PCE Inflation Jumps: Two Fed Dissents Signal Looming Hike

Washington D.C. The Federal Reserves preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, accelerated in September, complicating the central banks efforts to tame price pressures even as the US economy showed robust growth. The Commerce Department reported on Thursday that headline PCE increased 0.5% monthly and 3.6% annually, up from 3.4% in August and moving further away from the Fed’s long-run 2% target.

Core PCE, which strips out volatile food and energy costs, also rose, climbing 0.3% month-over-month and 3.1% year-over-year. Both headline and core figures were in line with LSEG economist expectations but marked their highest levels since May, indicating persistent inflationary forces across the economy. This data emerged just as the Bureau of Economic Analysis estimated a strong 3.4% annualized growth for third-quarter GDP, outpacing the 3.2% estimate.

What is the Fed’s Preferred Inflation Gauge?

The Federal Reserve primarily monitors the Personal Consumption Expenditures (PCE) price index as its preferred measure of inflation. Unlike the Consumer Price Index (CPI), PCE captures a broader range of goods and services, including those purchased by consumers and on their behalf by employers (e.g., healthcare). It also allows for shifts in consumer spending patterns, making it generally considered a more comprehensive and accurate indicator of underlying inflation trends that align with the Feds dual mandate of maximum employment and price stability.

PCE: A Closer Look at September’s Data

September’s PCE report highlighted an ongoing challenge for policymakers. The 3.6% annual increase in headline PCE and 3.1% for core PCE demonstrate that price pressures remain elevated. Goods prices saw a 3.9% year-over-year increase, while services prices were up 3.5% from a year ago. Simultaneously, the personal savings rate as a percentage of disposable personal income continued its decline, falling to 3.8% from 4% in August, suggesting consumers may be drawing down savings to maintain spending levels.

Inflation Metric	August Reading	September Reading	Fed Target
Headline PCE (YoY)	3.4%	3.6%	2%
Core PCE (YoY)	3.0%	3.1%	2%

Strong GDP Growth Challenges Fed’s Stance

The Commerce Departments advance estimate for third-quarter GDP painted a picture of economic vigor. Growth at 3.4% annualized exceeded expectations, primarily driven by strong personal consumption and a notable increase in federal government spending, which hit its highest level in at least five years. This resilience, fueled by an indefatigable U.S. consumer and a nascent AI investment boom, as noted by James McCann, senior economist at Edward Jones, complicates the Fed’s path. While robust growth typically indicates a healthy economy, it also signals persistent demand that can fuel inflation.

What This Means for Fed Policy and Interest Rates

Despite the Federal Reserve holding interest rates steady at their October meeting, the latest inflation and growth data suggest pressure for further tightening remains high. The CME FedWatch tool indicates a 79.6% probability that the Fed will raise rates by 25 basis points in December, pushing the federal funds rate to a range of 4% to 4.25%. This probability, though slightly down from 84.2% yesterday, is higher than the 73.3% recorded a week ago, reflecting persistent market conviction in a December hike.

Market Reaction to the Data

Following the release of the PCE and GDP data on Thursday morning, major US equity indices experienced declines. The benchmark S&P 500 Index dropped more than 0.4%, the Dow Jones Industrial Average fell over 0.3%, and the Nasdaq Composite slid more than 1.4%. Investors appear to be digesting the implications of stubborn inflation alongside strong economic activity, weighing the potential for continued monetary tightening against the backdrop of robust corporate earnings and consumer spending.