31 Mar Why Core PCE Inflation Remains Sticky and What It Means for Markets in 2025
The U.S. economy in early 2025 is at an inflection point. Inflation, although off its pandemic-era highs, remains uncomfortably sticky, particularly core Personal Consumption Expenditures (PCE), the Federal Reserve’s preferred measure of inflation. As of February 2025, the core PCE index climbed 0.4% month-over-month and 2.8% year-over-year, reigniting concerns that the disinflationary progress of 2023–2024 is stalling. Here’s why inflation is proving stubborn, and what it means for markets and policy going forward.
1. Core PCE Inflation: Still Sticky at 2.8%
The primary culprits behind persistent inflation are services, particularly housing, healthcare, and insurance, as well as recent cost pressures stemming from tariffs and global supply chain disruptions. With labor markets still tight and wages elevated, service sector inflation has not cooled in line with goods prices. Compounding this is the effect of new tariffs and fiscal expansion, which are starting to impact consumer prices more broadly.
2. The Cost Triad: Housing, Healthcare, and Insurance
Since the fall of 2024, the most significant contributors to sticky inflation have been:
- Housing: High home prices and rising mortgage rates have made renting more attractive; however, rents remain elevated due to a tight supply.
- Healthcare: Wage pressures and medical supply chain issues continue to drive up costs.
- Homeowners Insurance: Premiums have surged 13.6% in 2024 alone, and over 60% since 2018, driven by climate risks and insurer retreat from high-risk markets.
These sectors are heavily weighted in the PCE index and show no signs of reversing in the short term.
3. Inflation Plateauing Near 3%
While headline inflation has eased to around 2.5%, core Personal Consumption Expenditures (PCE )is stuck near 2.8%–3.0%. The Federal Reserve’s March projections indicate a gradual glide path to 2.2% by the end of 2025 and 2.0% by 2026; however, recent data casts doubt on this optimistic trajectory. Inflation expectations are becoming unanchored, and consumers are adjusting their behavior accordingly.
4. Did COVID-Era Monetary Policy Create a Housing Bubble?
Yes. The Fed’s ultra-accommodative stance during the COVID crisis fueled a housing boom: historically low mortgage rates and excessive liquidity led to asset inflation, particularly in real estate. Now, as rates normalize, housing prices remain elevated due to low supply and high replacement costs, making shelter inflation a long-term issue.
5. Can the Fed Hit Its 2.0% Inflation Target Without a Recession?
Increasingly unlikely. The Fed hopes to engineer a soft landing, but entrenched service-sector inflation may not subside without a significant economic slowdown. Unless demand falls — either from a fiscal contraction or recession — inflation may not return to the target by 2026.
6. The Impact of Persistent U.S. Deficit Spending
The Congressional Budget Office projects deficits of 6.2% of GDP in 2025, with debt-to-GDP climbing toward 156% by mid-century. This means the U.S. Treasury will continue to issue substantial amounts of new debt, potentially crowding out private investment and increasing interest rates. Higher term premiums could compress equity valuations, especially in growth stocks.
7. The Trump Tariff Gambit: Boon or Bane?
The reintroduction of steep tariffs on Chinese goods, autos, and parts has immediate inflationary consequences. Consumer prices for durable goods have started rising again, while retaliatory tariffs risk disrupting exports. Most economists agree that tariffs are a net drag on short-term GDP growth and a source of inflation.
8. Market Volatility: A Symptom of Policy and Macro Crosswinds
U.S. equity markets have been choppy in Q1 2025, reflecting:
- Persistent inflation
- Trade policy uncertainty
- Weak consumer sentiment
- Fed policy ambiguity
Growth sectors — particularly tech — have borne the brunt of this volatility, while value and energy sectors have held up better.
9. What Could Improve Market Sentiment in 2025?
There are a few bright spots to watch:
- Seasonal tailwinds and oversold conditions could prompt a market rebound.
- Moderating inflation (if it materializes) would give the Fed room to cut rates.
- Tax reform and deregulation under a new administration could boost corporate earnings.
- AI and productivity gains may start to materialize meaningfully in H2 2025.
Conclusion:
2025 is shaping up to be a year of transition — and tension. Structural inflationary pressures, geopolitical trade shifts, and fiscal overhangs are converging to create a challenging environment for policymakers and investors. As always, prudent portfolio construction, diversification, and a focus on quality remain essential. At Exponential Wealth Management, we position portfolios with a defensive tilt, seeking opportunities amid volatility while managing long-term growth and liquidity goals.
Ram Kolluri founded Exponential Wealth Management, LLC, an independent fiduciary advisory firm (located in Austin, TX) serving high-net-worth families. With four decades of investment management experience, he provides expert insight into navigating complex markets and long-term financial planning.
