Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Splitting From the Markets This Season
Transcript
- Lucas: So the S&P 500 is sitting just above 7,700, up nearly a percent on the week, and the Nasdaq is even stronger. But if you look at the macro data underneath that rally, it's a strange picture. Luna: Strange how? I mean, the jobs market still looks okay — unemployment at 4.1 percent, initial claims at 203,000. Lucas: Right, those are solid. But the Fed's preferred inflation gauge, the core PCE deflator, just printed 3.3 percent annualized for July. That's still well above their 2 percent target. And yet the 10-year breakeven rate — the market's own inflation expectation — dropped to 2.31 percent this week. Luna: So the market is saying inflation is coming down, but the Fed's own data says it's sticky. That's a pretty big gap. Lucas: Exactly. And it explains why you have Fed officials like Hammack saying 'now is the time to act' on rates, while bond traders are pricing in a cut by early next year. Something has to give. Luna: Let's dig into that. Why does the Fed even care about the 10-year breakeven? Is it just a market poll? Lucas: It's more than a poll. It's the yield on a ten-year Treasury minus the yield on a ten-year inflation-protected security. That difference tells you what investors collectively think inflation will average over the next decade. When it falls, it's a signal that long-run inflation expectations are anchored — which the Fed loves. But when it falls while core PCE is running hot, it creates this awkward disconnect. Luna: So the market is saying 'we trust you, Fed, you'll get inflation down,' but the data right now isn't cooperating. Lucas: Right. And that's the core tension. Let's look at the numbers. Real GDP growth annualized was just 1.5 percent in the second quarter, down from 2.1 percent. That's a slowdown. But core PCE is at 3.3. That's a stagflation-lite mix, and it puts the Fed in a bind. Luna: Stagflation-lite — I like that. So what does the Fed do? Do they hike into a slowdown, or wait? Lucas: The hawks are saying hike now. Hammack's comment is pretty direct. But the market is skeptical because the breakeven is falling. When inflation expectations drop, the Fed can afford to be patient. The problem is the core PCE is still sticky — it's not just energy or food, it's services, rents, medical care. Luna: And the breakeven is at 2.31, which is still above the Fed's 2 percent target but not by crazy amounts. So maybe the market thinks they'll overshoot on the downside? Lucas: That's a real possibility. If the Fed over-tightens, they could push inflation below target. The breakeven at 2.31 suggests investors see that risk. But the Fed's own forecasts, the dot plot, probably still show one more hike this year. So there's a real disconnect between what the Fed says and what the market prices. Luna: And that's what makes this macro environment so tricky. Let's talk about the stock market. The S&P 500 is at record highs, but the Russell 2000 is down on the week. That's a divergence. Lucas: Yeah, small caps are getting hammered. The Russell is down about 0.8 percent over five days. That's typically a sign that investors are worried about economic growth, because small caps are more sensitive to domestic cycles. But large-cap tech is doing great. The Nasdaq is up 1.6 percent. Luna: So big tech is ignoring the macro, but small caps are paying attention. That's a classic late-cycle pattern. Lucas: It is. And it's why you hear economists argue about the shape of the economy — K-shaped, C-shaped, whatever. The data is mixed. Payrolls actually fell by 23,000 in July, according to the nonfarm number, though that could be a quirk. But job openings are down to 7.36 million from 7.5 million. The labor market is cooling, just not collapsing. Luna: And yet the Fed is talking about hiking. That's the puzzle. Lucas: The key is that the Fed under Chair Warsh has signaled a 'quieter' approach — they want to communicate less, not more. But that means the market is left guessing. And that's why this breakeven gap matters so much. It's one of the few transparent signals we have. Luna: So what should the average investor make of all this? We've got a Fed that might hike, a market that thinks they'll cut, and an economy that's slowing but not crashing. Lucas: I think the takeaway is that the Fed is data-dependent, but the data is pointing in opposite directions. So they're going to be cautious. The breakeven rate is falling, which gives them cover to wait. But if core PCE doesn't come down in the next few months, they'll be forced to act. Luna: And if they act, that could be a gut punch for the markets, especially small caps that are already struggling. Lucas: Exactly. So keep an eye on the core PCE next month. If it ticks down, the market breathes easier. If it stays at 3.3, expect more hawkish talk from the Fed. Luna: And that's why we do this show, right? To help people make sense of these crosscurrents. If today's conversation actually helped you see the macro picture a little clearer, the way we keep this podcast ad-free is through listener support. If you find value in our daily breakdowns, you can toss a coffee our way at buy me a coffee dot com slash fexingo. It genuinely keeps us going. Lucas: Yeah, appreciate that. And it's a small way to say thanks if we've saved you some confusion. But back to the data — one more thing that's been under the radar is the Treasury General Account. With the debt at $40 trillion, the Treasury's cash buffer is getting watched closely. Luna: Right, because if the TGA gets too low, that can add liquidity to the system, which could complicate the Fed's tightening. Lucas: Exactly. And given the market's sensitivity to supply, any drama there could push yields around. So there's a lot to track. But for now, the breakeven is the canary in the coal mine. Luna: Let's hope it's not chirping too loudly. Thanks for joining us, and we'll be back tomorrow.