Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The ECB Rate Hike and Why It Matters for US Inflation
Transcript
- Lucas: The European Central Bank just hiked rates for the first time since 2023. That happened this morning. And if you think it's just Europe's problem, it's not. Luna: Yeah, I saw that. The ECB raised by a quarter point. The rationale was basically energy prices from the Iran situation spilling into their inflation readings. Lucas: Exactly. The headline is that the ECB is now at 3.75 percent on the deposit rate. But the real story is the transmission to us. When the ECB tightens, it strengthens the euro relative to the dollar, all else equal. That makes our imports cheaper, which is a disinflationary force for the US. But it also complicates the Fed's path because a weaker dollar can boost exports and GDP. Luna: Right, and we just got CPI at 4.2 percent annual, the highest in three years. So the Fed is already in a tough spot. Does an ECB hike make them more likely to cut or to hold? Lucas: Short term, it probably keeps them on hold. The Fed is watching inflation expectations closely, and the 10-year breakeven rate has crept up to 2.34 percent. That's not alarming, but it's above the Fed's comfort zone. If the euro strengthens and oil prices stay elevated because of the Iran conflict, the Fed may worry that imported inflation gets replaced by domestic demand-side pressures. So they wait. Luna: Interesting. And wholesale prices came in hot today too — up 1.1 percent in May, mostly on energy. That's going to feed into core PCE eventually. Lucas: It will. The PCE price index for April was already at 130.9, up from 130.38. The wholesale number suggests May PCE could tick higher. But here's the nuance: the Fed's preferred measure is core PCE, which strips out food and energy. So the energy surge might not directly move the needle on their target, but it does affect consumer inflation expectations. And that's what they really care about. Luna: So the ECB hike is basically a signal that global central banks are still fighting inflation, even if the Fed is pausing. That keeps financial conditions tight worldwide. Lucas: Exactly. And that's where the yield curve comes in. The US 10-year is at 4.53 percent, the 2-year is at 4.26 percent. That's still inverted, but less so than a year ago. The fact that the ECB is hiking while the Fed is on hold means the dollar could weaken, which would actually help narrow the inversion by pushing long-term yields up on inflation expectations. Luna: I want to go back to the labor market for a second. JOLTS job openings surged to 7.6 million in April, up from 6.9 million. That's a big jump. How does that fit with the ECB and inflation story? Lucas: It fits because it shows the US labor market is still tight. Wage growth is running at about 4 percent annualized. If the ECB is tightening and the dollar weakens, that could boost US exports and keep the labor market even tighter. That's the opposite of what the Fed wants if they're trying to cool inflation. Luna: So you're saying the ECB hike might actually make the Fed's job harder, not easier. Lucas: Potentially. Because if the dollar weakens, it makes US exports cheaper, which could boost demand and put upward pressure on prices. But it also makes imports more expensive, which is inflationary. So it's a double-edged sword. The net effect depends on how much the euro appreciates and how sensitive US trade is to exchange rates. Luna: Let's look at the numbers. The euro is trading around 1.12 today, up from 1.08 a month ago. That's a meaningful move. Lucas: It is. And if it goes to 1.15, that's roughly a 6 percent appreciation. That would directly lower US import prices by about half that, given pass-through estimates. So that's a disinflationary force. But it also means US goods are cheaper for Europeans, which could boost our exports. The net effect on GDP might be positive, but on inflation, it's ambiguous. Luna: I want to bring up something else. The unemployment rate is at 4.3 percent, flat from last month. But long-term unemployment has been rising. That's a structural concern that the ECB hike doesn't address. Lucas: No, it doesn't. And that's the thing — we have this weird mix: tight labor market in terms of openings, but rising long-term unemployment. That suggests some skill mismatches or geographic mismatches. The Fed can't fix that with rate policy. They need fiscal or structural policy. But the ECB hike is a reminder that global monetary policy is still in tightening mode, which puts a ceiling on how loose the Fed can afford to be. Luna: Before we move on, I wanted to mention something that's been on my mind. If walking through the economy with us has made something click — maybe you've started noticing how central bank decisions actually affect your daily life — we just want to say that listener support is what keeps this show ad-free. You can find us at buy me a coffee dot com slash fexingo. No pressure, just if it's added value. Lucas: Yeah, Luna's right. That kind of support means we can keep doing deep dives without chasing clicks. So appreciated. Lucas: Back to the macro picture. The other big number this week was the CPI print. 4.2 percent annual headline. That's the highest since 2023. And the core came in at 3.6 percent. That's still well above the Fed's 2 percent target. So the ECB hike is happening in a context where US inflation is sticky. Luna: What's driving the core? Is it services? Housing? Lucas: Mostly services. Shelter costs are still elevated, though they've moderated a bit. But other services like medical care and transportation are rising. And goods prices are actually falling in some categories, which is the deflationary part of the story. So the inflation we have is increasingly domestic and demand-driven, not supply chain driven. That makes it harder for the Fed to ignore. Luna: So the ECB hike, combined with US inflation staying hot, means the Fed is probably on hold for the next few meetings. The fed funds rate is at 3.62 percent effective. The market is pricing in maybe one cut by year-end. Does that seem right? Lucas: It seems optimistic. I think the Fed needs to see several months of declining core PCE before they cut. And with wholesale prices rising, that's not happening soon. Plus, the labor market is still adding jobs — nonfarm payrolls at 159 million, up from 158.8 million. So the economy is still growing, real GDP at 1.6 percent annualized in Q1. That's not booming, but it's not recessionary either. Luna: Yet the yield curve is still inverted. The 10-year minus 2-year spread is about 27 basis points. That's still signaling recession risk. Lucas: It is. But the curve has been inverted for over two years now, and we haven't had a recession. Some argue this time is different because of quantitative tightening and the lag effects. But historically, an inversion this long usually precedes a recession. The question is when, not if. Luna: So the ECB hike might be the straw that breaks the camel's back for some European economies, but for the US, it's just another headwind. Lucas: Exactly. The US is relatively insulated because of our energy independence and domestic demand. But Europe is more exposed to energy shocks. The ECB hike is a preemptive move to contain inflation expectations. If it works, it could actually help the global economy by preventing a wage-price spiral. But if it tips Europe into recession, that's a drag on US exports. Luna: What about the dollar? You mentioned it might weaken. Where do you see it going? Lucas: I think the dollar could weaken modestly against the euro over the next few months, maybe to 1.15 or 1.18. That would be a 5-8 percent move. That's significant for multinational companies. But the dollar is also a safe haven, so if the Iran situation escalates, it could strengthen again. So it's a tug of war. Luna: Let's talk about what this means for investors. If the ECB is hiking and the Fed is on hold, where should people be looking? Lucas: I'd look at sectors that benefit from a weaker dollar: industrials, materials, and technology companies with large export exposure. Also, commodities tend to rise when the dollar falls. But energy is tricky because of the geopolitical risk. I'd be cautious there. Luna: Bonds? The 10-year at 4.53 percent is attractive, but if inflation stays high, real yields are still negative. Lucas: Real yields on the 10-year are about 2.2 percent if you use breakeven inflation. That's actually positive and historically decent. So bonds are starting to offer some value. But the risk is that inflation expectations rise further, which would push nominal yields up and bond prices down. So it's a mixed picture. Luna: I want to go back to the JOLTS number for a second. 7.6 million job openings. That's a huge jump from 6.9 million. What's driving that? Lucas: A lot of it is in leisure and hospitality, and in professional services. It suggests that businesses are still confident enough to hire, even with high interest rates. But it also means the labor market is not cooling as fast as the Fed would like. That could delay rate cuts. Luna: So the Fed is stuck. Inflation too high, labor market too tight, global central banks hiking. They can't cut without risking a reacceleration of inflation. Lucas: That's the nutshell. And the longer they stay on hold, the more the yield curve inversion persists, and the more recession risk builds. It's a delicate balancing act. Luna: One last thing: the ECB's move today was accompanied by a statement that they are data-dependent and will not pre-commit. That's similar to the Fed's language. So we're in a world where every data point matters. Lucas: Exactly. Next week we get retail sales and industrial production. Those will give us a read on Q2 GDP. If consumption weakens, that might give the Fed cover to cut. But if it holds up, we're in for a long summer of waiting. Luna: And the Iran situation is a wildcard. If energy prices spike further, that could force the Fed's hand in the other direction — maybe even a hike. Lucas: That's the nightmare scenario. But for now, the ECB hike is the big story. It's a reminder that the global inflation fight is not over, and that central banks are still willing to act. The question is whether they can coordinate without breaking anything. Luna: One more thought: the 10-year breakeven at 2.34 percent is still below the 2.5 percent that the Fed might consider alarming. So inflation expectations are anchored for now. Lucas: That's the one bright spot. If breakevens start moving toward 2.5 or higher, then the Fed will have to respond. But for now, they can afford to wait. And the ECB hike might actually help keep global inflation expectations in check. Luna: Alright, so to sum up: ECB hikes, dollar weakens, US inflation sticky, Fed on hold, yield curve still inverted, labor market tight but with structural issues. That's the macro picture as of June 11, 2026. Lucas: That's it. Thanks for joining us on The Macro Memo. We'll be back tomorrow with more.