PCE: More Garbage Out

PCE printed slightly hot on headline at .2 vs. expectations of .1 and core came in at line at .2.  The PCE index continues to be highly misleading with portfolio management representing half of the increase for the month in core. The BEA estimated that portfolio management inflation ran at an annual rate of 72% in July.  Financial services inflation is a fantasy of the BEA that treats stock market price increases as inflation.  In addition, the BEA treats increases in interest rates as inflationary as it imputes a price of checking accounts based on lost interest income.

We publish a corrected version of PCE core on our website (infracapfunds.com) that corrects for the distorted financial services component and adjusts shelter inflation to reflect market prices.  That index is running at 2.1% year over year.  Although the BEA is planning to correct some of the distortions of PCE over the next few months, the Fed should focus on CPI as its consumption weightings represent what consumers actually spend and, more importantly, the weightings of CPI are dominated by shelter, which is the main price that the Fed can control via interest rate policy.  PCE is dominated by healthcare inflation which is a component that Fed policy has almost no effect on.

The fact that the Fed is actively considering raising rates solely due to a flawed index, demonstrates that the institution is fatally flawed.  Specifically, 1)  The Fed fails to use the money supply as the key indicator of inflation 2) it follows deeply flawed inflation indices and 3) its inflation target is too low as the US has been more prosperous when inflation was 3-4%.  The Fed should consider raising rates when interest sensitive sectors are booming and causing inflation in the housing, auto and consumer durables market, such as occurred in early 2021.