What just happened: What is PCE inflation, and why does it matter?

What just happened?

August's US Personal Consumption Expenditure Price Index (PCE), or PCEPI as the US Federal Reserve (Fed) refers to it, clocked in at an annualized rate of 2.2% YoY on September 27, the lowest print of the key inflation metric since March of 2021. This is an important step toward the Fed being able to claim 'victory' over inflation as price indexes continue to ease toward the US central bank's overall target of 2% annual PCE inflation.

Despite the rosy print in headline PCEPI inflation in August, several headwinds to the Fed's policy goals remain. Core PCEPI, a measure of PCE inflation that excludes food and energy prices which are subject to seasonality and volatility, ticked higher to 2.7% YoY in August, implying that underlying price pressures still remain.

Why does PCE inflation matter?

PCEPI is a key metric in the Fed's wide stable of metrics. The Fed broadly favors PCEPI over the widely-followed Consumer Price Index (CPI), because the basket of goods and services used to track PCEPI is adjusted on a more regular basis, and includes out-of-pocket spending for both urban and rural communities. CPI inflation metrics only look at consumer expenses within urban regions, and the CPI index is updated biannually, as opposed to the PCEPI's quarterly rebalance. Because of this, the Fed gives a heavier weighting to changes in PCEPI numbers when setting targets and debating policy shifts.

What happens next?

With PCEPI figures continuing to grind toward in Fed price targets (albeit in a wobbly way), the Fed and global markets will be pivoting to the next round of key US labor and employment figures. The Fed will also be looking for confirmation signs in other inflation metrics, such as the monthly CPI figure, to confirm that inflation will continue to head in the preferred direction.