Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How the Fed Weighs Tariff and Oil Shocks Against Soft Inflation
Transcript
- Lucas: Luna, we have a really interesting tension in the data right now. On one hand, core CPI actually ticked down — from 336.12 to 336.1 — and the overall CPI fell from 333.98 to 332.6. On the other hand, import prices from China just posted their biggest gain since 2008, and President Trump announced a new global tariff last week. Luna: So the Fed is getting completely mixed signals — falling consumer prices but rising input costs from tariffs and oil. How do they even begin to parse that? Lucas: Well, the first thing is they lean heavily on the PCE index, not CPI. And PCE is still rising — the headline PCE went from 130.94 to 131.5, and core PCE from 129.67 to 130.1. So their preferred gauge says inflation is still sticky, even if CPI shows some softening. Luna: Right, because PCE captures changes in consumption patterns and includes things like medical care more heavily. So the tariff and oil shocks might hit PCE harder. Lucas: Exactly. And the market's expectation of inflation, as measured by the ten-year breakeven rate, actually fell slightly — from 2.28 to 2.26 percent. That suggests bond traders don't think these supply shocks will be persistent. But the Fed isn't so sure. Luna: So the Fed is likely to stay on hold at the next meeting? The fed funds rate has been flat at 3.63 percent since June. Lucas: Probably. Chair Powell — or actually, there's been a lot of attention on Kevin Warsh's recent comments, since he's seen as a potential successor. He used three key phrases that Fed watchers are parsing. One of them was 'patient but vigilant.' That suggests they're not ready to cut, even with CPI falling, because they need to see how tariffs and oil feed through. Luna: It's like they're waiting for the fog to clear. But what about the global dimension? Singapore just tightened policy in a surprise move because of rising oil prices. Lucas: That's a great point. Singapore's tightening is a signal that other central banks see inflation risks from energy. If oil keeps rising, it could push up U.S. headline inflation even if core goods are softening. The Fed has to factor in that global backdrop — especially because a stronger dollar, which we've seen recently, could offset some of the import price pressure. Luna: But the dollar hasn't really rallied that much against major currencies this week. The tariff announcement actually created uncertainty. Lucas: True. The tariff is a supply shock that raises costs for importers, and if companies pass those costs on, it could lift core goods inflation — which had been declining. That's the exact opposite of what the Fed wants. They're trying to quell the last mile of inflation, and now they have potential upward pressure from trade policy. Luna: So the Fed's reaction function is getting more complicated. They might need to hold rates higher for longer, despite soft CPI, because the tariff and oil shocks are inflationary on the supply side. Lucas: Exactly. And they also have to watch the yield curve. The ten-year is at 4.65 percent, the thirty-year at 5.13 percent — that's a steep curve, which usually signals growth expectations. But the two-year, which tracks fed policy, is around 3.80 percent — that's still below the fed funds rate, implying the market expects cuts eventually. Luna: So the market is pricing in cuts, but the Fed is pushing back. That disconnect is typical around turning points. Lucas: Right. And this kind of analysis is exactly why people tell us they support the show — it's the nuance that's hard to get from headlines. A couple of dollars a month on buy me a coffee dot com slash fexingo genuinely keeps these episodes ad-free and lets us dig into the data like this. Luna: Yeah, we hear from listeners who say it helps them understand what the Fed is actually thinking. If that's you, we appreciate the support. Lucas: So to summarize: the Fed is in a wait and see mode. They're worried that tariffs and oil could rekindle inflation, even as core CPI edges down. The next FOMC meeting in September will be crucial — we'll see if the data tilts them toward a cut or keeps them on hold. Luna: And one thing to watch is the next PCE release, which gives a more complete picture. That'll be out before the September meeting. Lucas: Absolutely. The PCE data for June should drop in late August, and it will likely show whether the tariff and oil effects are starting to show up in consumer prices. That's the key number the Fed will be watching.