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 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).
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 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.
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.
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.
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 BLS reported 272 thousand new jobs according to its Establishment Survey, easily beating economists’ expectations of 190 thousand reported by Bloomberg. The job gains for May exceed the average for the previous 12 months, 232 thousand. Job gains for March were revised down 5 thousand while those for April were revised down 10 thousand.
In contrast, the Household Survey indicates that the economy lost 408 thousand jobs in May. Indeed, 5 out of the last 8 months have seen the two surveys going in opposite directions.
The BLS also reported that the unemployment rate rose slightly, from 3.86% to 3.96% in May.
Meanwhile, the labor force participation rate dropped slightly, from 62.7% to 62.5%.
Average hours of work remained at 34.3 and private employment rose 229 thousand, leading to a 2.1% increase in total hours of work. Average hourly earnings climbed $0.14 and continue to lie above year over year inflation, thereby increasing real wages.
While the headline employment numbers come from the establishment survey, the labor force participation rate is calculated from a household survey, and is calculated by the number of people unemployed plus the number of people employed relative to the age 16 and over non-institutional population. Since the labor force participation rate fell, it follows that the sum of employed and unemployed people must have fallen. We also know that the number of people unemployed rose from 6.5 million to 6.65 million. Consequently, for the sum of employed and unemployed people to fall, it must be that the number of people employed fell. And that’s exactly what the Household Survey tells us. But not the Establishment Survey.
Overall, the labor market shows continued strength and will make the Fed’s decision a little more difficult. Inflation is still above the 2.0% target and with the strong economy there seems little reason to lower the rate at the next meeting. However, as we discussed above, reading the labor market is not as easy as first appears.
