PCE Inflation Overview
The Federal Reserve's preferred inflation gauge remained elevated in December as price pressures continued to challenge consumers. The Commerce Department reported that the personal consumption expenditures (PCE) index rose 0.4% on a monthly basis and 2.9% from a year ago, figures slightly hotter than LSEG economists' estimates of 0.3% and 2.8%, respectively. Core PCE, excluding volatile food and energy prices, increased 0.4% monthly and 3% year-over-year, surpassing expectations of 0.3% and 2.9%.
Federal Reserve Focus and Trends
Federal Reserve policymakers target the PCE headline figure to return inflation to 2%, while viewing core data as a superior indicator. Headline PCE trended up to 2.9% after 2.8% in November and 2.7% in October, with core PCE reaching 3% for the first time since May. These developments occur amid growing Fed dissent on potential interest rate hikes due to stubborn inflation.
Goods and Services Price Breakdown
Prices for goods rose 1.7% annually in December, up from 1.5% in November and significantly higher than lows of 0.6% in June and July. Durable goods jumped 2.1% year-over-year after hovering near 1% since June, while nondurable goods increased 1.6%, slightly below November's 1.7%. Services prices remained unchanged at 3.4% from a year ago since September.
Personal Savings and Consumer Dynamics
The personal savings rate as a percentage of disposable personal income fell to 3.6% in December, down from 3.7% in October and November, continuing a decline from 4.9% in May.
PCE inflation ticking up is a reminder that Fed officials won’t just be watching the labor market in 2026. Core PCE inflation rose to 3%, the highest since February 2025, and headline PCE inflation hit the highest since March 2024. This will trigger more concern inside the Fed that inflation needs a closer look again.
The PCE inflation data shows that the economy's foundation of consumer spending is becoming increasingly stretched. Consumer activity is being propelled by affluent households while middle- and lower-income consumers are heavily relying on savings and borrowing to make ends meet. Inflation is likely to remain near 3% in the first half of the year.
The firm thinks that the Fed will continue to support the labor market with 3 or more rate cuts this year and will be patient as the inflation numbers come down (albeit at a slow pace).
Implications for Monetary Policy
The hotter-than-expected December PCE reading reduces the likelihood of a Federal Reserve interest rate cut at its next meeting. The CME FedWatch tool indicates a 96% probability of unchanged rates, up from 90.8% a week ago and 78% a month ago.
