Fed Favored “Core” PCE Price Index Rises 4.1%, Least since Sept 2021, on Drop in Durable Goods. But Monthly Services Inflation Accelerates

This is roughly what happened in June compared to May: Prices of motor vehicles, and of durable goods overall, fell in June from May. But gasoline prices rose in June from May, after plunging for seven months in a row. And services prices bounced off on hot inflation in housing, finance & insurance, recreation services, and other services, according to the PCE price index data released by the Bureau of Economic Analysis today.

So month-to-month, the core PCE price index, which excludes food and energy products, rose by 0.17% in June from May, the smallest increase since July last year, on a big drop in durable goods (-0.3%) and an acceleration of inflation in services (+0.3%).

The month-to-month index (green line) is very volatile with big ups and downs. The six-month moving average (red) shows the trend. And the trend is moving in the right direction but remains high (0.34% in June, or 4.2% annualized).

Year-over-year, the “core” PCE price index, the inflation measure favored by the Fed, rose by 4.1%, the smallest increase since September 2021, and the first significant deviation from the 4.6%-range that it had maintained over the past six months. The Fed’s target is 2%:

The overall PCE price index rose by 3.0% year-over-year, pulled down by the 28% year-over-year plunge in energy prices, which caused the overall PCE price index (green in the chart below) to be under the core PCE price index (red) for the fourth month in a row.

Food prices dipped in June from May (-0.12%), which reduced the year-over-year increase to 4.6%, the lowest since September 2021.

The energy price spike had peaked in June 2022, and so the year-over-year increase in the overall PCE price index had also peaked in June 2022 at 7.0%.

The base effect. Today’s year-over-year comparison is against the base of a year ago, which was the peak of the year-over-year change in the PCE price index, after a very steep run-up of the index itself. And this high base of the index itself a year ago lowers today’s year-over-year increase.

But this “base effect” will begin to become less favorable and then unfavorable in the second half of 2023, and will become one of the headwinds for the year-over-year readings later this year.

In addition, energy prices stopped plunging and in June rose again from the prior month. Crude oil grade WTI is now back in the $80 range. So, combined with the base effect, energy prices (primarily gasoline) on a year-over-year basis will become an unfavorable factor in the price index in the second half. And then the overall PCE will revert to its normal place near core PCE.

Services inflation in June accelerated from the prior month, to 0.28% (annualized 3.4%), driven by much sharper increases among the usual suspects, with a combined increase when annualized at over 5%:

What helped keep the services index from blowing out was the sharp drop in prices of transportation services: -0.37%.

Year-over-year, the services PCE price index rose by 4.9%, the lowest since July 2022:

Durable goods prices fell in June from May by 0.31%, with all three major categories declining:

Only “other” durable goods rose (+01.16%). The index has now normalized, compared to pre-pandemic times:

In other words, some of the horrendous price spikes of durable goods, particularly motor vehicles, in 2021 and into 2022 have been getting partially unwound since mid-2022.

Year-over-year, the PCE price index for durable goods fell by 0.4%. In normal pre-pandemic times, the index for durable goods was negative year-over-year, driven by manufacturing efficiencies, offshoring, and competition, plus the infamous hedonic quality adjustments that remove the costs of improvements from the cost base, on the principle that consumer price inflation is the change in dollars to buy the same product over time, and cost increases due to improvements are not inflation (though they make the product more expensive).

Motor vehicles are the biggest example of hedonic quality adjustments. For example, the standard four-speed automatic transmission of a Ford pickup in 1990 gave way to the standard silky-smooth 10-speed automatic today. For the purpose of calculation consumer price inflation, the costs of that transition were removed from the cost basis because you’re not paying more for the same product, you’re paying more for an improved product.

The durable goods PCE price index is normalizing. Though absolute prices of durable goods remain high, they’re no longer surging, and some are falling (such as big price cuts for new EVs). Those ridiculous price spikes of 2021 had been caused by an overstimulated consumer who, awash in cash, decided to pay whatever to overcome the supply disruptions. And that’s over, thankfully:

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