Critical PCE Inflation Report Thursday Will Test Fed’s 2% Target Progress
WASHINGTON – January 22, 2026 — All eyes turn to Thursday morning’s release of the Personal Consumption Expenditures (PCE) price index—the Federal Reserve’s preferred inflation measure—which could dramatically reshape expectations for interest rate cuts in 2026 and determine whether the stock market’s recent volatility intensifies or subsides.
The Numbers Everyone’s Watching
Thursday Release (8:30 AM EST, January 23):
| Metric | Consensus | Previous | Range | Impact if Exceeded |
| Core PCE (YoY) | 2.8% | 2.8% | 2.6-3.1% | Hawkish Fed signal |
| Core PCE (MoM) | +0.25% | +0.18% | 0.2-0.3% | Rate cut doubts |
| Headline PCE | 2.9% | 2.9% | 2.7-3.2% | Inflation concerns |
| Personal Spending | +0.4% | +0.4% | 0.3-0.5% | Economic strength |
| Personal Income | +0.3% | +0.3% | 0.2-0.4% | Wage pressure gauge |
Critical Thresholds:
- Above 3.0%: Would likely trigger market selloff and slash rate cut expectations
- 2.5-2.9%: Neutral reading, maintains status quo expectations
- Below 2.5%: Could spark relief rally and reinforce three-cut scenario
The PCE data carries extra weight because it’s the Federal Reserve’s official inflation target metric—more important to policymakers than the better-known Consumer Price Index (CPI).
Why PCE Matters More Than CPI
PCE vs CPI Differences:
| Feature | PCE | CPI | Why PCE Preferred |
| Coverage | All consumer spending | Urban consumer basket | More comprehensive |
| Weights | Updated quarterly | Updated annually | More responsive to behavior |
| Healthcare | Includes employer spending | Only out-of-pocket | Better captures total costs |
| Housing | Rental equivalence | Actual rents | Less volatile |
| Fed Target | ✓ Official 2% target | ✗ Not targeted | Direct policy relevance |
Federal Reserve Chair Jerome Powell has repeatedly emphasized that the Fed watches PCE, not CPI, when making rate decisions. A 0.3% difference between the two measures can dramatically shift policy expectations.
The Timing Couldn’t Be Worse (or Better)
Thursday’s PCE release lands amid an particularly sensitive moment:
#1: Trump Tariff Threats If implemented, 10-25% tariffs on European goods would reignite inflation by raising import costs. Markets trying to price this potential into inflation expectations.
#2: Fed Chair Nomination Imminent Treasury Secretary Bessent said Trump will announce nomination “maybe as soon as next week.” A hawkish choice (Kevin Warsh) becomes more likely if inflation runs hot.
#3: Markets Already Stressed S&P 500 erased all 2026 gains Tuesday on Greenland crisis. Hot inflation number could trigger another 2-3% decline. Cold number could spark 2-3% rally.
#4: Rate Cut Pricing Shifting Market currently prices 72% probability of three quarter-point cuts in 2026 (totaling 75 basis points). Hot PCE could reduce this to two cuts. Cold PCE could increase to four cuts.
What Analysts Expect
Consensus Forecasts:
- Goldman Sachs: 2.7% (below consensus, bullish for stocks)
- JP Morgan: 2.9% (in-line, neutral)
- Bank of America: 3.0% (above consensus, bearish for stocks)
- Morgan Stanley: 2.8% (in-line)
- Citigroup: 3.1% (most hawkish, predicts market negative reaction)
The wide range reflects genuine uncertainty. Energy prices fell in December (deflationary), but services inflation remained sticky (inflationary). Healthcare costs rose (inflationary), but goods prices stabilized (disinflationary).
Jan Hatzius, Goldman Sachs Chief Economist: “We expect core PCE to come in slightly below consensus at 2.7%, reflecting continued progress on inflation. This would support our view that the Fed can cut rates three times in 2026 without reigniting price pressures.”
The Inflation Components Breakdown
What’s Driving PCE in December 2025:
Deflationary Forces:
| Category | Monthly Change | Weight | Impact |
| Energy Prices | -2.8% | 7% | -0.20 pts |
| Used Cars | -1.2% | 3% | -0.04 pts |
| Electronics | -0.8% | 2% | -0.02 pts |
| Apparel | -0.3% | 3% | -0.01 pts |
Inflationary Forces:
| Category | Monthly Change | Weight | Impact |
| Healthcare Services | +0.5% | 16% | +0.08 pts |
| Housing Services | +0.4% | 15% | +0.06 pts |
| Food Services | +0.5% | 5% | +0.03 pts |
| Education | +0.6% | 3% | +0.02 pts |
The battle between falling goods prices and rising services prices determines the overall reading. Services inflation (more than 60% of PCE) remains stubbornly elevated—the Fed’s primary concern.
Market Reaction Scenarios
Scenario 1: Hot Number (3.0%+)
- Immediate: S&P 500 falls 1.5-2.5%, yields jump 8-12 basis points
- Rate Cut Pricing: Shifts from three cuts to two cuts (-25 basis points expected)
- Fed Chair: Increases probability of hawkish Kevin Warsh selection
- Dollar: Strengthens on higher-for-longer rate expectations
- Gold: Paradoxically could rise on inflation hedge demand despite higher rates
Scenario 2: In-Line (2.7-2.9%)
- Immediate: Modest volatility, likely small decline (0.3-0.7%)
- Rate Cut Pricing: Maintains three-cut expectation (status quo)
- Fed Chair: Doesn’t significantly impact selection
- Dollar: Range-bound trading
- Gold: Consolidates near current levels
Scenario 3: Cool Number (Below 2.5%)
- Immediate: S&P 500 rallies 1.5-2.0%, yields fall 6-10 basis points
- Rate Cut Pricing: Shifts to four cuts (+25 basis points expected)
- Fed Chair: Increases probability of dovish Kevin Hassett
- Dollar: Weakens on dovish Fed expectations
- Gold: Mixed reaction (lower inflation but also lower rates)
The Tariff Complication
What makes this PCE report especially tricky: it reflects December 2025 data, BEFORE Trump’s tariff threats. So even a benign reading doesn’t capture the potential inflationary impact of 10-25% tariffs on European goods.
Estimated Tariff Impact on Future Inflation:
| Tariff Scenario | Direct Impact | Indirect Impact | Total Effect |
| 10% on targeted goods | +0.3-0.4% | +0.1-0.2% | +0.4-0.6% |
| 25% on targeted goods | +0.7-0.9% | +0.2-0.3% | +0.9-1.2% |
| Broader trade war | +1.2-1.5% | +0.4-0.6% | +1.6-2.1% |
This means even if Thursday’s PCE comes in at 2.5%, forward-looking inflation could jump to 3.0-3.5% if tariffs are fully implemented. Markets trying to price this uncertainty, creating extra volatility.
Consumer Spending: The Other Critical Data Point
Beyond inflation, Thursday’s report includes personal spending and income data:
Why It Matters:
- Consumer spending represents 70% of U.S. GDP
- Strong spending + high inflation = Fed more likely to keep rates higher
- Weak spending + high inflation = Stagflation concerns
- Strong spending + low inflation = Goldilocks scenario (best for stocks)
Expected:
- Personal spending: +0.4% (steady consumer demand)
- Personal income: +0.3% (wage growth moderating)
- Savings rate: 4.8% (down from 5.0%, suggests confident consumers)
The combination of spending strength and inflation rate determines economic narrative. Strong spending with cooling inflation is ideal. Strong spending with rising inflation is problematic.
Historical Context: PCE Surprises and Market Moves
Recent PCE Surprises and S&P 500 Reactions:
| Date | Expected | Actual | Surprise | S&P 500 Move |
| Nov 2025 | 2.9% | 2.8% | -0.1% | +1.2% |
| Oct 2025 | 2.7% | 2.9% | +0.2% | -1.8% |
| Sep 2025 | 2.6% | 2.6% | 0.0% | -0.3% |
| Aug 2025 | 2.7% | 2.5% | -0.2% | +1.5% |
On average, each 0.1% surprise moves the S&P 500 by approximately 0.9% in the opposite direction (hot inflation = stocks down, cool inflation = stocks up). A 0.3% surprise could trigger 2-3% moves.
What the Fed Is Really Thinking
Federal Reserve officials entered their traditional “blackout period” last week ahead of their February 4-5 policy meeting, but recent speeches provided clues:
Hawkish Camp (No Rush to Cut):
- Christopher Waller: “We should take our time. Inflation progress has stalled.”
- Loretta Mester: “I want to see more evidence inflation is moving sustainably toward 2%.”
Dovish Camp (Ready to Cut):
- Austan Goolsbee: “If labor market weakens, we should be prepared to act.”
- Mary Daly: “The time to begin normalizing rates is approaching.”
The median Fed official expects two rate cuts in 2026, according to December’s “dot plot.” But that was before Trump’s tariff threats and recent inflation data. Thursday’s PCE could shift the entire committee’s thinking.
Bottom Line
Thursday’s PCE inflation report represents one of the most consequential economic data releases of early 2026. With markets already stressed from Greenland crisis, Fed Chair nomination imminent, and tariff threats looming, a surprise in either direction could trigger significant volatility.
Traders should prepare for potential 2%+ swings in equity markets based on the release. Options market activity suggests institutions are heavily hedging for Thursday’s 8:30 AM EST release.
For longer-term investors, the key question: is inflation genuinely returning to the Fed’s 2% target, or has progress stalled in the 2.5-3.0% range? The answer determines whether the Fed can cut rates aggressively (bullish for stocks) or must keep policy restrictive (bearish for valuations).
One thing is certain: Thursday morning will be must-watch financial television. Set your alarms for 8:30 AM EST.
