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.
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.
Inflation as measured by the CPI is up in November. Month-over-month, the all-items CPI inflation rose from 2.97% in October to 3.82% in November. A more modest rise in this measure of inflation was recorded on a year-over-year basis, from 2.58% (October) to 2.73%. Our measure of trend CPI inflation popped up half a percentage point, from 2.31% to 2.81%. As we have emphasized in the past, our trend measure is smoother than the monthly inflation rate while at the same time responding in a more timely fashion to changes in trend than the annual inflation rate.
The situation is broadly similar when looking at inflation based on core CPI (excluding food and energy). While the year-over-year core CPI inflation rate is essentially unchanged at 3.30%, the month-over-month rate rose from 3.42% to 3.76%. Our trend measure is up nearly 0.2 percentage points, from 3.18% to 3.37%.
While, the FOMC mainly focuses on inflation as measured by the core PCE price index, this measure of inflation, and that measured by the CPI, tend to move together. The best that can be said of the November CPI report is that year-over-year core CPI inflation was unchanged. This observation is of little comfort given that October’s year-over-year core PCE inflation rate was 2.80% — well above the Fed’s stated 2% target. In an earlier post on the October PCE inflation results, we pointed out that comments from FOMC members have raised expectations for a December rate cut; given the negative inflation picture painted by the October PCE, we asked whether the committee would defy those expectations. As we see it, inflation has not been brought to heel. Our recommendation: no change in the Fed funds rate target at the December meeting, and start preparing the public for the possibility of raising this rate in the future to bring inflation well and truly down to target.
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.
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 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 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.
Today’s PCE report was largely foreshadowed by the CPI report two weeks ago. Our measure of trend core PCE inflation fell 0.8 percentage points, from 3.42% to 2.61%, compared to the 0.7 point fall in the corresponding CPI inflation rate. The year-over-year core PCE inflation rate fell a more modest 0.2 percentage points to 2.57%. Meanwhile, the month-over-month rate fell a whopping 2.15 points (compared to 1.6 points for CPI) to 1.0%.
The overall (non-core) PCE inflation rate fell to -0.1% on a month-over-month basis; our trend measure fell 1.2 points to 2.25%; and the year-over-year rate dropped a more modest 0.1 points to 2.56%. These changes are roughly in line with the earlier May CPI inflation numbers.
Policy Outlook
As we have earlier pointed out, our trend measures of inflation see through the volatile monthly inflation rate changes while at the same time responding rapidly to changes in the underlying inflation trend — unlike the annual inflation measures. While the monthly inflation rate for May is a welcome development, it is but a single report for a series known for its volatility; the FOMC is unlikely to respond to a single positive report. On the other hand, assuming that monthly inflation rates continue to come in near the FOMC’s 2% target, it will take many months for the annual inflation rate to similarly reflect this 2% rate. While our trend measure of PCE inflation has moved towards the 2% target, it isn’t there yet. Between now and the FOMC’s July 30-31 meeting is a single CPI report, and a PCE report on July 30. Unless the real side of the economy softens, we do not anticipate a rate cut at the end of July.
The FOMC meeting September 17-18 will have PCE inflation measures for July and August, as well as a CPI release on September 11. Given that CPI changes are typically subsequently realized in the PCE, there may be sufficient positive inflation developments by the September meeting to warrant a cut to the Fed funds rate. The only fly in the ointment is that the Fed takes pains to avoid the perception that it is in any way meddling in U.S. elections, and so may feel constrained to wait until after the presidential election.
