The Fed chair's diffusion measure found 54% of prices rising faster than 3%. Weight those items by what consumers actually spend, Nomura's economists argue, and the measure tilts toward the most volatile corners of the basket.
When Federal Reserve Chair Kevin Warsh wanted to explain why inflation worried him, he did not cite a headline index. He counted prices.
"To try to gauge underlying inflation, I find it instructive to disaggregate the 199 individual components of the PCE price measure," Warsh said in his August speech at Jackson Hole. "Over the past 12 months, 54% of goods and services in the PCE basket showed price increases above 3%." He noted that the share was well below its postpandemic peak of 77% but above the 32% average in the two decades before the pandemic.
Three weeks later, the Fed raised rates for the first time since 2023. That sequence gives Warsh's counting method more weight than a speech statistic usually carries, and it has drawn a critique from economists at Nomura led by Aichi Amemiya.
Their first objection is about weighting. Warsh's measure treats each of the 199 components equally, no matter how much consumers spend on it. "That distinction matters," the Nomura economists wrote. "Food, energy and core goods account for roughly 47% of the 199 components on an equal-weighted basis, but only about 32% after accounting for expenditure weights."
Housing shows the gap from the other side. It accounts for just 3% of the 199 categories but about 16% of consumer spending. A count that gives every category one vote therefore leans heavily on food, energy and goods, the parts of the basket that tend to swing the most, and gives little voice to shelter.
The second objection is about timing. Nomura found that diffusion measures have not historically led core PCE inflation. "Around major turning points, including the post-global financial crisis disinflation and postpandemic inflation surge, neither diffusion measure identified inflections in the trend materially earlier than core PCE inflation," the economists wrote.
Their conclusion was that if Warsh and other policymakers lean harder on diffusion, they risk reacting to false signals.
Nomura did not argue the measure is useless. Fed officials including Janet Yellen, when she was vice chair, and current Governor Christopher Waller have cited diffusion data in the past. The Bank of Canada is among foreign central banks that track it.
The debate arrives at a sensitive moment. Energy prices have been the main driver of this year's inflation scare, and energy is one of the categories that equal weighting amplifies. If oil falls back, a diffusion count could improve quickly. If it stays high, the count could keep flashing red even if shelter and services cooled.
Markets are pricing the hawkish reading for now. Traders put the odds of an October hike near 70% on Wednesday after a hot business survey and fresh calls for tightening from Fed Governor Michael Barr, and the two-year Treasury yield touched its highest level since 2024. The next PCE report will show whether the share of prices running above 3% is still rising, and whether the weighted measures agree with it.