October PCE Data Destroys the Soft Landing Narrative
Today is November 26, 2025. The Bureau of Economic Analysis just released the October Personal Consumption Expenditures (PCE) report. The numbers are a cold shower for those expecting a December rate cut. Core PCE inflation, which excludes volatile food and energy costs, printed at 2.8 percent on an annual basis. This is a move in the wrong direction. The market expected 2.6 percent. This 20 basis point overshoot is not a rounding error. It is a structural warning. The Federal Reserve now faces a wall of data suggesting that the last mile of inflation is not just sticky, it is hardening.
Personal income increased by 0.4 percent in October. Personal spending rose by 0.5 percent. Americans are not slowing down. They are spending their way through the price increases. This resilience is the Fed’s primary nightmare. Per the latest BEA release, the personal saving rate has dipped to 3.2 percent. Consumers are draining their buffers to maintain lifestyle standards. This creates a feedback loop. High spending keeps demand high. High demand prevents prices from cooling. The cycle is unbroken.
The Gapen Thesis and the Productivity Mirage
Michael Gapen, Head of US Economics at Morgan Stanley, has long argued that the US economy can handle higher rates because of a structural shift in productivity. However, the Q3 productivity data released earlier this month tells a different story. While Gapen suggests that AI integration would offset wage growth, the actual unit labor costs rose by 1.9 percent. This suggests that the AI revolution is not yet paying the bills. Companies are paying more for labor but are not seeing the exponential output gains promised in late 2024.
The disconnect is found in the services sector. Services inflation remains at 4.1 percent. You cannot automate a plumber or a nurse with a large language model yet. This is where the inflation is entrenched. Gapen’s previous optimism relied on a neutral rate (r-star) of roughly 3.0 percent. With Core PCE at 2.8 percent and the Fed Funds rate at 4.75 percent, the real interest rate is only 1.95 percent. Historically, this is not restrictive enough to crush 4 percent services inflation. The market is finally waking up to the reality that 4 percent might be the new floor for the Fed Funds rate, not the ceiling.
October 2025 Inflation Components
| Category | Annual Change (%) | Monthly Contribution |
|---|---|---|
| Core PCE (Ex-Food/Energy) | 2.8 | +0.3 |
| Services (Less Energy) | 4.1 | +0.4 |
| Durable Goods | -1.2 | -0.1 |
| Food | 1.9 | +0.1 |
| Energy | -4.5 | -0.5 |
The table above highlights the problem. Deflation in energy and goods is the only thing keeping the headline number from exploding. If oil prices stabilize or rise due to geopolitical tensions in the Middle East, the headline PCE will move toward 3.5 percent rapidly. The Fed has no margin for error.
The D3 Visualization of the Inflation Gap
The chart below illustrates the widening gap between the Fed’s 2 percent target and the current Core PCE trajectory. The divergence in late 2025 indicates a failure of the current restrictive policy to reach the final objective.
Market Disconnect and the December FOMC Meeting
Wall Street is in denial. According to the CME FedWatch Tool, traders are still pricing in a 42 percent chance of a 25 basis point cut on December 17. This is delusional. The Fed cannot cut rates while Core PCE is accelerating. Doing so would signal a surrender to inflation. It would unanchor inflation expectations, leading to a 1970s style wage-price spiral.
Equity markets are currently trading at a forward P/E of 22.5. This valuation assumes that interest rates will drop and earnings will grow by 12 percent. If the Fed stays on hold, or heaven forbid, discusses a hike, those multiples must compress. The tech sector is particularly vulnerable. High rates punish future cash flows. If the 10 Year Treasury yield breaks 4.5 percent, expect a massive rotation out of growth stocks and into defensive utilities and consumer staples.
The logic is simple. Inflation affects margins. Higher wages affect margins. High interest rates affect debt servicing. When all three move upward simultaneously, the equity risk premium disappears. Investors are currently being paid very little to take on stock market risk compared to the safety of a 4.4 percent Treasury yield. The math no longer supports the bull case at these levels.
The Real Mechanics of the Inflation Trap
The mechanism of our current inflation is driven by the fiscal-monetary divergence. While the Fed is trying to tighten, the federal deficit continues to expand. This fiscal stimulus offsets the central bank’s efforts. We are seeing a tug of war between Jerome Powell and the Treasury. Every dollar the Fed takes out of the economy via high rates, the government puts back in through deficit spending. This is why the economy has not crashed despite the fastest tightening cycle in 40 years.
Technical analysis of the PCE trend shows a clear ascending triangle. We have higher lows forming since July 2025. Today’s print broke the horizontal resistance at 2.7 percent. This is a technical breakout for inflation. For those looking at Reuters market data, the immediate reaction in the bond market was a sharp selloff in the 2-year Note. The yield jumped to 4.31 percent within minutes of the release. The bond market is telling the Fed to stay the course.
The next major milestone is the January 28, 2026, FOMC meeting. By then, we will have the full Q4 2025 GDP data and the first look at 2026 fiscal policy. Watch the 2.8 percent Core PCE level closely. If the November print, released in late December, does not fall below 2.7 percent, the Fed will likely be forced to move the dot plot toward a terminal rate of 5.25 percent or higher for the duration of 2026.
