The Federal Reserve’s Preferred Measure of Price Growth

The Federal Reserve’s preferred measure of price growth is expected to have slowed significantly in June, adding to the ongoing decline from its peak. The question now is how long this relief can last.

Forecasted Slowdown in Core PCE Price Index

Economists are forecasting that the core personal consumption expenditures (PCE) price index climbed by 0.2% in June, based on consensus expectations from FactSet. This is a decrease from the 0.3% increase seen in May. If this forecast holds, it would bring the annual pace of PCE price growth to a rate of 4.2%, down from the 4.6% annual pace recorded in May.

Factors Contributing to the Expected Slowdown

The anticipated slowdown in price growth can be attributed to various factors, including cooling shelter costs, falling prices for used cars, and lower-than-expected airfare prices. Additionally, gas prices, which are not considered in the core PCE measure but included in the headline figure, were also lower last month. As a result, consensus forecasts indicate that headline PCE inflation is expected to slow to a 3% annual pace in June, compared to 3.8% in May.

Welcomed News for the Federal Reserve

The cooling of price growth will be welcomed by the Federal Reserve as it strengthens expectations that disinflation is beginning to take hold. However, it is still too early to determine if the June data reflects the start of a longer-term trend.

Wall Street’s Optimism

Wall Street remains hopeful that continued inflation data showing a deceleration in price growth for another month or two will lead the Fed to halt its interest rate hikes. This would also increase the likelihood of the economy avoiding a recession. The progress made so far is evident, with an annualized core PCE inflation rate of 4.2% being the slowest growth rate since September 2021. This marks a significant decline from the peak of 5.4% reached in February 2022.

The Road to Achieving Target Inflation

The Federal Reserve has set a target inflation level of 2%, but it seems there is still a long way to go before core inflation reaches this goal. Economists are warning that the second half of the year could present greater challenges in achieving progress, especially in the Personal Consumption Expenditures (PCE) index, which is the preferred metric for the Fed.

Diverging Components in Inflation Measurements

One reason for the discrepancy lies in the forthcoming months, where significant declines in price growth are expected in the shelter and used-car categories. While these are major components of the Consumer Price Index (CPI) and heavily weighted, they receive only half as much weight in PCE calculations. As a result, the decline in PCE figures may appear less pronounced.

Veronica Clark, an economist with Citi, explains, “So when those numbers are coming down, the drag on PCE is going to be smaller.”

Core Services That Will Keep PCE Elevated

Despite the potential decline in certain categories, core services excluding shelter still show strength. In fact, these services make up a larger share of PCE compared to CPI. Notably, medical services are expected to see a rise this year, while sectors like recreation services are poised to remain strong. Consequently, these factors will contribute to maintaining elevated levels of core PCE.

Clark adds, “At least in our forecasts, you can get three or four months where you keep your running monthly core CPI at around 0.2%, and that looks pretty good. But our core PCE forecasts are actually more like 0.3% every month.”

Looking Ahead

The release of PCE data by the Commerce Department is eagerly awaited at 8:30 a.m. As economists continue to monitor inflation levels closely, it remains to be seen whether the Fed’s 2% target can be achieved in the near future.