The inflation measure most favored by Federal Reserve officials—the core Personal Consumption Expenditures (PCE) index, which excludes the more volatile food and energy components—has recorded its largest monthly increase since April. The year-over-year rise in core PCE was also slightly higher than economists’ general expectations. These figures provide a significant basis for slowing the Fed's rate cuts, especially following last month’s unexpected 50-basis-point reduction. Together with strong retail sales and ADP employment data, some traders are now betting that the Fed may pause rate cuts in December.

According to the latest data released Thursday by the U.S. Bureau of Economic Analysis, core PCE, which excludes volatile food and energy items, rose 0.3% month-over-month in September and 2.7% year-over-year. While the monthly rise matched economists’ expectations, the annual increase was slightly above the consensus of 2.6%.

On the bright side, the overall PCE index showed a more optimistic trend, rising just 2.1% year-over-year in September, the lowest level since early 2021, closely aligned with economists' expectations and only slightly above the Fed’s 2% inflation target. Following the release of the latest PCE report, futures for the three major U.S. stock indexes continued to dip, while the yield on the 10-year Treasury bond turned upward.

What is Core PCE?

Core PCE is an inflation indicator that measures the overall change in the prices of goods and services purchased by consumers. Unlike the more commonly seen Consumer Price Index (CPI), the core PCE index filters out the volatile food and energy categories, focusing instead on more stable prices of consumer goods and services. For example, if oil prices suddenly surge, the CPI would reflect that change immediately, whereas the core PCE would not be affected by short-term fluctuations. This filtering allows core PCE to more accurately reflect long-term price trends.

Why is Core PCE So Important?

For the Federal Reserve, core PCE is crucial for shaping monetary policy. The Fed’s long-term inflation target is 2%; if core PCE rises above this target, the Fed may take action to “cool down” the economy, for instance by raising interest rates. Conversely, if core PCE is significantly below 2%, the Fed might lower rates to stimulate the economy. These policy decisions ultimately impact your loan rates, mortgage costs, and even the prices of everyday purchases.

How Does Core PCE Affect Our Lives?

Imagine core PCE as a “filter” during fluctuations in oil or food prices, helping the Fed get a clearer view of the economic landscape. This not only grounds the Fed’s decisions but also mitigates the impact of short-term price swings on the overall economy.

For example, if inflation were a ship, core PCE would be the compass that guides the Fed’s course, allowing it to steer through economic turbulence with greater confidence and ensure a stable economic journey.

Though core PCE may not be as intuitive as CPI, it plays the role of an “invisible commander” in policy-making, helping the Fed gauge economic trends. For us, understanding the role of core PCE can shed light on interest rate changes, economic policies, and even price fluctuations in our daily lives.

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