Market Minute: August 29th, 2025 — How the PCE Index Shapes Fed Rate Decisions

What’s in a definition? Inflation is measured in several ways, including the Consumer Price Index (CPI), the Producer Price Index (PPI), and the Personal Consumption Expenditures Price Index (PCE).

The Consumer Price Index measures price changes for a basket of goods purchased by consumers. The Producer Price Index measures price changes for economic inputs at the producer level, for example, the costs a manufacturer pays for raw materials used in production. This is an important measure because if producer prices rise materially, it is reasonable to expect that manufacturers will pass these increased expenses on to their customers. Finally, the PCE Price Index measures U.S. inflation by tracking changes in the cost of living for households. It follows the prices of a basket of goods and services, each with different weightings, to reflect how much a typical household spends each month.

The weightings are important. Say the price of gasoline rises in a given month, but the price of oranges falls. Gasoline represents a larger portion of a family’s monthly budget, so it’s weighted more heavily in calculating PCE. That means rising gas prices have a bigger impact on the overall index than cheaper oranges. For purposes of this discussion, the basket of goods and weightings are a little different than the CPI index, and even more importantly, the PCE index is the key inflation indicator guiding the Fed.

In July, the PCE index rose 0.3% with an annual increase of 2.9%. Both figures were in line with estimates. The other key factor with the PCE index is that it is the preferred inflation gauge for the Federal Reserve. While policymakers certainly review other inflation metrics and economic indicators when setting interest rate policy, the Fed’s eye to inflation starts with its focus on the PCE index.

What does this mean for investors?

In a previous note, I mentioned that Federal Reserve Chairman Jerome Powell had signaled a willingness to lower interest rates in September. However, that willingness will have to be reinforced by data showing that inflation is cooling and the economy is slowing. The most recent inflation data indicates that the PCE Index is not tracking towards the Fed’s 2.0% target, and this will certainly weigh on their interest rate decision.

We are not predicting that the Fed will refrain from cutting rates. We believe that the rate cut is not 100% locked in, and economic information showing health in the economy and stubborn inflation may weigh against Fed activity.

More to come.

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