Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What the Fed's Preferred Inflation Gauge Tells Us Now
Transcript
- Lucas: So today, the Fed's preferred inflation gauge — the core PCE price index — came in at an annual rate of 3.3% for April, exactly as expected. And the bond market's reaction was basically a shrug. Luna: Right — ten-year yield actually dropped a few basis points over the past five days, down to 4.45%. That's not the reaction you'd expect if inflation were surprising to the upside. Lucas: Exactly. The ten-year yield is actually down 2.3% in the last five days. And the ten-year breakeven inflation rate — that's the market's expectation for average inflation over the next decade — ticked down to 2.39% from 2.40% yesterday. Luna: So the market is basically saying, 'We see the sticky inflation, Kevin Warsh sees it, but we don't think it's going to spiral.' Lucas: That's the narrative. But here's where it gets interesting. The core PCE at 3.3% is still well above the Fed's 2% target. And the effective fed funds rate has been flat at 3.64% since April. So the Fed is essentially holding its ground. Luna: And the market is okay with that? Because we've seen episodes where the bond market punished the Fed for not moving. But now it seems like the ten-year yield is actually declining. Lucas: Right. Look, the ten-year yield peaked around 4.55% a couple weeks ago. The fact that it's eased back suggests the market believes the Fed has the situation under control — or at least that no rate hike is imminent. But the details in the PCE report matter. Luna: What stood out to you? Lucas: Energy. Headline PCE rose to 130.9 in April from 130.38 in March. A lot of that move is energy. And we heard from Chicago Fed President Goolsbee today saying energy inflation has been more persistent than expected. That's a key wildcard. Luna: Because energy prices are volatile, right? They can spike on geopolitical news and then fade. But if they stay elevated, they bleed into core inflation through transportation and production costs. Lucas: That's the concern. Core PCE — which strips out food and energy — was 129.6 in April, up from 129.32. So even the core is creeping up. It's not accelerating dramatically, but it's not cooling either. The three-month annualized rate for core PCE is probably around 3.6%. Luna: And that's the number the Fed watches most closely. So why isn't the bond market panicking? Lucas: Part of it is the labor market. Minneapolis Fed President Kashkari said today that the inflation fight takes priority because the labor market is 'in decent shape.' So the Fed has cover to hold steady. The market knows that. Luna: Also, the five-year yield — that's the two-year note equivalent — is at 3.59%, almost exactly where it was five days ago. The short end is anchored. The market isn't pricing in a rate hike. Lucas: Correct. The fed funds futures are pricing in a rate cut around the middle of 2027, but nothing imminent. And Chair Warsh has been clear: he wants to see actual progress on inflation, not just projections. So the standoff continues. Luna: Let's talk about the consumer. Because we've had record-low consumer sentiment readings, but the Fed seems to be ignoring that. How does that square with the PCE data? Lucas: It's a tension. Consumer sentiment is about expectations — how people feel about the future. PCE is about actual spending. And actual spending has been resilient. The savings rate is down, but people are still spending. So the Fed is looking at the hard data, not the mood. Luna: Right. And the mood might improve if inflation actually comes down. But for now, the Fed's message is: we're watching the numbers, and the numbers say hold. Lucas: One more thing on the breakeven rate. At 2.39%, the market is essentially pricing in inflation that averages just under 2.4% over the next decade. That's above the Fed's target, but it's not runaway. It suggests the market trusts the Fed to eventually get inflation down, just slowly. Luna: So the biggest risk is that energy prices keep rising, core inflation sticks above 3%, and the market loses patience. That's when you'd see the ten-year yield break above 4.5% again. Lucas: Or if the labor market suddenly weakens, then the Fed would have a different problem. But right now, the data is consistent with a 'higher for longer' stance. And if today's PCE report gave us anything, it's confirmation that the Fed isn't moving anytime soon. Luna: If this conversation helped you make sense of what the Fed is actually looking at, the way we keep these episodes ad-free is through listener support — buy me a coffee dot com slash fexingo. Lucas: Yeah. The economics shows especially — we want to keep them accessible to everyone. So if today was useful, that's the link. Luna: And we're back to the data. One thing I want to dig into is the regional Fed commentary. We heard from Goolsbee and Kashkari today, but also the ECB is talking tough. How much does global central bank communication affect the Fed? Lucas: It matters indirectly. If the ECB keeps hiking — or holds — it keeps the dollar strong, which can help contain imported inflation. But the Fed's mandate is domestic. I think the bigger influence is the U.S. bond market itself. Luna: And the U.S. bond market is watching the same PCE data we are. So the feedback loop is pretty tight. Lucas: Exactly. The ten-year yield didn't move much on the PCE release because it was in line. But if next month's core PCE comes in at 3.5% or higher, you'll see a different reaction. The market is calibrated to 'sticky but not accelerating.' Luna: So we're in a waiting game. The Fed waits for inflation to come down, the market waits for the Fed to cut, and the consumer waits for relief. Lucas: That's the macro picture in a nutshell. And the data we got today — the core PCE at 3.3%, the breakeven at 2.39%, the ten-year at 4.45% — all of it says the stalemate continues.