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Economic Monitor – Weekly Commentary
by Eugenio Alemán

Forget the CPI: Zoom in on the PCE Price Index, particularly the core measure

March 15, 2024

Do you know that the headline Personal Consumption Expenditures (PCE) was 2.4% in January while the core PCE was 2.8%? This is very close to the 2% target. We are not saying the road ahead is not going to be bumpy for markets and for the Federal Reserve (Fed), but there is light at the end of the tunnel.

Since the start of the post-pandemic inflationary burst markets and analysts have been looking at both, the headline Consumer Price Index (CPI), and the headline PCE price indices. However, today, the Fed has a much more important concern than the headline PCE price index (and it actually could not care less about the headline CPI for policymaking). Although the headline PCE price index is important, it has a much more important concern.

The most important indicator for the Fed today when deciding when to start lowering interest rates would be the behavior of core inflation numbers, that is, inflation indices that do not include volatile food and energy prices. But particularly, it is going to look at what is happening to the core PCE price index while markets are probably going to use the core CPI price index to get a hint of what is going to happen to the core PCE price index, as these indices are released with about 15 days difference, which has made the CPI a ‘favorite’ for market analysts and reporters.

Thus, there are two basic reasons why markets and reporters favor the CPI release. First, it comes out early in the month, so it is probably a good indication of how hot or cold the PCE price index is going to be later in the month. But for us, perhaps the most important reason is the second one. Since February of 1959, the correlation between the headline CPI and the headline PCE price indices on a month-over-month basis has been 91.1%, which makes the CPI release a relatively good indication of what we should expect for the PCE price index, which is released later every month. Furthermore, once again, we have to point out that the weight of shelter costs in this index is about 33% compared to only about 13% for the PCE price index so, highly correlated but not the same. However, the core price indices are not as highly correlated as the headline price indices. The correlation between the core CPI and the core PCE price indices since February of 1959 is ‘just’ 78%, still high but not as high as the correlation between the headline CPI and PCE price indices. That is, close, but not that close.

But most importantly, what the Fed is going to focus on during the next several months is what happens with the year-over-year rate of headline inflation (both CPI as well as PCE) versus what is happening with the year-over-year rate in the core CPI as well as core PCE. We continue to prefer the core PCE because it will be what Fed official will focus on going forward and the preferred characteristics of the PCE price index versus the CPI, which we have written about in previous weeklies, added to the fact that the PCE price index is the target the Fed uses to conduct monetary policy.

February’s CPI report is a clear example of what we are talking about. Monthly headline and core prices were both up 0.4% on a seasonally adjusted basis. However, the year-over-year headline rate of inflation increased from 3.1% in January to 3.2% in February while the year-over-year core CPI went down, from a 4.9% rate in January to a 4.8% rate in February. That is, even if the direction of the headline number disappointed, the direction of the core measure continued to move down, even if the month-over-month core CPI was higher than what markets were expecting.

Of course, the core inflation measures will benefit from those sectors that have remained relatively sticky to the downside, like shelter costs and overall services prices so the path forward for core prices is going to remain treacherous, but as long as the Fed continues to see improvement in the core measures going forward, it will become more confident that inflation will remain under control and thus will be willing to start to lower interest rates as soon as midyear.


Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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