The Inflation Wedge

The positive inflation wedge is making inflation appear back at target in Core CPI while remaining elevated in Core PCE, complicating the Federal Reserve’s policy assessment.

• June data showed Core PCE inflation at 3.3% versus 2.6% for Core CPI, with the two measures increasingly sending different signals.
• The Cleveland Fed’s nowcast projects Q3 Core PCE at around 3.0%, while Core CPI is expected to fall to 1.9%, below the Fed’s 2% target.
• The wedge reflects differences in weighting, formula construction, and spending coverage, rather than different underlying inflation concepts.
• Shelter receives a much larger weight in CPI and has driven both the current positive wedge and the negative wedge seen during 2022–2024.
• Services such as healthcare, financial services, and business services carry larger weights in PCE; AI investment may be indirectly sustaining demand for skilled labor and related services, although AI is not directly represented in the inflation measures.

Takeaway: Investors and policymakers should avoid treating either inflation gauge as definitive, because the divergence between CPI and PCE may persist and complicate the Fed’s response.