Jim Iuorio, for CME Group
At a Glance
- Habit and timing play important roles in the market’s preference for CPI, despite PCE offering a more dynamic and comprehensive measure.
- CPI, typically 0.4 percentage points higher than PCE, saw its gap widen significantly in summer 2022.
For decades, the Consumer Price Index (CPI) was considered the primary measure of U.S. inflation. This well-known metric, published by the Bureau of Labor Statistics (BLS), was the go-to for economists, investors, media and the general public. However, a shift occurred in February 2000.
During his bi-annual congressional testimony, then-Federal Reserve Chairman Alan Greenspan announced that he would primarily use the Personal Consumption Expenditures (PCE) price index, compiled by the Bureau of Economic Analysis (BEA), as his preferred inflation gauge.
The Fed's Case for PCE
Greenspan's decision was rooted in the PCE's methodology that offers a broader, more dynamic picture of inflationary pressures. Unlike the CPI's fixed "basket" of goods, the PCE index's weighting adjusts more frequently, which better captures how consumers substitute with cheaper goods when prices rise. For instance, if beef prices skyrocket, consumers might buy more chicken. The PCE's methodology reflects this shift, while the CPI is slower to adjust. This is why, historically, this methodological difference has led to the CPI being about 0.4 percentage points higher than the PCE, a gap that dramatically widened in the summer of 2022 when CPI hit 9.0% compared to PCE's 7.1%.
Perhaps the most crucial distinction lies in how each index weighs different categories. The CPI assigns roughly double the weight to shelter costs compared to the PCE, which places greater emphasis on healthcare. The heavy weighting of "owners' equivalent rent" in the CPI is particularly challenging, as it relies on survey data where homeowners often overestimate their potential rental income. The PCE was specifically designed to mitigate these issues, incorporating a broader range of goods and services, updating weights more frequently and explicitly accounting for substitution.
Why Is Wall Street Fixated on the Old Favorite?
Despite the Fed's long-standing preference for PCE, markets and media continue to fixate on CPI. This persistence stems from two key factors: habit and timing.
First, old habits die hard. Even if traders know the Fed watches PCE, that knowledge matters little when the broader market continues to react to CPI. Unless a critical mass of participants simultaneously shift to trading off PCE, individuals remain bound to the data that everyone else is trading. This explains why CPI tends to drive short-term market movements, while PCE often lingers in the background. According to FRED data, equity market volatility after CPI releases is approximately double that following PCE, though this pattern is slowly evolving.
The second, and perhaps more fundamental, factor is timing. Both indices reflect the prior month's data, but the CPI (BLS) is released approximately two weeks before the PCE (BEA). Markets tend to prioritize "flawed data now" over "better data later," giving CPI disproportionate influence simply because it arrives first. In essence, the market often treats CPI as the initial headline figure, with PCE serving as a sort of "first revision" that only gains significance if it sharply contradicts the earlier number.
The market’s fixation on the earliest available data isn't just about the CPI being released before the PCE; it's also about how traders can react to that data immediately. Both the CPI and PCE are released at 8:30 a.m. EDT, a full hour before the U.S. stock market opens. During this window, the only liquid markets available for traders to react and price in the new information are futures markets.
This pre-market trading activity, particularly in equity index futures, is what drives much of the volatility you see. Historically, futures products were sized for institutional investors, limiting choice and access for retail traders. Today, that's no longer the case. CME Group's introduction of smaller-sized futures contracts has democratized access, making it possible for a much wider range of traders to participate.
Highly liquid Micro contracts are now available across all four major equity indexes. For example, Micro E-mini Nasdaq-100 futures have a notional value of approximately $47,000 ($2 times the index value). Even smaller are the newly launched Spot Quoted futures with the Spot Quoted Nasdaq having a notional value of $2,350 (5% of the micro contract). These contracts are also available for other indexes, like the S&P 500 and the Russell 2000, significantly increasing participation by retail traders and investors, allowing them to hedge risk or express directional biases during market events.
For now, the trading and investing community largely remains anchored to CPI, undervaluing PCE despite its greater importance to Federal Reserve policymakers. While the timing difference accounts for some of this anomaly, most analysts anticipate an eventual alignment of market focus toward PCE. However, like many shifts in finance, this change could take several years.
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