The PCE Makeover

• Portfolio management methodology will shift from assets-under-management fees to firm revenues relative to services, reducing inflation by 0.2 percentage points
• Software price calculations will broaden to include video game software and web hosting, lowering inflation by roughly 0.1 percentage points
• The revised components account for 4% of core PCE but only 1% of core CPI, indicating their outsized influence on Fed's preferred inflation measure

Summary: PCE Inflation Index Revisions Expected to Lower Readings

The Bureau of Economic Analysis (BEA) plans to implement methodological updates to the Personal Consumption Expenditures (PCE) price index as early as September 30, potentially making the Federal Reserve's 2% inflation target more achievable.

Key Changes:

The revisions aim to better reflect actual household spending patterns through three primary adjustments:

1. Portfolio management services methodology shift (from assets under management to revenues relative to services): Expected to reduce inflation by 0.2 percentage points

1. Software price index expansion (incorporating video games and web hosting): Expected to lower inflation by 0.1 percentage points

1. Legal services calculations using more producer price data: Modest impact anticipated

Market Implications:

These components, while representing only 4% of core PCE (versus 1% in CPI), have disproportionately influenced recent inflation volatility. The PCE index has become increasingly sensitive to equity market dynamics, particularly due to the AI-driven stock rally affecting both software prices and portfolio management weightings.

Fed Governor Miran has suggested strong stock market performance shouldn't count toward inflation, supporting these methodological changes.

Trade-offs:

While revisions will likely show the Fed was closer to its 2% target than previously measured, there's a downside risk: reduced sensitivity means the index may not capture disinflationary pressures if asset prices or the AI rally reverse.

The updates represent technical improvements in measurement accuracy, but don't fundamentally alter underlying inflationary pressures. The changes could provide the Fed political and mechanical flexibility in achieving its stated objectives, though questions remain about sustainability at the 2% level.