Underlying Inflation Falls to Lowest Levels in Five Years
The Bureau of Economic Analysis reported Wednesday that the personal consumption expenditures price index rose 0.4 percent in February, a pickup from January’s 0.3 percent. Goods prices jumped 0.7 percent, led by a 1.1 percent surge in durables. Recreational goods and vehicles were up 2.2 percent. On the surface, this looks like a troubling inflation report that should give the Federal Reserve pause.
But look beneath the surface, and a very different picture emerges. Measures designed to capture the underlying trend in inflation — the ones that strip out the noise of a few categories behaving badly — actually improved in February.
One of the best measures of underlying inflation is the Dallas Fed’s 16 percent trimmed mean. This measure lops off the biggest movers on both ends of the price distribution each month, leaving just the broad middle. In February, the one-month annualized trimmed mean fell to 1.82 percent from 2.71 percent in January. That’s a sharp deceleration. The six-month annualized rate slipped below two percent to 1.99 percent, its lowest reading since March 2021. The 12-month rate continued its steady descent, falling to 2.33 percent, also the lowest since 2021.
We also look to the Cleveland Fed’s median PCE, which isolates the single price change sitting at the midpoint of the distribution. The year-over-year median fell to 2.79 percent in February from 2.89 percent in January, extending a decline that has brought it down from above 3.4 percent last summer. On a six-month annualized basis, median PCE inflation fell to 2.25 percent, its lowest reading since April 2021.
What these two measures are telling us is straightforward: the February acceleration in headline and core PCE was driven by outliers, not by a broad-based pickup in price pressures. A handful of categories — recreational goods, clothing, other durables — printed big numbers. But the typical price change in the economy actually got smaller.
Underlying Inflation Declined Despite Strong Spending
This is the opposite of what a genuine inflation reacceleration looks like. When inflation is broadening, the trimmed mean and median move up alongside the headline. When a few volatile categories are driving the headline higher while everything else is well-behaved, the trimmed mean and median diverge from the headline. That is exactly what happened in February.
The services side of the ledger reinforces the benign reading. Services prices rose just 0.2 percent in February, down from 0.4 percent in January and matching the coolest monthly readings seen several times over the past year. Housing and utilities were up only 0.2 percent, continuing a slow moderation.
It’s worth stepping back and looking at where these trend measures stand relative to the Fed’s two percent target. The trimmed mean six-month annualized rate is at 1.99 percent — essentially at target. The 12-month rate is at 2.33 percent and falling. The trajectory is clear and has been consistent for months.
None of this means inflation is fully vanquished. The median PCE at 2.79 percent year-over-year still has ground to cover. But the direction of travel is unambiguous, and the speed of the decline has been impressive. A year ago, the debate was about whether inflation was stuck above three percent. That debate should be over.
It’s important to note that these readings came from a month that still included the Liberation Day tariffs, which were not overturned by the Supreme Court until February 20. So, the tame underlying inflation readings are not the result of the tariffs being reduced.
Another important piece of context here is that the progress on underlying inflation was not the result of weak consumer spending. Personal consumption expenditures climbed 0.5 percent in February, with big increases in spending on cars, health care, clothing, transportation services, and recreational goods.
The risk for the Fed is that it focuses too heavily on the headline number and not enough on what the underlying trend measures are signaling. A hot PCE print driven by a few noisy categories is not the same as a hot PCE print driven by broad-based price pressures. The trimmed mean and median exist precisely to make this distinction, and right now they are both pointing to an economy where the inflation problem is largely behind us.
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