Fed's preferred inflation gauge show prices increased even before Iran war began

• Core PCE inflation accelerated to 3.1% annually in January, up from 3.0% in December, with monthly increases of 0.4% suggesting inflation remained sticky before geopolitical disruptions
• The Iran war that began Feb. 28 has shut down the Strait of Hormuz, cutting one-fifth of global oil supply and driving gas prices to $3.60 per gallon from under $3, likely to spike inflation further in March and April
• Consumer spending rose a solid 0.4% in January while incomes also increased 0.4%, with after-tax incomes jumping 0.9% due to Social Security cost-of-living adjustments, indicating consumers maintained spending without depleting savings

Summary

The Federal Reserve's preferred inflation measure, the Personal Consumption Expenditures (PCE) index, showed rising price pressures in January before the Iran conflict escalated. Overall prices increased 2.8% year-over-year in January, slightly below December's gain. More concerning, core PCE (excluding food and energy) rose 3.1%, up from 3.0% in December—the highest level in nearly two years.

Key Data Points:

• Monthly price increases: 0.3% overall, 0.4% core inflation (second consecutive month at this pace)
• If sustained, this monthly pace would push annual inflation well above the Fed's 2% target
• Consumer spending rose 0.4% in January, matching December
• Incomes increased 0.4%, with after-tax incomes jumping 0.9% due to Social Security cost-of-living adjustments

Market Implications:

The Iran war, which began February 28 and shut down the Strait of Hormuz, has since disrupted one-fifth of global oil supply. Oil prices have surged over 40% since the conflict started, with gas prices climbing to $3.60 per gallon from under $3.00 a month earlier. Economists forecast these developments will cause inflation to spike in March and potentially April.

The Fed meets next week and is widely expected to maintain its elevated interest rate unchanged, given the short-term inflationary pressures from the Middle East conflict. The PCE index is currently running hotter than the more widely-followed Consumer Price Index (CPI), primarily because it assigns less weight to cooling rental costs.

The data release was delayed due to a six-week government shutdown from fall, creating a backlog that has now mostly cleared.