What Is the 'Core Personal Consumption Index' and Why Does it Matter to Investors?

We all know that inflation is bad, right? Don’t we hear about it all the time on TV, online and, for those who still get them, newspapers? That is particularly true right now if you prefer your news with a Republican bias, where Fox, et al, are delighting in running stories about gas and grocery prices soaring, with the obvious implication that it is Joe Biden’s fault. It isn’t, of course, no more than covid was Trump’s fault, or the credit crisis in 2008 due to George W. Bush’s presidency.

External Factors Impacting Core PCE

One could argue that green energy talk and promises in the U.S. have made things worse by discouraging oil output increases, but that doesn’t explain reduced investment in the Middle East and elsewhere. And the Russian war in Ukraine has been far more influential on the price of oil than the words of any politician. A much stronger argument could be made that pushing through billions of dollars of stimulus in 2021, when the economy was already recovering from the shock caused by the pandemic, was an inflationary mistake. I would be inclined to agree with that but, even then, the Fed’s trillions of added liquidity and ultra-low rates were much more impactful than giving lower-paid Americans a few hundred bucks.

Ultimately, inflation is about the devaluation of the currency, and the value of the dollar is the Fed’s responsibility, not the President’s, no matter which Party he or she may represent. The problem this time has been that for the first year or so of rising prices, the Fed insisted that the problem was "transitory" and didn’t start to attempt to combat inflation until this year. Their belief at the time was logical enough, given the supply chain disruptions wrought by the pandemic and other problems that time would heal, but it flew in the face of the experiences of everyday Americans. They saw the three biggest influences on their cost of living -- housing, fuel, and food -- soaring.

What is Core Personal Consumption Index (Core CPE)?

The frustrating thing has been that in the Fed’s calculations, two of those three apparently don’t count. Their preferred measure of inflation is the Core Personal Consumption Index rather than the Consumer Price Index that most would follow. Both measure the prices that people pay for goods and services, but the biggest difference between the two is that the former doesn’t include food and energy prices, and the latter does. That makes the former pretty much an irrelevance to most consumers, so why does the Fed still follow that metric?

Because the Fed doesn’t care about consumers.

I mean that not in a heartless way, but a practical one. Their job is to protect the American currency, not the American consumer. They look at inflation as an economic problem, not a personal one, and as such, things that have typically shown extreme volatility based on exceptional circumstances outside the control of economists -- things like food and energy -- are simply not part of their equation. They are distortions that must be excluded to give an accurate read of true inflationary pressure.

That belief, that even the major expenditures of households should be excluded from inflation calculations, is why they were slow to react to inflation last year. Price rises were led by gas and food, so didn’t show up in the Core Personal Consumption Expenditure Index for some time. Hence, people knew inflation was there for more than a year, even as the Fed said it really wasn’t, and refused to act.

That was the bad side of relying on the core number, but it is quite possible that we will soon see the good side. The data released this morning showed a 4.9% increase in the index in April, down from 5.2% in March. That suggests that even though gas is still well over $4 a gallon and companies like Costco (COST) are saying that they are going to raise prices more in the future because of higher costs to them, core inflation is moderating.

That might not matter much to consumers immediately, but it matters to markets. It hints that the Fed may not hike rates as fast or for as long as some have feared and, if that is the case, the call I made on Tuesday, that the S&P 500 may have finally found its bottom, will turn out to be accurate. If so, investors should be thankful that the Fed stuck to its guns and focused on theoretical rather than real inflation, because a recovery in their portfolios will more than offset a few percentage points rise in fuel costs.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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