Inflation Is in Services despite Powell’s Denials: PCE Price Index for Core Services Accelerated Further. Durable Goods Prices Fell for 2nd Month

The latest PCE Price Index for August indicates an acceleration in both overall and core inflation, reaching +2.7% and +2.9% year-over-year respectively, surpassing the Fed's 2% target and exceeding last year's figures. This inflationary pressure is predominantly driven by services, with core services PCE accelerating for the fourth consecutive month to an annualized 4.1% in August, fueled by rising rents, while durable goods prices experienced a second consecutive monthly decline. This data underscores persistent domestic inflation, particularly in services, potentially complicating the Federal Reserve's monetary policy outlook and contradicting prior statements attributing inflation to tariffs.

Analysis

The August PCE Price Index data reveals a sustained and accelerating inflationary trend, presenting a significant challenge to the Federal Reserve's current policy outlook. Both the headline PCE and core PCE price indices accelerated for the fourth consecutive month to +2.7% and +2.9% year-over-year, respectively, levels that are not only above the Fed's 2% target but also worse than a year ago. The primary driver of this inflation is the services sector, where the core services PCE index accelerated to a 4.1% annualized rate, fueled by a 4.4% annualized increase in rent inflation. This directly contrasts with the durable goods sector, where prices fell for a second consecutive month, negating the narrative that tariffs are a principal inflationary force. Furthermore, the labor market remains exceptionally tight, evidenced by a prime-age (25-54) employment-to-population ratio near its historic high at 80.7%. This strength structurally limits job growth capacity and undermines any argument for rate cuts based on a 'cooling' labor market, suggesting inflation is more entrenched domestically than Fed communications have recently acknowledged.

Key Decisions for Investors

• Given that accelerating inflation is being driven by persistent domestic services, investors should prepare for a sustained 'higher for longer' interest rate environment, which increases the risk for long-duration fixed-income and rate-sensitive equities.
• It is prudent to analyze portfolio exposure by sector, favoring companies in the services industry with demonstrated pricing power while remaining cautious on durable goods producers who face margin compression from weak consumer demand.
• Monitor the prime-age employment-to-population ratio and wage data closely; continued strength in these metrics invalidates the narrative of a cooling labor market and could force a more hawkish Fed response, creating policy-driven volatility.
• The data creates a credibility gap for the Federal Reserve, so investors should anticipate heightened market volatility around future inflation reports and Fed communications, as any divergence between data and rhetoric could prompt sharp market repricing.