of inflation rose to 4.11% in March after increasing 3.85% in February and 3.06% in January.
The core CPI inflation (excluding food and energy) also rose 0.4%, 4.39% annualized. The trend measure of inflation increased from 4.06% to 4.17% on an annualized basis.
We know that the folks on the FOMC look to core PCE inflation, not (core) CPI inflation. However, the March PCE price won’t be released for a couple of weeks. Given the overlap in the goods covered by the two price indices, the CPI presumably provides some information for what to expect of the March PCE price index. While the two price indices move together at “long” horizons (annual or longer), at a monthly frequency the relationship is looser. In other words, seeing an increase in core CPI inflation of, say, 0.2 percentage points, does not necessarily mean that the core PCE inflation rate will similarly rise by 0.2 percentage points. With all of these qualifications in mind, the March CPI inflation numbers give us little confidence that March core PCE inflation will be down — much less that it’ll be near the FOMC’s stated 2% target. Considering that the FOMC will probably like to see more than a single month’s inflation at it’s target before lowering the Fed funds rate, we would not bet on lower interest rates any time soon — especially given the continued strength of the labor market and GDP.
The BLS announced that payroll employment increased 303,000 in March, another solid reading that will likely change the Fed’s stance concerning the timing of cuts in the Fed Funds rate. The private sector added 232,000.
The construction sector jumped up 39,000, the largest increase since May of 2022.
Average weekly hours of work rose from 34.3 to 34.4 leading to a 5.7% (annualized) increase in total hours of work.
The household survey also showed considerable strength with employment increasing 498,000. The labor force increase 469,000 leading to an increase in the labor force participation rate to 62.7 (was 62.5). The number of unemployed persons fell 29,000 and the unemployment rate fell from 3.86% to 3.83%.
On April 2 the BLS JOLTS data showed that job openings changed little in February, at 8.8 million and the rate of job openings remained at 5.3% for the third straight month.
The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000 average over the previous 12 months. The payroll data for January and December were revised down by a total of 167,000. The private sector added 223,000 new jobs, the largest gain since May of last year.
Temporary help services employment continues a steep decline after a sharp post-pandemic rise.
Average hours of work increased from 34.2 to 34.3. The increase, along with the 223,000 private employment increase led to a hefty increase in total hours of 5.6% at an annualized rate, also the largest increase since May of last year.
The establishment report, once again, beat “expectations;” the WSJ survey of economists was 198,000. Other than the downward revisions, mentioned above, another bit of negative news was a smallish increase in wage growth, from $34.52 to $34.57.
The household survey shows that the labor force increased 150,000, a drop in employment of 184,000 and an increase in the number of unemployed persons of 334,000. The labor force participation rate held steady at 62.5, the employment to population ratio decreased from 60.2 to 60.1 and the unemployment rate increased from 3.66 to 3.86. Remember that the unemployment rate is the number of unemployed relative to the labor force (the number employed plus the number unemployed). Consequently, the unemployment rate can go up if the number of unemployed rises holding fixed the labor force, or if the labor force shrinks holding the number unemployed unchanged. An increase in the unemployment rate is not necessarily a bad thing: it may reflect a strong labor market drawing “marginally attached” individuals from outside the labor force. Indeed, there was a 96,000 decline in those workers.
Earlier in the week, the BLS announced JOLTS (Job Openings and Labor Turnover Survey) data for January. There isn’t much to report here as the job openings changed little at 8.9 million, the number of hires and total separations were little changed at 5.7 million and 5.3 million, respectively.
As has been the case for the last couple of years, the number of job openings remains higher than the number of unemployed persons.
Also earlier in the week the BLS announced that productivity increased 3.2% in the 4th quarter with output rising 3.5% and hours of work rising 0.3%.
The bottom line is that the labor market continues its surprisingly (to some) strong performance, once again proving stronger than many had expected. This strength makes it difficult to justify any interest rate cuts soon, particularly given the recent inflation spike.
