Inflation: CPI vs. PCE

Inflation impacts our household budgets and also our investments.

CPI is used to adjust the income from I-Bonds and TIPS. The Fed pays more attention to PCE inflation when making decisions on the fed funds rate.

One Says 2.4%, Another Says 3.1%. Which Inflation Metric Is Right?

The Labor Department’s measure makes headlines. The Commerce Department’s measure, released Thursday, is what the Fed watches.

By Justin Lahart, The Wall Street Journal, Feb. 29, 2024

The Labor Department’s monthly report on consumer prices, known as the consumer-price index or CPI, is generally thought of as “the” inflation report. It generates headlines, features in politicians’ speeches and moves markets—including earlier this month when a hotter-than-expected report sent the Dow Jones Industrial Average tumbling over 500 points.

But the Labor Department’s figures aren’t the Fed’s focus. Instead, the central bank bases its 2% inflation target on the inflation data that comes out with the Commerce Department’s monthly report on income and spending. That is known as the personal-consumption expenditures price index, or PCE…

PCE prices run cooler than the CPI, and lately the gap between the two has been especially large. Thursday, the Commerce Department reported that overall consumer prices rose 0.3% in January from December, putting them up 2.4% from a year earlier. In contrast, the January CPI was up 3.1% from a year earlier… [end quote]

Bond investors have a number of choices which include whether or not the bond yield is inflation-adjusted and also the duration of the bond. The Fed tracks inflation expectations for various periods of time.

These are all in the 2.1% - 2.5% range. Is this realistic or optimistic?

If inflation turns out to be higher than the market expects, TIPS would be a better investment than Treasuries (or equivalent ultra-safe FDIC-insured bank CDs or AAA corporate bonds).

Lower inflation for an “extended period of time” would encourage the Federal Reserve to cut the fed funds rate since the real yield is rising as inflation falls. That would be beneficial for the stock market, especially for tech companies with high borrowing and little or no profits.



Background reading on the differences between the two yardsticks/meter sticks.
Crosswalk Talk: What’s the difference between the PCE and the CPI? | CEA | The White House.


@WendyBG some of this is new territory twisting in the wind.

The main goal is to keep inflation down and taxation moderate. The rates may drop but possibly not by much. This means interest rate spreads against inflation may be very rich for quite some time to come.

In counter-cyclical economics, the reason is last cycle low treasury yields hurt capitalization much later in the cycle and higher taxes now would face brutal pressures to come down into inflation later in the cycle. The timing is reversed this time. This will save the USD from devaluation and extend the demand-side industrial period in the US.