PCE and the *Supercore* Inflation Reading

Issue LVIII

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Today’s Bullets:

• What is PCE?

• CPI vs. PCE methodology

• WTH is Supercore?

• What does the last PCE reading tell us?

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Inspirational Tweet:

Charlie Bilello @charliebilello

The Fed Funds Rate is now above Core PCE (the Fed's preferred measure of inflation). Since 2008, the only other period w/ a Fed Funds Rate above Core PCE was Oct 2018 - Sep 2019. That ended with Fed rate cuts in 2019 & a swift move back to easy money.

With CPI seemingly dominating inflation headlines lately, PCE has gotten less attention than it should. After all, it has been dubbed the preferred measure of inflation for the Fed, so it ought to be the main star on the inflation stage.

But what exactly is PCE, how is it different than CPI, and is it better? Plus, what are this week’s readings telling us? More importantly, what does the Fed think about the numbers?

Lots to cover here, but hey, it’s Sunday morning and we have a few minutes for this one. So, saddle up and settle in, we’ll unpack this nice and easy, as always.

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🧐What is PCE?

Personal consumption expenditures or PCE is a monthly inflation measure, compiled by the Bureau of Economic Analysis (BEA). Much like the CPI does, PCE tracks consumer spending on goods and services. And, also like CPI, the PCE numbers include a separate Core reading which excludes food and energy.

Because, less is more, right? We’ll get into that.

But first, there are some key differences between PCE and CPI, and we’ll get to those in a bit. But first, let’s tackle PCE itself.

For PCE, there are actually two separate calculations: Personal Consumption Expenditures (PCE) and the Personal Consumption Expenditures Deflator (known as the PCE Deflator).

These are related data, but they serve different purposes.

PCE measures all consumer spending on goods and services in the economy. And so, PCE is a key component of Gross Domestic Product (GDP) as PCE makes up about two-thirds of all domestic spending.

The PCE Deflator, on the other hand, is a measure of inflation that tracks the changes in the prices of those goods and services over time. This is calculated by dividing the nominal PCE (includes impact of price changes) by the real PCE (includes inflation).

Huh?

Basically, the PCE Deflator takes the *number of things bought* out of the equation and only looks at *price differences* to calculate the inflation rate.

For the math geeks, here’s a simple example to see how it works. If you care not, skip ahead to the bold inflation number below.

So, pretend we have an economy where people only spend money on two items: steaks and gym memberships.

Last year quantities (units sold) and prices were:

• Steaks: 100 units, $10 each

• Gym Memberships: 50 units, $100 each

Then this year, the quantities and prices changed to:

• Steaks: 120 units, $12 each

• Gym Memberships: 60 units, $110 each

Nominal PCEs are:

Last year’s nominal PCE = (100 units × $10) + (50 units × $100) = $1000 + $5000 = $6000

This year’s nominal PCE = (120 units × $12) + (60 units × $110) = $1440 + $6600 = $8040

For the PCE Deflator, or inflation calculation, we need to normalize the units of goods and services bought in order to isolate the price changes and measure just that change.

So, we need the Real PCE of this year, which is:

(120 units × $10) + (60 units × $100) = $1200 + $6000 = $7200

And so, the PCE Deflator is:

Nominal PCE / Real PCE = $8040 / $7200 = 1.1167

In other words, the PCE Deflator is telling us that there has been an 11.67% increase in prices for the goods and services in our simplified economy over the past year.

Cute that they call it the PCE Deflator, but let’s call it what it is:

11.67% inflation.

OK. So then, how exactly is this different from the CPI Index, and which measure is better, more accurate?

Good questions, and important ones.

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🤨 CPI vs. PCE methodology

A number of you may have heard me talk about CPI and its problems and limitations and endless manipulations. But for those of you who have not, or if you want a refresher, I wrote all about it in a recent newsletter here:

CPI and How the Measure of Inflation is 'Inconsistent'

And more recently, here:

The New CPI: A Wilderness of Mirrors

For the TL;DR crowd: CPI or the Consumer Price Index is basically an index that tracks a ‘basket of goods’ over periods of time to measure inflation or (rarely) deflation.

This basket, however, has been adjusted significantly over its life and it has gone from being a measure of cost of a fixed basket of goods sold (COGS) to cost of living index (COLI). This new CPI measure is supposed to reflect changes in the cost to maintain a constant standard of living.

Exactly. Flawed at best.

In any case, let’s compare and contrast the two measures:

• Coverage: The PCE measure has a broader coverage than the CPI, as PCE includes things like health care programs and financial services— either excluded or only partially included in CPI.

• Methodology: supposedly different, as PCE uses a chain-type index, which allows for changes in consumer spending patterns over time as prices change. CPI uses a quasi fixed-weight index, which presumes consumer spending patterns remain constant, even when prices change (though we all know how this can be manipulated—see the articles above, if you want more context there).

• Weighting: PCE and CPI assign different weights to various goods and services in their respective baskets, based on their importance to overall consumer spending.

• Population coverage: The CPI only measures urban areas( ~93% of the U.S. population), and PCE covers the entire population.

On the face of it, they look like different measures of a lot of the same data, but PCE is more broad, right?

This is true, mostly.

But the way they collect the data is important, too.

The CPI relies on BLS surveys only, tracking about 94K prices per month.

For PCE, on the other hand, the BEA uses multiple sources of data, including:

• Retail sales data collected by the U.S. Census Bureau on sales from retailers for consumer goods data

• Surveys conducted by BLS on administrative data from government agencies, for data on consumer spending on services

• Trade source data from the Census Bureau and BLS the U.S. for information on imports and exports

• And BEA uses the CPI and PPI indices to adjust nominal PCE data for inflation and calculate the real PCE

Wait.

That last part, can you repeat that, please?

That’s right, The PCE uses the BLS-generated CPI and PPI to adjust some of the price data and then calculate their own(🙄) inflation numbers.

Which may be why these two chart plots look so similar, even if the overall readings are slightly different.

And there you have it.

Two numbers, seemingly completely different surveys and collections, but in reality, the most important measure (inflation) is coordinated between the two.

That’s like taking a test, calculating all the answers yourself, then peeking over at your buddy’s sheet and adjusting part of your calculations to match his.

What a crock.

Problem is, the teacher in this case is relying on the answers to make decisions. Big decisions.

Ones that affect the financial markets across the entire world.

Still, one of these tests must be crowned king of them all, but which one?

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👑 WTH is Supercore?

In comparison, and in the Fed’s view, the PCE Deflator gives a more comprehensive view of inflation, as it captures a broader range of expenditures than the CPI.

Even if the numbers are somewhat coordinated between the two.

Digging further, the Fed usually prefers Core PCE Deflator numbers over the broad reading, as Core removes food and energy.

Why?

Because food and energy prices can be super volatile short-term when compared to other goods and services.

You think?

I mean, I agree that eggs should not be included if they fluctuate 100 to 200% in a month. But nobody can deny that food prices are not just inflating overall, they’re also pretty damned important to the average consumer.

But wait, it gets better.

Because recently, with volatility coming in from all angles, the Fed specifically looks at something called the supercore PCE Deflator number.

W.T.H. Is supercore, you may ask?

It’s unofficial, in that BEA doesn’t break it out for us, but supercore is the already lean PCE Core Deflator number that also removes gas, electricity, and housing.

Because who needs those things?

Amiright?

Well, even if food, housing, gas, and electricity costs rising are affecting you, they’re just too noisy for the Fed recently, so we aren’t going to look at those when making a decision.

Because supercore is where it’s at.

Less is more. And less of less is even moar.

And there you have it. The Supercore PCE Deflator number is the King of Inflation Indication, in the Fed’s mind. Flawed or not, infected by the CPI data or not. Complete or even relevant.

Or not.

But hey, new PCE readings came out this week, so let’s see how our buddies did on the exam.

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🤡 What does the last PCE reading tell us? 

That’s right. On Friday, we got a new batch of PCE readings, and some Fed speak to go with it.

In short:

• Overall PCE was +5% year over year, down from the +5.3% last month and right about at the expected 5.1% rate

• Core PCE was +4.6%, down from +4.7% last month and also right about at the expected 4.7%

• And drumroll…Supercore PCE was +4.6%, according to Bloomberg’s calculations

Ooooh. That’s a nice move downward this month (the white line). Did you feel it? All that disinflation?

Of course not, it basically excludes everything you need and use daily and focuses on other goods and services, like new Teslas and Four Seasons spa visits.

Bottom line, though, the overall data supports the argument that inflation has peaked, at least for now. But it hasn’t fallen quite enough for the Fed to start easing rates yet, IMO.

Boston Fed Chief Susan Collins echoed this sentiment on Friday, saying, “We still do have more work to do and more to see to know that inflation is really on a sustained downward path.”

So, there you have it.

More work to do can only equal one of two things. Raising rates more or keeping them where they are until those readings, particularly the one that matters to them the most and you the least, the Supercore PCE Deflator reading, comes downs further toward the perceived 2% level.

Apparently easier said than done.

And that’s about as much inflation that they can admit to and still get way with.

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That’s it. I hope you feel a little bit smarter knowing about PCE inflation, core and supercore readings, and how the Fed may see all this. Before leaving, feel free to respond to this newsletter with questions or future topics of interest.

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✌️Talk soon,

James