U.S. Economic Snapshot

By Paul Gomme and Peter Rupert

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.

By Paul Gomme and Peter Rupert

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.

FOMC, June 12

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.

By Paul Gomme and Peter Rupert

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.

By Paul Gomme and Peter Rupert

The BLS announced that payroll employment rose by 175,000. In addition, the BLS revised down previous estimates by a total of 22,000, down 34,000 in February but up 12,000 in March. Expectations by professional economists were in the 240,000 range. The slowing was evident pretty much across the board as can be seen in the charts below.

Employment gains in retail and health care, however, remained about the same over the last several months.

Temporary help services have been on a steady decline over the past two years, with only January this year showing an increase.

Average weekly hours of work fell from 34.4 to 34.3, leading to a decline in total hours of work.

The household survey showed an increase of 85,000 in the number employed, 63,000 more unemployed and no change in the labor force participation rate. The unemployment rate rose slightly from 3.83% to 3.86%.

Policy Outlook

The stock market shot up due to several events that occurred over the past week: Q1 GDP, PCE price index, Fed announcement after their meeting and today the employment report. We commented on the GDP and PCE price index reports here. Q1 GDP came in somewhat lower than expected and the PCE price index showed continued inflation pressures. Our bottom line was that while it may have slightly increased the probability of upcoming rate cuts, inflation was still stubbornly high. Indeed the FOMC statement contained the following comment, “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.” Evidently, there has been no recent progress to that end.

Today’s jobs report seems to have the market increasing the odds of a rate cut by summer’s end. The WSJ called it “goldilocks job report for the Fed.” Does a downtick in employment lead to an imminent recession?

To “see through” the effects of the pandemic recession, we removed a set observations from March to September 2020, since those effects were massive. In the figure, months during which the NBER determined the economy was in an expansion, and for which the monthly employment change was less than 175,000 are marked with red dots. There’s a lot of red dots. Looking at periods when the economy did well for a prolonged period of time, 1960s, 1990s, 2010s, the current job numbers look similar. Staring at this figure, it’s difficult to put a lot of credence in the notion that low job gains precede recessions. Or, to borrow a phrase, low job gains have predicted 9 of the last 3 recessions.

By Paul Gomme and Peter Rupert

The Bureau of Economic Analysis announced that, on an annualized basis, the personal consumption expenditures (PCE) price index increased 3.94% and core PCE (excluding food and energy) — the Fed’s preferred measure — rose 3.86%, up from 3.24% in the previous month. As we have commented many times, the monthly numbers are quite volatile and therefore we calculate a “trend” measure that we feel better captures the underlying trend, shown in red below. Both the trend measures indicate an uptick in inflation. These higher PCE inflation numbers were foreshadowed by the CPI release from about two weeks ago.

Earlier in the week the Bureau of Economic Analysis released its advance estimate for first quarter GDP. Output growth has decelerated from 4.9% in the third quarter of 2003 to 3.4% in the fourth quarter of 2023 and 1.6% in the most recent quarter. Personal consumption expenditures increased 2.5% in the first quarter after increasing 3.3% in the previous quarter. Indeed, consumer spending on services was a driving force in the most recent report. Investment increased 3.2% with the residential component increasing 13.9%, the largest increase since the fourth quarter of 2020.

The table below breaks down output growth by the contributions of its major components. The contribution of, say, investment (0.6 percentage points) is given by its growth rate (3.2%) weighted by its share of GDP (18%). Between 2023Q3 and 2024Q1, output growth has fallen by 3.3 percentage points. Of this decline, 0.4 percentage points (2.1 – 1.7) is due to consumption. Investment contributed 1.2 percentage points; government 0.8 points; and exports and imports have both contributed 0.5 points. This tells us that the fall in output growth has occurred due to all components of output, with particularly large contributions by investment and government spending.

Outlook

Over the last few months the likely prospect of several interest rate cuts became dimmer due to a rise in the underlying inflation trend. Has the deceleration in GDP growth over the last couple of quarters increased the likelihood of a rate cut? Given the rising trend in inflation it does not seem likely that a rate cut will happen any time soon.

Our measure of trend core PCE inflation now stands at 3.5% — considerably higher than the FOMC’s 2% target, and moving in the wrong direction. Some may point to the slower output growth numbers as a signal of lower future inflation. But, arguably the right thing to do at this stage is to raise interest rates. However, the FOMC has painted itself into a corner with earlier promises of lower interest rates. While it’s tempting to point to the real side weakness to justify a rate cut, in the longer term, addressing inflation is the better course of action as we learned in the 1970s when the U.S. was hit by stagflation — a stagnating real side along with high inflation.

By Paul Gomme and Peter Rupert

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.

Uh oh! While the year-over-year inflation rate as measured by the PCE deflator was essentially unchanged in February (it rose slightly, from 2.43% in January to 2.45%), the annualized month-over-month inflation rate, at 4.1%, is still running well above the Fed’s 2% target. Our measure of trend inflation rose half a point, from 2.6% to 3.1%. It bears repeating that our measure of trend inflation is designed to filter out much of the high frequency movements in the month-over-month inflation rate while responding in a timely fashion to changes in the trend.

The outlook is not much better when the “volatile” food and energy components of the PCE deflator are removed: The month-over-month inflation rate dropped from 5.6% to 3.2% (good), but is still well above the Fed’s 2% target (bad). The year-over-year inflation rate fell slightly, from 2.9% to 2.8%. And our measure of trend inflation was essentially unchanged, coming in at 3.16%.

The Policy Outlook

In a sense, the latest core PCE inflation numbers are not a surprise: they were foreshadowed by core CPI inflation which came out a couple of weeks ago. For the first two months of 2024, trend core inflation is up and is considerably higher than the Fed’s 2% target. If the monthly inflation rate continues to come in on the high side, expect to see the year-over-year inflation rate start to rise — just as it did in 2020-21. Along side the solid GDP growth and labor market, recent inflation makes it easier for those building a case for raising (or not lowering) interest rates.