Two Measures of Inflation: May 2025

As of May 2025, core PCE and CPI remain above the Federal Reserve's 2% target at 2.7% and 2.8% respectively, leading the Fed to hold rates steady at 4.25-4.50% for the fourth consecutive meeting while reaffirming its commitment to price stability. The Fed continues to favor the less volatile core PCE as its primary inflation gauge for trend assessment, noting its historical divergence from the higher core CPI. Despite declines from 2022 peaks, recent data indicates inflation may be stalling above the target, suggesting ongoing challenges for monetary policy.

Analysis

As of May 2025, core inflation metrics remain stubbornly above the Federal Reserve's 2% target, with core PCE at 2.7% and core CPI at 2.8%. In response, the Federal Open Market Committee has maintained the federal funds rate at a steady 4.25-4.50% for the fourth consecutive meeting, reinforcing its commitment to price stability despite acknowledging inflation is now only "somewhat elevated." The central bank's continued preference for the less volatile core PCE index as its primary policy guide is significant, especially as the disinflationary trend observed since the 2022 peaks (5.57% for core PCE) shows signs of stalling. This persistence of inflation above target suggests the final phase of monetary tightening's impact is facing headwinds. Notably, the historical gap between core CPI and core PCE has narrowed from an average of 48 basis points to just 11 basis points, indicating a potential shift in inflationary components that warrants close monitoring.

Key Decisions for Investors

• Given the Fed's fourth consecutive rate hold and commentary on 'somewhat elevated' inflation, investors should anticipate a 'higher-for-longer' interest rate environment and moderate expectations for near-term rate cuts.
• Focus monitoring efforts on the core PCE index, as the Fed has explicitly identified it as its primary, less volatile gauge for assessing inflation trends and making policy decisions.
• The stalling disinflationary trend poses a risk to fixed-income returns and equity valuations, prompting consideration of portfolio adjustments toward assets that may offer resilience in a persistent inflationary environment, such as commodities.