Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Core Inflation Is Sticky But Consumers Are Still Spending
Transcript
- Lucas: So headline CPI ticked down to 332.6 in June from 333.98 in May — a drop of about 0.4 percent. But core CPI? It barely budged, sitting at 336.1 compared to 336.12 the month before. You look at that and think, okay, the headline improvement is mostly energy and maybe some food volatility, but the underlying trend is still stubborn. Luna: Right, and the PCE data tells a similar story. The headline PCE index rose to 131.5 from 130.94, and core PCE went from 129.67 to 130.1. So we're still seeing upward pressure in the Fed's preferred gauge. Lucas: Exactly. And what's interesting is the composition. The drop in wholesale prices — PPI fell 0.3 percent in June, largely on gasoline — should eventually feed into consumer prices. But the pipeline from producer to consumer isn't instantaneous, and services inflation is proving especially sticky. Luna: Housing is the big one there. Shelter costs are still running hot. Core CPI ex-shelter looks a lot more benign, but the Fed can't ignore rent and owners' equivalent rent — that's roughly a third of the CPI basket. Lucas: And that's the tension. The 10-year breakeven inflation rate is at 2.24 percent, up slightly from 2.22 a few days ago. That suggests the bond market expects inflation to settle a bit above the Fed's 2 percent target over the medium term. Not alarmingly so, but enough to keep the Fed from rushing into cuts. Luna: Meanwhile, the fed funds rate is sitting at 3.63 percent, and the rate on reserve balances is 3.65. So real rates — if you use core PCE around 2.6 percent — are roughly 1 percentage point. That's restrictive, but not dramatically so. Lucas: That's the right framing. The Fed has engineered a modestly restrictive stance, but the economy is still growing. Real GDP growth annualized at 2.1 percent in Q1, up from 0.5 percent in the previous quarter. And the unemployment rate fell to 4.2 percent from 4.3 percent. So the economy isn't begging for stimulus. Luna: But consumer spending is where the warning lights are flickering. We saw that World Cup bump in bars and restaurants — the Fed's Beige Book noted that. But outside of that, retail sales have been soft. And credit card balances are creeping up again. Lucas: Right. The household is increasingly reliant on credit to maintain spending, and that's not sustainable if wage growth doesn't accelerate. Average hourly earnings are up to $37.60, but that's only about 2.3 percent year-over-year. Meanwhile, core inflation is running around 2.6-2.7 percent. So real wages are actually slightly negative. Luna: That's the puzzle for the Fed. If the consumer starts to buckle, the case for cutting grows stronger. But if inflation stays sticky because of housing and services, they can't cut without risking a reacceleration. It's a classic policy trap. Lucas: And the market is pricing in a cut at the September FOMC meeting. The fed funds futures imply about a 70 percent chance of a quarter-point reduction. But I wonder if the data between now and then will support that. We've got two more CPI and PCE releases before the September meeting. Luna: Do you think the Fed might be too focused on backward-looking data? I mean, the wholesale price decline and the softening in global demand — especially from China — suggest disinflationary pressures are building. Lucas: I think Chair Powell would say they're data-dependent, not data-reactive. They want to see a sustained trend, not just one or two prints. But you raise a fair point — if they wait too long, they might be cutting into a slowdown rather than preempting one. Luna: And the global backdrop adds another layer. China's economy is slowing — their quarterly growth was the weakest since 2022. That's pushing down export prices, which is disinflationary for the US. But at the same time, renewed tensions in the Strait of Hormuz are pushing up energy prices. So we've got conflicting forces. Lucas: Yeah, oil is the wildcard. If gasoline prices spike again, headline CPI could reverse its recent decline, and that would make the Fed even more cautious. But for now, the core services story is the main event. Luna: So where does that leave the consumer? If real wages are negative and credit is maxing out, something has to give. Lucas: I think the key is the labor market. As long as job openings remain elevated — JOLTS came in at 7.594 million, up from 7.585 — and layoffs stay low — initial claims dropped to 208,000 — the consumer has income support. The question is whether that support is enough to sustain spending without additional borrowing. Luna: And if the consumer does pull back, that could actually help the Fed by cooling demand and reducing inflation. So in a weird way, a slowdown in spending might be what allows them to cut. Lucas: Exactly. The Fed needs to see either inflation come down or the economy weaken. Right now, we're in a gray zone where neither is happening decisively. And that's why rates are on hold. Luna: Before we wrap, I want to mention something. We get a lot of listener questions about how we keep the show ad-free and independent. Lucas: Yeah, it's a good question. The short answer is listener support. A few dollars a month from people who find these conversations useful goes a long way to covering hosting costs and research time. Luna: If you've gotten something out of the show — maybe a clearer understanding of why inflation is sticky or what the Fed is thinking — consider tossing a couple of bucks our way. It's buy me a coffee dot com slash fexingo. Lucas: And we genuinely mean a couple of dollars. That's all it takes to keep this going. No pressure, but if it's made a difference in how you think about the economy, we appreciate the support. Luna: Alright, back to the numbers. One thing I want to circle back to is the yield curve. The two-year yield is at 3.71 percent, the ten-year at 4.54, so the curve is still inverted but less so than earlier this year. What does that tell us? Lucas: The flattening inversion suggests the market is pricing in near-term rate cuts but also higher term premiums — maybe because of fiscal concerns or inflation uncertainty. A steeper curve typically precedes a recession, but this time it might just reflect the Fed's path rather than a growth scare. Luna: So it's not the reliable recession signal it used to be. Lucas: Right. Post-pandemic, the curve has been distorted by quantitative tightening, the huge supply of Treasuries, and foreign demand shifts. So I'd take the inversion signal with a grain of salt. Luna: But the real risk, I think, is that the Fed keeps policy too tight for too long and inadvertently breaks something in the financial system. Lucas: That's the perennial risk. But the Fed is acutely aware of it. They've got their ears to the ground on commercial real estate, regional banks, and credit conditions. So far, nothing has cracked, but vigilance is warranted. Luna: Let's see what the July CPI print brings. If we get another month of sticky core, the September cut narrative might fade. Lucas: Agreed. And if the economy keeps chugging along at 2 percent growth with a 4.2 percent unemployment rate, the Fed can afford to wait. Patience might be the right play. Luna: Alright, that's a good place to leave it. Thanks for listening.