Not Much Change in the Data or the Forecast

The economy is at, or very close to, full employment at present. The unemployment rate has been relatively stable over the past year, in part because there has been a pause in the downtrend in the labor force participation rate. By the middle of this year, we expect that downtrend to resume. And with growth expected to run a bit above potential, we are projecting the unemployment rate to drop below the NAIRU  over the forecast period.  

▪ The unemployment rate was 4.8% in January, a tenth lower than a year before but equal to participants’ median estimate of the NAIRU. 

▪ Projected above-trend growth drives the unemployment rate down to 4.5% by the end of this year and to 4.3% by the end of 2018. By the end of 2019, the unemployment rate is expected to be 4.2%,  about ½ pp below our estimate of the NAIRU. 

Payroll employment growth was robust in 2016, with an average monthly gain of 187K, and got off to a  good start in January 2017 with a gain of 227K. 

▪ Reflecting this momentum, and more importantly the continued low level of initial claims for unemployment insurance, we now expect payroll gains to be maintained around 180K per month in the first half of 2017. This is an upward revision of about 20K per month from our previous forecast. 

▪ Further down the road, we still expect payroll employment growth to slow, reflecting some modest increase in productivity growth from its recent anemic pace. 

Core PCE inflation was soft in Q4, as expected, reflecting residual seasonality. For 2016 as a whole, core inflation advanced 1.7%. 

▪ We expect the 12-month increase in core PCE prices to remain at 1.7% for several more months, before edging up to 1.9% by the end of this year. At 1.9%, the FOMC will have virtually hit its 2% inflation objective, what we would call “good enough for government work”! 

▪ After that, we expect core inflation to rise very gradually a bit further to 2.1% as pressure from a tight labor market eventually overcomes substantial inertia and well-anchored inflation expectations. And that barely counts as an overshooting. 

Is wage inflation already on an upward trend? Depends who you ask! 

▪ Recently Fischer and Yellen confidently said that wage inflation was already rising. They read the wage data as providing some confirmation that labor markets have, in fact, tightened. 

▪ Those comments surprised us a bit. We too read the data as suggesting there has probably been some firming of wage inflation. But with the ECI for private compensation—the Fed’s preferred measure, and ours as well—running 2.2% over the past four quarters, we are somewhat less confident that wage pressures are building.  

▪ Average hourly earnings have bounced around some, but over the past 12 months have increased  2.5%, the same rate as a year ago. The Atlanta Fed Wage Growth Tracker has increased faster than these measures for some time, but it too has recently slipped well below its earlier pace. 

▪ Given the softness of the full constellation of wage measures, we have lowered our forecast for the ECI  this year and next. But we still see the trajectory as one of modest acceleration in response to further tightening of the labor market. 

Labor Market: Undershoot 

Inflation: Slight Overshoot 

Major Economic Indicators 

By default, values represent seasonally-adjusted, annualized growth rates (%) for the series indicated n the leftmost column. 

Note on Units and Transformations 

“Quarterly” values are q/q rates; “Annual” values are q4/q4 rates. For series followed by units I n parentheses, “Quarterly” values are quarterly averages, and “Annual” values are q4 averages. 

* “Quarterly” values are not compounded to annual rates.

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