The Fed’s preferred inflation gauge just moved in the wrong direction

(CNN) — Inflation remained stubbornly high last month, but it hasn’t stopped Americans from spending.

The Personal Consumption Expenditures price index — a closely watched inflation gauge favored by the Federal Reserve — accelerated to 2.7% for the year ended in March, according to data released Friday by the Commerce Department.

That rate was above economists’ expectations for a 2.6% gain and landed above February’s reading of 2.5%.

On a monthly basis, prices rose 0.3%, unchanged from the pace seen in February.

“We’re moving in the wrong direction, again, on the inflation story,” Ben Ayers, Nationwide’s senior economist, told CNN in an interview.

Inflation has cooled significantly from the decades-high levels seen in the summer of 2022; however, progress that was made last year did not continue into 2024. While rising gas prices played their role, the biggest bogeyman to lower inflation has been shelter costs and overall services, where price hikes tend to be more “sticky.”

“Those [price increases for services] don’t go away overnight, and I think that’s the concerning part for us as economists, but also for the Fed,” Ayers said. “That means a longer road for this higher inflationary environment over this year than we thought.”

Inflation in neutral has the Fed still on hold

While many economists prefer to measure the nation’s inflation levels using the monthly Consumer Price Index (which shows prices are up 3.5% annually through March), the Fed bases its 2% inflation target on the overall PCE index. In its evaluation of monetary policy, the Fed also is closely watching shifts in underlying inflation — seen best through the “core” PCE index that strips out volatile food and energy prices.

The core PCE index held steady in March on both a monthly and annual basis, 0.3% and 2.8%, respectively.

While both indexes are much lower than they were at their peaks (7.1% PCE inflation in June 2022, 5.6% for core in February 2022), they also remain stuck above the Fed’s 2% target. After 11 rate hikes in two years, the Fed has been on hold and eyeing potential rate cuts for this year.

The timing of those cuts got pushed back after a series of hot inflation reports to start 2024, economists and analysts say.

The Fed has a policymaking meeting next week, and central bankers are widely expected to stay the course and keep rates where they are until clearer progress is being made.

That’s expected to occur in the coming months, wrote Tuan Nguyen, economist at RSM US. A key reason for that will be disinflation in housing prices.

Inflation gauges capture changes in rent — and the implicit rental value of owned homes — on a lag. Market-rate rents have stabilized, and economists expect that to be reflected in the inflation data in the coming months.

“We expect housing inflation to likely be halved, bringing overall inflation much closer to the Fed’s 2% target than currently anticipated,” Nguyen wrote, adding that RSM views the first rate cuts as not likely to occur until September.

Rent hikes have cooled but the car insurance stings

When Ross Fondren moved to Austin, Texas, from Arkansas in 2020, it didn’t take long for housing costs to take a huge bite of income. From 2021 to 2022, Austin was among the top 10 fastest-growing rental markets in the nation, with rents rising on average by more than 25% in some months.

More recently, rents have been stable and have gone down in some places across the city, Fondren said.

The trip to the grocery store certainly isn’t as painful as it was two years ago, he said, but the most significant increases he and his wife are seeing now are in their insurance renewal notices and from other service providers.

His wife’s six-month auto premium went up by $75 and his by $100, increases of 7% and 10%, respectively.

“You definitely notice those things,” said Fondren, 32, who has a part-time job working for UPS and another officiating soccer. “Thankfully, we’ve paid off debts for our cars, so it’s not as impactful as if it would’ve happened last year before we had paid some things off. But you still notice a price increase here and there.”

The oil changes that two years ago ran under $100 are now topping off at $115, he said. The basic haircut for Fondren (who jests that as a “half-balding man already, so not a lot to do,”) that was $15 is now $20. Internet and other bills seem to be inching up by $1 or $2 each month, he added.

The increases, even those ticky-tacky ones, do add up. But for now, they’re manageable, Fondren said, noting he and his wife both received “decent raises” recently in addition to paying down debt.

“It’s probably my first time as an adult of going through a big economic change like Covid and then the big inflation jump. So it’s a wake-up call for me, and I think, ‘Oh, this is how the world works at times,’” Fondren said. “But I think overall, it’s fine.”

The propensity to spend remains high

Despite higher-than-typical inflation seemingly stuck in neutral, the economy-powering consumers aren’t batting an eye: Spending remained strong last month and didn’t taper off like economists had been expecting.

Consumer spending remained strong in March, jumping 0.8% and equaling the blistering pace seen a month before. Economists were expecting consumers to pull back some: They forecasted an increase of 0.5%, according to FactSet estimates.

Taking inflation out of the equation, the economy-powering spending was still up 0.5%, according to the report. Inflation-adjusted disposable personal income grew 0.2%.

“We’ve seen good hiring, good levels of spending,” Nationwide’s Ayers said, “but the downside is that has also brought back inflation concerns to the front.”

It likely will need to take a slowdown in the historically strong labor market to help ease inflation, Ayers said. And if there’s a significant cooling, that could leave many people in a bind, he added.

“I think the propensity to spend for consumers is higher than it usually is,” Ayers said. “And that is raising some concerns that — not everyone — but some households have overextended themselves.”

Friday’s report showed that savings as a percentage of disposable income dropped to 3.2%, the lowest rate since October 2022.

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