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Understanding PCE Inflation, the Ultimate US Rate Hike Spoiler

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What is PCE inflation?

The level of inflation has several measures, the most popular ones being the CPI (Consumer Price Index) and the PPI (Producer Price Index). But policymakers at the Federal Reserve use a separate measure of inflation: PCE inflation. This is the price index for personal consumption expenditures, or PCE. According to the central bank, this indicator is “most consistent over the longer run with the US Federal Reserve’s statutory mandate.”

Understanding PCE Inflation, the Ultimate US Rate Hike Spoiler

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Policymaker views on inflation

According to the April 2016 meeting minutes, policymakers were expecting the rise of inflation to be only gradual, even with core inflation picking up the pace in the first two months of the year. There were many participants that observed that the strong job market was putting little upward pressure on inflation. Many saw the downside risks to inflation as market-based measures of inflation compensation remained low.

However, others felt that the strength in core inflation was broad-based and not due to just a few factors. They also viewed depreciation in the dollar and a rise in crude oil prices as positives, because these will reduce the downward pressure on PCE inflation.

Keeping an eye on PCE inflation

PCE inflation is still being held down by energy prices, apart from import prices. However, some policymakers are confident that the broad-based rise in core prices will soon reflect in overall inflation, which could warrant a rate hike as early as June.

A rise in inflation would increase demand for inflation-protected funds like the iShares TIPS Bond ETF (TIP), the Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX), and the Fidelity Inflation-Protected Bond Fund (FINPX), among others. Meanwhile, a rate hike is expected to help insurers like Assurant (AIZ), Unum Group (UNM), and Alleghany Corporation (Y), among others.

In the next and final part of this series, we’ll summarize the Fed’s expectations for a rate hike in June.

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