PCE Index Drops to 2.1%, But Many Americans Still Think Prices Are Too High

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The Personal Consumption Expenditures (PCE) price index, the Federal Reserve’s preferred tool for gauging inflation, reported a 2.1% year-over-year increase in September, according to recent Commerce Department data. This rate marks the lowest annual inflation since early 2021 and sits just shy of the Fed’s target of 2%. The decrease aligns with economists’ expectations, suggesting that the Fed’s efforts to tame inflation might finally be paying off. But what does this mean for future interest rates and the broader economy?

Why the Fed Prefers the PCE Index

The Federal Reserve relies on the PCE index as its primary inflation gauge over other metrics, such as the Consumer Price Index (CPI), due to its broader scope and the way it adjusts for changes in consumer behavior. While the CPI only tracks out-of-pocket expenses for households, the PCE includes costs borne by others on behalf of consumers, like employer-sponsored healthcare. The PCE also accounts for shifts in spending habits, such as buying less of a costly item, making it a more flexible and responsive measure.

The current 2.1% PCE Index reading, down from 2.3% in August, has heightened market expectations of a rate cut when the Fed meets next week. For over a year, the Fed raised interest rates aggressively, yet the inflation rate has only recently approached the target. Analysts expect that the Fed, buoyed by disinflationary trends and a strong labor market, will implement a modest 0.25% cut, with further cuts projected in 2024.

Reading the Numbers: What the PCE Index Means for the Economy

This month’s PCE Index data reflects not just a cooling of inflation but also a promising outlook for consumer spending and the economy overall. Core PCE, which excludes volatile food and energy prices, rose 0.3% in September, maintaining an annual rate of 2.7%. While still above the Fed’s target, this figure signals stability in underlying inflation pressures. Much of the lingering inflation in the core index is due to real estate and insurance costs, which tend to adjust slowly.

Economists see these signs as supportive of the Fed’s easing monetary policy. According to Gregory Daco, chief economist at EY, “With inflation near the target, it’s likely time for the Fed to pivot from its restrictive stance.”

Impacts on Consumers and the Economy

Inflation’s cooling has brought relief to American consumers, particularly as wages and spending continue to rise. Personal income and spending were both up in September—by 0.3% and 0.5%, respectively. Adjusted for inflation, real spending increased 0.4%, suggesting that consumers continue to feel confident. However, the personal savings rate dipped to 4.6%, the lowest of the year, highlighting that while spending persists, Americans are drawing more from savings to sustain it.

For households, the slowing pace of inflation has lessened pressure on budgets, yet price levels remain elevated. Americans are still cautious about day-to-day expenses, with many still feeling the sting of higher costs. This sentiment underscores why inflation remains a prominent election issue, with candidates from both parties proposing ways to address essentials like food and energy.

What’s the Fed’s Next Move? 

The latest PCE index report and its proximity to the Fed’s target suggest that a rate cut is highly probable. Market analysts widely expect a 0.25% cut, building on September’s half-point reduction. Further cuts in 2024 could bring the federal funds rate down to 4.4% by December and potentially to 3.4% by mid-2025.

As the Fed prepares for its next meeting, indicators of the labor market’s resilience are also key factors. The October jobs report, though likely impacted by recent strikes and weather disruptions, is projected to show a net gain of around 117,500 jobs. If job gains remain steady, it would reinforce the Fed’s confidence in implementing further rate cuts without stalling economic growth.

The Bottom Line: It’s the Economy

The Federal Reserve’s strategy aims to balance price stability with economic expansion. With inflation slowing and consumers still spending, the U.S. economy appears poised for stable growth. While Americans continue to feel the pinch from higher prices, the gradual return of inflation to target levels signals a period of economic resilience. By leveraging the PCE index’s insights, the Fed can make more informed decisions to sustain this trend, benefiting both households and investors.

The latest PCE data paints a cautiously optimistic picture for the U.S. economy, showing the Fed’s inflation control measures are making headway. As inflation nears the target, a pivot in monetary policy could offer relief for consumers and businesses alike. But while inflation may be slowing, maintaining economic stability will require close monitoring of spending, employment, and market trends.

Do you agree with the Fed’s assessment that the economy is close to stability? Tell us what you think!

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