According to recent BEA release, inflation as measured by the PCE (personal consumption expenditure) price index rose in August. On a month-over-month basis, this measure of inflation shot up from 0.61% in July to 3.79% in August. There was a more modest increase, from 3.36% to 3.42%, on a year-over-year basis. Our measure of trend rose from 3.36% to 3.42%.
As our readers well know, the Fed places more emphasis on core PCE inflation — that is, after removing the food and energy components. By this measure, monthly inflation rose from 1.52% to 3.01% (annualized) while the annual rate was almost unchanged, increasing from 2.98% to 3.01%. Our measure of trend bumped up from 2.46% to 2.64%.
Chairman Warsh has commented previously about inflation measures and some have suggested using a “trim” rather than a “core” measure. The PCE trimmed mean came in at 1.92% on an annualized monthly basis and 2.19% year over year. We will see what measure the Fed will start to rely on….
These inflation numbers put the Fed in a bind. 3% is well above the committee’s stated target of 2%. To be sure, the trimmed mean PCE inflation rate is near the Fed’s target — but there’s always a danger that the Fed will be seen as shopping for some measure of inflation that meets its target. While the FOMC raised the Fed funds rate by 0.25 percentage points at its last meeting in mid-September, it’s not clear that this increase is sufficient to bring inflation down to target in a timely fashion.
The Bureau of Labor Statistics’ September CPI release reports a marked increase in month-over-month inflation from 0.89% to 4.86% on an annualized basis for the overall CPI, and from 2.62% to 3.53% for core CPI. There was little change in the year-over-year inflation measures: From 3.30% to 3.35% for overall CPI, and a modest decline from 4.47% to 4.45% for core CPI. As we have discussed in previous posts, our trend measure of inflation takes a middle ground between the highly volatile month-over-month measures and the extremely sluggish year-over-year measures. Our measure of trend inflation rose from 1.92% to 2.90% for overall CPI, and a more modest increase, from 2.17% to 2.62%, for core CPI.
The 16% trimmed mean CPI inflation rate was little changed: it fell from 2.71% in July to 2.67% in August. As mentioned in an earlier post on the CPI and trimmed mean, there is a lot of noise in monthly price movements. The “core” notion, removing food and energy, is a now often used measure. As can be seen above, the headline number moved up substantially and the core measure by a little less. While the core removes food and energy alone, the price movements across all areas can also be volatile. The components graph below shows a few different categories, with medical care prices falling substantially. The 16% trimmed mean removes the top and bottom 8% of the price changes.
By almost any measure, the price numbers remain well above the Fed’s 2% target, putting more likelihood on rising interest rates in the near future.
According to the BLS, the U.S. economy shed 23,000 jobs in July. As if that’s not bad enough, May employment gains were revised down from 129,000 to 66,000 while June was revised down from 57,000 to 20,000.
At the same time, the same BLS report revealed that the unemployment rate fell from 4.19% to 4.09%. To be sure, the headline jobs numbers and unemployment rate are from different surveys: the jobs numbers from an Establishment Survey, unemployment from a Household Survey. But this is only part of the story since the household survey has shown even larger employment losses.
There have been recent discussions in the news regarding “breakeven” job gains. This discussion involves some math, but is nonetheless helpful since it points to reasons why low — or even negative — job changes can be consistent with an unchanging unemployment rate. To start, the population (P) (defined as those 16 years of age and not in an institution) can be divided into three mutually exclusive groups: employed (E), unemployed (U) and nonparticipants (N):
The labor force participation rate is given by
Now, suppose that the labor force participation rate is constant over time while population grows at rate n%:
For the participation rate to remain unchanged, it must be that the labor force, U+E, also grows at rate n%. Next, define breakeven employment gains as the increase in employment required to keep the unemployment rate unchanaged. Since the unemployment rate is given by
it follows that for the unemployment rate to remain fixed, it must be that the number of people unemployed, U, grows at the same rate as the labor force, U+E, and therefore, employment (E) also grows at the same rate, n.
What do these back-of-the-envelope derivations imply for breakeven job gains? Since 1970, U.S. population growth has averaged maybe 1% per year, or 0.08% per month. Since U.S. employment is around 159 million, breakeven job gains works out to nearly 132,000 per month (that is 0.08% of 159 million). However, U.S. population growth has slowed to perhaps 0.6% per year since 2000; the associated breakeven employment gain is close to 79,000 per month. Some commentators have suggested that U.S. population growth is actually negative. If population falls 0.5% per year, then the U.S. labor market can actually lose 66,000 jobs per month yet the unemployment rate will remain unchanged!
There are, of course, other things going on. For example, for the purposes of illustration, we worked with a constant labor force participation rate. Between 1960 and 2000, the labor force participation rate rose from less than 60% to around 67%. Such an increase would lead to a higher level for breakeven job gains. Since 2000, the labor force participation rate has fallen below 62% which, in contrast, would lower the value of breakeven job gains. The current labor force participation rate is 61.5%, suppose the labor force participation rate fell by 0.5 percentage points to 61%, the breakeven employment gain would be -23,900.
With all of the above in mind, it’s not clear that the labor market is displaying weakness when the U.S. job market is shedding jobs.
The Bureau of Economic Analysis has released Personal Consumption Expenditure data for May. On an annual basis, overall PCE inflation rose from 5.03% (April) to 5.53% (May). The year-over-year inflation rate also increased, from 3.80% to 4.07%. Our measure of trend PCE inflation is similarly up, from 5.29% to 5.37%. The Fed’s stated target is 2% inflation.
The Fed’s preferred measure, core PCE inflation shot up from 3.05% to 3.91% (month-over-month, annualized), or from 3.32% to 3.41% (year-over-year). Our measure of trend: 3.75%, up from 3.67%.
The new FOMC Chair, Kevin Warsh, has his job cut out for him. To be sure, after inflation rose in the post-pandemic environment, the Jerome Powell-led Fed failed to bring inflation down to its 2% target. Developments in the US-Iran war have, no doubt, contributed to the increase in overall PCE inflation. However, core PCE inflation — which strips out the “volatile” food and energy components — is far less susceptible to these developments.
To understand the problem facing Warsh, suppose that there are two types of central bankers: hawks who are tough on inflation, and doves who are not. It’s cheap for central bankers to go around telling everyone that they’re a hawk. Such speeches are largely uninformative. The implication is that when there is a change in leadership, the public is quite uncertain whether the new leader is a hawk or a dove. (We’re ignoring the unlikely case in which the central banker wants to be known as a dove.) How does a central banker gain a reputation for being a hawk? By making tough decisions that a dove would not. In the current environment, a dove would be prone to lowering the Fed funds rate; a hawk would raise it. Leaving the rate unchanged may well be interpreted as being dove-like. Importantly, once a central banker comes to be viewed as a dove, it is very difficult to rehabilitate that reputation: it would requite a prolonged period of hawk-like actions. Assuming that Warsh is committed to a 2% inflation target, he has a tough choice between: (a) immediately behaving like a hawk, raising the Fed funds rate; or (b) later acting like a hawk and for a much longer period of time. Acting later will be economically more disruptive than acting preemptively. Good luck Mr. Warsh.
Squinting just the right way, one may see some good news in the recent CPI report. To be sure, inflation is running far too high. On an annualized month-over-month basis, inflation was 5.82% in May — but that’s down from 7.96% in April. Our measure of trend inflation was 6.14% in May compared to 6.30% in April. That the year-over-year inflation rate rose from 3.78% to 4.17% chiefly reflects the burst in inflation that started with the US-Iran war.
The story is much the same with core CPI (that is, after stripping out food and energy prices). The month-over-month rate fell from an annualized 4.61% (April) to 2.53% (May); our measure of trend also fell from 3.26% to 3.01%. Again, the year-over-year measure rose, from 2.74% to 2.82%.
What all of this means for monetary policy is anyone’s guess. New Fed Chair Kevin Warsh is said to prefer trimmed mean measures of inflation. In brief, trimmed means throw out those prices with the highest and lowest changes in any given month. We suppose Warsh means trimmed PCE inflation, but maybe he means trimmed CPI inflation. Will the rest of the FOMC go along with Warsh? The danger in switching from core PCE to trimmed mean PCE inflation is that the Fed may be seen as acting opportunistically, choosing a measure of inflation that fits preconceived notions regarding the future trajectory of the Fed funds rate.
Employment report
The BLS announced that payroll employment increased 172,000, again crushing expectations. The private sector added 120,000 and the government also showed an increase of 52,000.
It has not been a very good year for private forecasters when it comes to employment…no one said it was easy!
Average weekly hours remained at 34.3 and average hourly earnings rose from $37.41 to $37.53.
The household survey showed an increase of 149,000 and the number of unemployed persons fell by 66,000. The unemployment rate fell slightly, from 4.34% to 4.30%.
Overall, the labor market continues to perform above “expectations” and will make it difficult for policy makers to point to a weak economy.
The good news from the Bureau of Labor Statistics’s CPI report is that annualized monthly CPI inflation fell from 10.89% (March) to 7.96% (April). Compared to a year ago, prices are up 3.78% (April) compared to 5.47% (March). Our measure of trend CPI inflation rose from 5.47% to 6.30%.
Core CPI inflation (that is, excluding food and energy) rose from 2.38% to 4.61% on an annualized monthly basis; from 2.60% to 2.74% for the year-over-year. Our measure of trend core CPI inflation rose from 2.58% to 3.26%.
Of course, the big news is the energy price shock due to the ongoing conflict in the middle east. Looking at energy commodities (gasoline and fuel oil), April (92.8%) also fell compared to March, 919%, but the March number was in rarefied air, see the scale on the vertical axis. Moreover, inflation expectations have begun to creep up. The hope, of course, is that the oil supply problem will be a temporary blip.
The Personal Consumption Expenditure price index will not be released for a couple of weeks. While the CPI for April suggests that monthly PCE inflation may fall, all other measures — including the all-important core PCE inflation — are likely to continue moving away from the FOMC’s 2% target.
The year-over-year core PCE inflation rate ticked up from 3% in December to 3.06% in January. The outlook is worse in the sense that the annualized month-over-month core PCE inflation rate has been running well over 4%. As discussed in previous posts, the year-over-year rate is roughly the average of the previous 12 month-over-month inflation rates. As a result, the change in the year-over-year rate between December 2025 and January 2026 is determined by the difference in the month-over-month observation being added into this 12 month average, 4.45% for January 2026, and the observation being dropped, 3.84 for January 2025. Our trend measure of inflation is the happy medium of the volatile month-over-month rate and the slow-to-adjust year-over-year rate. Trend core PCE inflation rose from 3.14% in December to 3.58% in January.
Year-over-year overall PCE inflation fell slightly from 2.91% in December to 2.83% in January as the month-over-month rate fell from 4.39% in December to 3.35% in January. Our trend measure moved up from 3.26% to 3.29%.
Policy Outlook
The bottom line is that core PCE inflation is running well above the Fed’s 2% target. Keep in mind that the latest PCE release is for January 2026. Earlier this week, CPI data for February was released. It is not until April 9 that the corresponding PCE data will be available — the delay once again due to the month-long federal government shutdown in the Fall. Consequently, the effects of the runup in oil prices in anticipation of the war with Iran have yet to show up in the PCE price data. While core inflation measures strip out the immediate effect of changes in energy prices, the effects of the war will eventually filter into other prices, partly through increased transportation costs that will be priced in to final goods prices, and eventually into food prices since the Middle East is an important supplier of fertilizer ingredients.
The BLS’s Consumer Price Index release is mildly bad news on the inflation front. While the overall CPI inflation rate fell, on an annual basis, from 2.61% in November to 2.65% in December, the monthly rate picked up from 1.23% to 3.75% (on an annualized basis). Our measure of trend rose from 2.19% to 2.71%.
Annual core CPI inflation (that is, excluding the `volatile’ food and energy components) showed little change, rising from 2.62% in November to 2.65% in December). However, the montly rate rose sharply from 0.96% to 2.91%. The increase in our trend measure was more moderate, rising from 1.94% to 2.26%.
The BLS also released Producer Prices for November 2025, so a bit dated. That portion of the producer price index relevant to personal consumption shows inflation running above the FOMC’s 2% target.
Much of our interest in the CPI data arises from its role as a signal for the PCE (personal consumption expenditure) index data that will be released in just over a week. Past experience tells us that while CPI and PCE inflation tend to move together, this is not a tight relationship in that one percentage point increase in CPI inflation is no guarantee that PCE inflation will similarly rise by one percentage point. With this in mind, we regressed measures of PCE inflation against their CPI counterparts, then used these regressions to develop predictions for PCE inflation later this month. This statistical model predicts that year-over-year PCE inflation for December will be around 2.36% (for both overall PCE and core PCE inflation) while our measure of trend will be 2.44% for overall PCE, and 2.11% for core PCE inflation. We will see how well these predictions fare.
Given these numbers it seems unlikely that the Fed will be lowering rates any time soon, i.e., inflation is, by no means, tamed.
We are finally seeing jobs numbers for October and November. The Bureau of Labor Statistics press release studiously failed to mention the loss of 105 thousand jobs in October — except to mention the 162 thousand fall in federal government employment. Perhaps this omission is a leftover from Trump having fired the previous head of the BLS after the BLS revised the May and June employment numbers down. With September employment revised down to 108 thousand (from 119 thousand), there was a scant 3,000 increase in employment over September and October. November delivered an anemic 64 thousand job gain.
As noted in the BLS press release, due to the Federal government shut down, the household survey for October was not collected. In the figures using household survey data, we have allocated half of the change from September to November to each of October and November (and omit the October figure to emphasize that this data is unavailable).
The unemployment rate is similarly missing for October 2025. The November unemployment rate rose to 4.56%, up from 4.44% in September. This is the highest unemployment rate in four years.
Overall, the employment numbers are fairly weak. Although average weekly hours rose from 34.2 to 34.3, so that total hours of work in the US rose. Moreover, firms continue to be opening jobs at a relatively high rate even though the hiring rate has been falling.
Inflation
There were two price index reports released, the September PCE and the November CPI. The September monthly (annualized) PCE rose slightly, from 3.14% to 3.27%. Our preferred trend measure rose from 2.70% to 2.89%. The Fed’s inflation measure of choice, the core PCE (PCEX) fell from 2.68% to 2.40% and our trend measure also fell, from 2.82% to 2.68%. While core PCE inflation is moving in the right direction, it is still above the FOMC’s 2% target.
Due to the federal government shutdown, October data for the Consumer Price Index was not collected. Below, the November CPI inflation rate is the average for the two months from September to November. The monthly annualized CPI rate for October November averaged 1.23%, down from 3.79% in September and our trend measure fell to 2.19% (October-November) from 3.38% in September. In the graphs below we have included the November number with dots. Annualized core CPI inflation was 0.92% in October-November while the trend measure was 1.94%.
Certainly good news on the inflation front: the last reading on the Fed’s preferred core PCE inflation measure moved down (albeit still above target) and the more timely CPI measures have continued downward, a trend that hopefully will soon be reflected in the PCE inflation measures. As inflation approaches target, the inflation hawks on the FOMC will have less reason to insist on keeping interest rates high. At the same time, the slow hiring in the labor market should allow some to argue more strongly for more rate cuts.
On Friday, the Bureau of Labor Statistics released Consumer Price Index data for September. While the annualized month-over-month CPI inflation rate fell (from 4.69% in August to 3.79% in September), the annual rate rose (2.94% to 3.02%) as did our measure of trend (from 3.18% to 3.38%).
Core CPI inflation provides a glimmer of good news: the monthly, annual and trend rates all fell. The annualized monthly inflation rate fell from 4.23% to 2.76; the anual rate from 3.11% to 3.03%, and our trend from 3.38% to 3.17%.
Policy Outlook
Rather than speculate as to what the FOMC is likely to do with its policy rate at its upcoming meeting, we’ll focus on what the committee should do. Keep in mind that the FOMC primarily looks at core PCE inflation, not (core) CPI inflation. However, the PCE data is not scheduled to be released until Friday while the committee meets Tuesday and Wednesday. (Given the federal government shutdown, we were taken by surprise when the BLS released the CPI numbers; we have no idea whether the BEA will similarly release the PCE data on Friday.) Keeping in mind that on average CPI inflation runs ½ percentage points higher than the corresponding PCE inflation rate, our trend measure of core CPI inflation for September suggests that trend PCE inflation can be expected to be around 2.7% – 0.7 percentage points higher than the FOMC’s target of 2%. Alternatively, if the change in trend core PCE inflation is the same as for trend core CPI inflation (0.2 percentage points), expect a PCE inflation rate just over 2.6% – again higher than target. Further lowering the Fed’s policy rate is not warranted given these inflation numbers. As many know, the Fed has a dual mandate and has indicated that the risks of a labor market slowdown has become a major factor in the decision making process. Unfortunately, the BLS has not released the latest employment numbers.
