The Fed's favorite inflation gauge was already hot. That was before war sent oil soaring

The Bureau of Economic Analysis on Friday published January's Personal Income and Outlays report — three weeks behind schedule, a casualty of last fall’s record-long government shutdown. But the delay is just a minor footnote once you get a look at the data, which shows that inflation was coming in hot even before the surprise U.S. attack on Iran.

Worse? It’s reasonable to conclude inflation is set to increase from the January numbers. Steeply rising gas prices alone are enough.

Here's what to know.

Core inflation moving in the wrong direction

The PCE price index — widely understood to be the Federal Reserve's preferred inflation measure — rose 0.3% in January from December. Strip out food and energy and the core reading came in at 0.4% for the month and 3.1% from a year ago. That’s well above the Fed's 2% target, and not moving in the right direction.

The personal saving rate ticked up to 4.5% in January (driven in part by the cost-of-living bump to Social Security payments). But it’s still a low rate by long-term historical standards, suggesting that American consumers were already challenged by the rising cost of living before the oil shock hit. Many households are now staring down significantly higher daily expenses, even as their financial cushions remain thin or even nonexistent.

Soaring gas prices threaten household budgets

Since the PCE report data was collected, the U.S. attack on Iran has sent crude oil rocketing roughly 70% in a matter of just days. The national average for a gallon of gas hit $3.63 on Friday morning, up from $2.99 just days ago. Because oil is an input cost for freight, fertilizer, manufacturing, and air travel, a sustained energy shock has the potential to embed itself in the price of nearly everything Americans buy — exactly the dynamic that makes the services end of PCE somewhat stubborn, hard for the Fed to manage via rate policy alone.

Services make up about 70% of the PCE index, and cover everything from utility bills to tuition, haircuts, streaming services like Netflix $NFLX, and airfares. Economists say that in scenarios where gas prices quickly rise, and remain elevated, that the price of goods generally rises first, later followed by rising services prices as costs are passed on down the line and throughout sectors. But the speed and rate of today’s gas-price increase makes for a tough comparison. The last time prices changed this fast was with the Russian invasion of Ukraine, and before that, a far more regional shock caused by Hurricane Katrina in 2005.

More immediately, the Federal Reserve meets next week. Prediction markets put the probability of an interest rate cut at just 1%. Caught between the new PCE data, worrying trends in the labor market, and the more general shock of suddenly finding the nation at war — after very little buildup, public discussion, even the advancement of a coherent rationale or timeline — the Fed has little choice but to wait and see what happens next.