Two Measures of Inflation: August 2025

As of August 2025, core PCE and CPI remain elevated at 2.9% and 3.1% respectively, exceeding the Federal Reserve’s 2% target, despite the Fed implementing its first 25 basis point rate cut of the year, bringing the federal funds rate to 4.00%-4.25%. The Fed, which anticipates two more cuts this year, reaffirmed its commitment to the 2% objective while noting inflation is "somewhat elevated," and continues to favor core PCE due to its lower volatility and better reflection of underlying trends compared to core CPI.

Analysis

The Federal Reserve has initiated a monetary easing cycle, executing a 25 basis point cut to the federal funds rate to a 4.00%-4.25% range, with guidance suggesting two additional quarter-point cuts are anticipated before year-end. This dovish pivot occurs despite persistent inflation, with the Fed's preferred gauge, core Personal Consumption Expenditures (PCE), standing at 2.9% and core Consumer Price Index (CPI) at 3.1%, both significantly above the 2% objective. The Fed's action signals a forward-looking stance, predicated on the belief that the disinflationary trend will resume, even as recent data indicates inflation has 'stalled' after declining from its 2022 peaks. The decision is heavily reliant on the core PCE metric, which is historically less volatile and currently lower than core CPI, providing the Committee with the justification to begin easing. The spread between core CPI and core PCE has notably narrowed to 21 basis points from its historical average of 48 basis points, which could suggest a convergence in underlying price trends, though the Fed explicitly acknowledges that inflation remains 'somewhat elevated'.

Key Decisions for Investors

• Given the Fed's clear dovish pivot with a confirmed rate cut and guidance for more, investors should consider increasing exposure to longer-duration fixed-income assets to capitalize on the expected further decline in yields.
• While the start of an easing cycle is generally supportive for equity valuations, the primary risk is the 'stalling' inflation at 2.9%; any failure of core PCE to resume its downward trend could force a pause in rate cuts, creating volatility for risk assets.
• Considering that core inflation remains stubbornly above target, maintaining a strategic allocation to inflation-hedging assets, such as commodities or Treasury Inflation-Protected Securities (TIPS), is a prudent measure against the risk of inflation re-accelerating or remaining elevated for longer than the Fed anticipates.