Two Measures of Inflation: August 2025
News Summary
As of August 2025, both the core Personal Consumption Expenditures (PCE) Price Index and core Consumer Price Index (CPI) remain above the Federal Reserve's 2% inflation target, registering 2.9% and 3.1% respectively. The Federal Reserve, which prioritizes core PCE as its primary inflation gauge due to its lower volatility, recently implemented a 25 basis point cut to the federal funds rate, bringing it to 4.00%-4.25%. This marks the first rate cut of the year, with two more anticipated before year-end, despite the Committee acknowledging that "inflation has moved up and remains somewhat elevated." Historically, core CPI has consistently shown higher readings and greater volatility compared to core PCE, though the gap has narrowed to 0.21% as of August 2025. While core inflation measures exclude volatile food and energy prices to identify trends, their omission can be a source of public confusion.
Background
Inflation, a key economic indicator measuring the rate at which prices for goods and services are rising, has direct implications for consumer purchasing power, business costs, and central bank monetary policy decisions. The Federal Reserve's dual mandate is to achieve price stability and maximum employment. To fulfill its price stability mandate, the Fed targets 2% inflation and relies on the federal funds rate (FFR) as its primary policy tool. The August 2025 data, showing core inflation still above target despite the Fed initiating a rate-cutting cycle, highlights the ongoing challenge of balancing economic growth with price control.
In-Depth AI Insights
What are the core risks to the Federal Reserve's rate-cutting cycle speed and persistence? - Despite the Fed initiating rate cuts, core inflation data remains above its 2% target, with PCE and CPI at 2.9% and 3.1% respectively. This suggests inflation pressures might be more entrenched than the Fed anticipates, or there's a lag in its policy transmission. - The article notes that "inflation has moved up and remains somewhat elevated," which presents a potential contradiction with the rationale for rate cuts. If future inflation data fails to consistently decline as expected, the Fed might be forced to pause or even reverse cuts, sparking market volatility and reigniting recession fears. - Under President Donald J. Trump's administration, fiscal spending is likely to remain expansive, which could further stimulate demand and exert upward pressure on inflation. This might counteract the Fed's accommodative monetary policy, limiting the effectiveness of its rate cuts. How does the disconnect between core inflation measures and actual cost of living impact the Fed's credibility and policy effectiveness? - While core inflation (excluding food and energy) can be useful for the Fed in identifying trends, its exclusion of these essential household expenses can foster public distrust regarding the actual effectiveness of the Fed's anti-inflation efforts. - The persistent historical discrepancy between core PCE and core CPI, with CPI often higher and more volatile, further compounds public confusion. This perceived "double standard" could erode the Fed's credibility in the public eye, especially if core measures decline while actual food and energy prices surge. - A sustained disconnect between perceived and official inflation could lead to de-anchored inflation expectations, making it more challenging for the Fed to guide economic behavior and achieve its inflation targets. How should investors assess the Fed's policy path and potential investment opportunities in the current economic cycle? - The Fed has commenced a rate-cutting cycle, with two more cuts anticipated this year, typically signaling slowing economic growth or the Fed's belief that inflation is under control. However, given inflation remains above target, investors should be wary of the risk of potential future policy tightening by the Fed. - The narrowing gap between core PCE and CPI might indicate converging inflation pressures, but both remaining above target suggests that long-term rates for fixed-income investments might not decline as rapidly as markets expect. Investors should prudently consider duration risk. - In a persistent inflationary environment, the article mentions agricultural commodity ETFs (like WEAT and CORN) as potentially attractive. This suggests investors might consider allocating to sectors and assets that historically perform well in inflationary conditions, possess pricing power, or benefit from real asset appreciation, to hedge against uncertainty.