Category: Inflation

The six month lag for Friday’s Core PCE report came in at 2.5% for August, down from 3.0% the previous month. The probability that centered 1 year inflation rose over the previous 6 months also fell to 21%. The 3 and 12 month figures were higher at 2.9%.

While 3 and 12 lagged inflation is far worse at predicting one year centered inflation than the 6 month lagged inflation, we need to be wary of data artifacts, in this case the unusually high price report from February 2025. We can guard against misinterpretation by bracketing our preferred measure with 5 and 7 month lagged inflation, which have nearly the same predictive power as 6 month inflation. Those 2 figures came in at 2.8% and 2.9%, respectively. Bottom line, the story is similar to last month, implying stable inflation of around 2.9%.

The 3, 6, and 12 month annualized percentage changes show similar core PCE inflation: they are pegged at 3.0%, 3.0%, and 2.9% respectively. Inflation is stable, albeit at a higher level than the Fed’s long run 2.0% target.
Economic historian and macroeconomist Brad DeLong has long argued that the 2.0% inflation target is too low. I tend to agree: we’ve come uncomfortably close to deflation three times over the past 30 years, which is three times too many. By my reckoning, we are at an inflation sweet spot and should tighten if inflation creeps upwards and loosen if it trends too far downwards. But the Fed’s official goals differ and they are properly concerned about their credibility with price setters. Even if the 2.0% target isn’t the best we could do, it’s the one that the economy has shaped itself around.
The market believes that the Fed will lower the Fed Funds target rate by a quarter percentage point after the September 16-17 meeting and that this week’s job report will be an important input into their reasoning. I interpret last Friday’s PCE inflation report as being relatively tame.

The six month annualized lag indicates that core PCE inflation crossed the 3 percent threshold, moving from 2.9% to 3.2%. The headline one year percentage change, which measures inflation centered on December 2024, increased from 2.7% to 2.8%.

The probability that one year centered inflation in June 2025 will be higher than centered inflation in December 2024 has risen to 78%. That is by no means a sure thing, but it’s fair to say that inflation is probably increasing.

The next Fed rate setting meeting is scheduled for September 16-17. There will be another PCE report available by then, as well as an additional CPI report. According to the CME group, fed fund futures imply a 39% chance of a rate cut in September. That seems a little high to me, though not unreasonable.

Core PCE inflation flatlined in April. The six month lag shows 2.6% inflation, with the 3 and 12 month clocking in at a virtually identical 2.7% and 2.5%. Probability of rising inflation is 60%, close to a 50-50 coin toss. There is little or no obvious evidence of the on and off trade war: monthly goods prices declined in both March and April.

The April 30th PCE report ran through March 2025, before Liberation day tariffs were announced on April 2nd. The headline PCE price index rose 2.3% relative to a year ago, down from 2.7% the previous month.
Underlying price pressures are better captured by stripping out food and energy: this is reflected in the core PCE metric. It rose by 2.6% relative to a year ago. The six month measure favored by this blog rose by 3.0%, down slightly from 3.1% from the previous month and well above the Fed’s target of 2.0%. There’s a 75% chance that inflation is rising, as measured by centered 1 year inflation.

Core PCE prices rose 2.8% over the preceding year, the same as last month’s report. The six month annualized figure was somewhat more reassuring, dropping from 2.4% to 2.3%. Given this data, we would expect centered inflation to be lower than it was 6 months ago with 85% confidence, based on historical experience and ignoring what we know about future tariff increases.

The six month annualized lagged percentage change is a better predictor of centered one year inflation than other lags. The six month perspective suggests that as of December 2024, the Fed was making steady progress towards its goal of 2% inflation. The higher 2.8% figure should be interpreted as the level of inflation in the economy as of 6 months ago. In the graph the 2 indicators show some contrast: the green 6 month lag shows a modest decline while the blue bars showing the 12 month lagged percentage change are relatively flat.

Bear in mind though that we’d expect an average divergence of 0.7% between the six month figure and the expected centered 12 month figure. Prospects of higher tariffs moving forward increase estimated uncertainty and suggest less complacency regarding future inflation. But as of December 2024 at least, inflation was declining towards its long run target.