We’ve recently talked a lot about inflation, a key focus for the Federal Reserve. With that said, we have yet to spend much time discussing the two primary measures of inflation, the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index.
First and foremost, while CPI is widely known and often generates headlines, the Federal Reserve actually bases its 2% inflation target on PCE. This is important and something that most news outlets skim right over. Therefore, understanding the differences between these measures is crucial for interpreting inflation data and its implications for Fed policy.
To start with, each report is produced by a different government agency. The CPI report is generated monthly by the U.S. Bureau of Labor and Statistics, an agency of the Department of Labor. At the same time, the PCE report is created monthly by the U.S. Bureau of Economic Analysis, an agency of the Department of Commerce.
Given the agencies involved, their calculation method is the most significant difference between CPI and PCE. The CPI information relies on consumer surveys to determine spending weights, while the PCE components use actual spending data. This leads to disparities, such as Americans devoting more spending to alcohol according to Commerce Department (PCE) data compared to Labor Department (CPI) figures.
The gap between the two measures has recently been significant, with PCE running cooler than CPI. In January, overall PCE rose 0.3% from December, up 2.4% from a year earlier. However, the January CPI was up 3.1% from a year earlier, indicating a much different inflation picture compared to PCE. The core figures, which exclude food and energy items, also show a notable difference, with core PCE rising by 2.8% and core CPI increasing by 3.9% from a year earlier.
As we’ve highlighted in previous weekly updates, housing costs play a significant role in inflation calculations, particularly in the CPI, where shelter costs account for about 36% of the index’s weight. However, in the PCE, shelter costs only comprise about 15% of the index. This weighting difference has contributed much to the current variations in the inflation rates. If shelter costs moderate, as expected in the coming year, the gap could begin normalizing.
Looking ahead, factors beyond shelter, like healthcare services, could impact inflation rates differently in the CPI and PCE. While healthcare services account for only 6.5% of the CPI, they comprise 16.1% of the PCE. This discrepancy, in addition to different data sources used for healthcare prices, could keep the gap between CPI and PCE inflation wide for most of the year.
Overall, most economists expect both core CPI and core PCE to cool over the course of the year. However, we know from history these forecasts are not remarkably accurate. Therefore, the focus will continue to be on the monthly reports for CPI and PCE. And remember, even though CPI will take most of the headlines, the PCE numbers will likely be the Fed Policy drivers.
Economy
- Markets kept pushing higher again this week, with the S&P 500 up 0.9%, the Nasdaq up 1.7%, and the small-cap Russell 2000 up 3.0%.
- The U.S. economy expanded an annualized 3.2% in Q4 2023, slightly below 3.3% in the advance estimate, following a 4.9% rate in Q3. The downward revision is due to private inventories.
- U.S. personal income rose by 1% MoM in January, up from 0.3% in the prior month and vastly exceeding market forecasts of a 0.4% advance.
- Continuing jobless claims rose by 45K to 1,905K the previous week, the highest since November and well above market expectations of 1,874K.
Stocks
- U.S. equities were in positive territory. Technology and Real Estate were the top performers, while Healthcare and Consumer Staples lagged. Growth stocks led value stocks, and small caps beat large caps.
- International equities closed higher for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield decreased eight basis points to 4.18% during the week.
- Global bond markets were in positive territory this week.
- Government bonds led for the week, followed by corporate bonds and high-yield bonds.
