Janet Yellen wants to tighten monetary policy before the end of the year, but the economy is not making it easy for her.
The latest economic statistics do not show the clear signals of improvement that Yellen and other members of the Fed are looking for.
The Federal Reserve is supposed to be conducting "data dependent" monetary policy, meaning that it will, at long last, raise interest rates when data suggests that employment is healthy and inflation is nearing its 2 percent target.
But a report on the gross domestic product released Thursday revealed that the economy grew at a mediocre 2.3 percent annual rate in the second quarter, short of the robust pick-up from the slow winter that Wall Street hoped for.
Then, a highly anticipated release on wages on Friday disappointed economists, showing the weakest growth in quarterly compensation in decades.
With expectations high for the Fed to raise rates for the first time since 2008 amid falling unemployment, the lack of clear progress toward the Fed's expectations for economic growth and inflation is raising questions about whether they are ahead of the curve or behind it.
"The short answer is: we don't really know," said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy, part of the Brookings Institution in Washington. "The thing that's really puzzling is what's happening to wages."
Compensation grew at just 2 percent annually through June, according to the broad measure, which was in line with recent estimates from other sources.
Yet, Wessel noted, with unemployment falling steadily in the past few months, wages and prices would be expected to move upward.
The unemployment rate stood at 5.3 percent in June, down from 6.1 percent a year ago and just barely above the level Fed officials believe reflects an economy at full health.
The disconnect probably relates to the fact that the unemployment rate understates the true weakness of the labor market: There are still large numbers of people who have been forced into part-time work or who have given up on the job hunt after finding no success.
Nevertheless, the unemployment rate could easily drop well below the Fed's optimistic long-run projections before the end of the year. One model published by the Brookings Institution predicts that unemployment will drop to 5.2 percent next month and to 4.5 percent by the end of the year, far below the Fed's projection of 5.2 percent on the low end. The model is based on flows of unemployed people into and out of the labor market and has outperformed the Fed's own projections.
In other words, the improvement in employment doesn't track with economic growth and inflation, at least not yet, creating a tough situation for Yellen and company to interpret.
"This whole debate about where employment should be, where wages should be — it's a really difficult undertaking even in retrospect," said Dan Greenhaus, chief global strategist for the financial services firm BTIG.
Shifts within industries, such as job losses in the relatively high-paying field of mining thanks to collapsing oil prices, might explain slow wage growth in the context of falling unemployment, Greenhaus suggested. He believes that the Fed will raise rates at its next meeting in September.
Prices in markets for futures tied to short-term interest rates suggest that most investors don't expect the Fed to move until December.
For her part, Yellen did raise hopes for a clear signal from Friday's wages, saying in June that the a previous spike in the same data source was one of a few "tentative signs of stronger wage growth."
Yellen has made it clear, however, that rising wages are not a precondition for the Fed to move, and that instead they will raise rates when job growth is strong enough to give them confidence that higher inflation is coming. In recent months, prices have been barely rising at all, thanks to oil prices.
Federal Reserve Bank of St. Louis President James Bullard told the Wall Street Journal Friday that weak wage growth would not prevent the Fed from raising rates in September, saying that "the outlook remains fairly good for the economy."
Greenhaus suggested that moderate output growth, falling unemployment and slow wage growth might be sufficient for the Fed as long as the broad trends are pointed in the right direction. "The Federal Reserve is not looking for the economy of our dreams. It's looking at the economy we've got."