PIMCO argues that the recent acceleration in core PCE inflation is largely a statistical artifact tied to AI-driven categories rather than evidence of broadening price pressures, suggesting that underlying US inflation remains contained well below the headline figure reported by the Bureau of Economic Analysis.

In a research note addressing growing debate over the reliability of standard inflation gauges — a debate sparked in part by Fed Chair Kevin Warsh's repeated characterization of those measures as imperfect — PIMCO said its analysis of a range of underlying inflation measures places the true trend between 2.2% and 2.8% through June. That is notably below the 3.3% core Personal Consumption Expenditures rate the Federal Reserve uses as its primary inflation yardstick, favored over the Consumer Price Index because it covers a broader swath of household spending and adjusts for consumers substituting toward cheaper alternatives.

The firm said that discrepancy makes the recent strength in core PCE an outlier relative to other gauges, most of which continue to sit in what PIMCO described as the "two-point-something zone."

How Underlying Measures Work — and Where They Fall Short

PIMCO's note walked through the mechanics of underlying inflation measures such as trimmed mean and median gauges — including the Dallas Fed's trimmed mean PCE and the Cleveland Fed's median CPI — which have long been used by regional Federal Reserve banks. These measures work by stripping out unusually large and idiosyncratic price moves to better isolate persistent trends.

However, PIMCO cautioned that such measures are not infallible. They can be systematically slow to catch genuine turning points when price shocks are concentrated in one direction, as occurred during the 2021–2022 inflation surge, when trimmed mean gauges initially understated the risk posed by what was then dubbed the "transitory inflation" episode.

This time, PIMCO argued, the situation looks different.

Two AI-Distorted Categories Explain Much of the Gap

The firm said the divergence between core PCE and core CPI can largely be attributed to two categories: portfolio management services and software-related pricing. Both have been heavily influenced by developments tied to artificial intelligence, including strong equity market performance lifting asset-based management fees and rapid price changes in certain technology inputs.

PIMCO contended that both categories arguably overstate genuine inflationary pressure. Current software price measures do not fully capture quality improvements from cloud services and AI functionality, the firm noted — a longstanding challenge for statistical agencies known as quality adjustment, where rapid technological improvement can make price declines difficult to measure accurately. Meanwhile, portfolio management fees — calculated as a percentage of assets under management — have actually been declining, even as the higher dollar value of assets under management shows up as inflation in the official data.

The firm also noted that the Bureau of Economic Analysis has already signalled methodological changes expected to lower reported year-over-year PCE inflation by roughly 0.2 to 0.3 percentage points, adjustments that would come as part of the agency's regular annual updates to the National Income and Product Accounts.

Divergence From 2022 Pattern

PIMCO pointed out that, unlike in 2022 when both core CPI and core PCE accelerated in tandem ahead of their respective underlying measures, the current acceleration is more specific to PCE data. Core CPI is not showing the same shift in the underlying distribution of price changes.

That divergence, the firm said, supports the view that recent core PCE strength reflects category-specific distortions rather than a broad-based pickup in inflation.

Outlook: Cooling Inflation, Steady Policy

Looking ahead, PIMCO said it expects core inflation to cool over time as pressures from tariffs, energy costs, and AI-related components fade. The firm observed that measures of core inflation tend to converge with labour costs over time, and noted that unit labour cost inflation is currently running in line with the Fed's 2% target — reinforcing its base case that the central bank will keep its policy rate on hold this year.

PIMCO concluded that while the full range of underlying inflation measures still sits slightly above the Fed's 2% target, the absence of a meaningful shift in the broader trend — despite a string of shocks over the past two years — reduces the urgency for policymakers to move quickly on rates. The intensified scrutiny of these measures, the firm added, reflects positively on the central bank's commitment to managing inflation risk carefully.

If PIMCO's assessment gains traction among investors, it could support rate cut expectations and pressure front-end yields lower relative to a scenario in which markets take the headline core PCE print at face value. Conversely, any signs that the skew in price distributions is beginning to broaden beyond AI-related categories would undercut the noise thesis and raise the odds of a more hawkish Fed response.

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Earlier: Fed's Cook: Fed running out of room for disinflation to return

Source: Investinglive