Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / How Sticky Services Inflation Traps The Economy
Transcript
- Lucas: The numbers coming out this week tell a story that is becoming increasingly familiar, yet deeply frustrating for anyone trying to plan a budget. Core PCE is sitting at 130.7, which means inflation in the services sector isn't just slowing down; it is effectively frozen at a level that feels like a permanent tax on middle-class income. Luna: It is the dichotomy that keeps economists up at night. Goods prices have stabilized, but when you look at the actual cost of getting your hair cut or fixing your roof, those numbers haven't budged an inch in eighteen months. Lucas: Exactly. And the data supports the idea that this is structural, not cyclical. Real GDP growth has decelerated to one point five percent annualized, while the unemployment rate holds steady at four point one percent. We are seeing the hallmark signs of a supply-constrained service economy where demand remains rigid despite higher borrowing costs. Luna: Right, and with seven thousand two hundred seventy-one job openings reported in the last JOLTS release, employers are still competing fiercely for talent in sectors like hospitality and personal care. That competition drives wages up, which then gets passed directly to the consumer as higher prices. Lucas: That wage pass through mechanism is the key here. In manufacturing, automation and global supply chains eventually dampen those cost increases. But in local services, labor is the product. You cannot automate a nurse, a teacher, or a plumber. So when wages rise to attract workers in a tight market, the price of the service rises immediately to protect margins. Luna: It creates a feedback loop that monetary policy struggles to break because raising rates doesn't magically create more nurses or plumbers. It just makes borrowing more expensive for everyone else. Lucas: Precisely. And we see this playing out in the broader market today. Gold has dropped two point three percent to four thousand three hundred twenty-three dollars, suggesting that investors are starting to lose faith in the safe-haven narrative against persistent domestic inflation. Meanwhile, the tech-heavy Nasdaq is up two percent, driven by efficiency plays that can scale without proportional labor costs. Luna: So the market is essentially betting on technology to solve the productivity problem that the service sector can't fix on its own. It is a divergence between what the stock market rewards and what the average household pays for. Lucas: That divergence is widening. Let's look at the ten-year breakeven inflation rate, which ticked up slightly to two point three five percent yesterday. This tells us that bond investors expect inflation to remain stubbornly above the Federal Reserve's two percent target for quite some time. Luna: Two point three five percent might sound small, but over a decade, that extra half percentage point compounds significantly into the cost of every mortgage and car loan. Lucas: It does. And consider the CPI reading from early August. The headline number hit 334.1, but the core component was even higher at 337.8. When you strip out food and energy, what remains is almost entirely services and shelter. Shelter costs are lagging indicators, but services are leading indicators of wage pressure. Luna: Which brings us back to the labor market. Average hourly earnings for private workers rose to thirty-seven point eight dollars. That is a consistent upward trend that correlates tightly with the services inflation we are tracking. Lucas: Yes, and notice that initial jobless claims have fallen to one hundred ninety-six thousand. The labor market is not breaking. If anything, it is too strong. A strong labor market is good for workers, but it is terrible for central bankers trying to cool inflation through demand destruction. Luna: So we are stuck in a holding pattern where the Fed can't tighten enough to kill inflation without crashing the employment numbers they are also tasked with protecting. Lucas: That is the definition of the policy dilemma. And it manifests in everyday life through what I call 'resilience pricing.' Businesses in services have learned that customers will pay more rather than go without. They have built operational resilience that allows them to maintain high prices even when volume dips slightly. Luna: I see this in my own neighborhood. Local gyms and dry cleaners raised prices last year and didn't lower them when supply chain issues eased. They just absorbed the margin increase to build cash reserves. Lucas: That behavioral shift is critical. It means inflation expectations are anchored higher in the consumer mind. When people expect prices to keep rising, they accept higher prices today, which validates the expectation. It is a self-fulfilling prophecy that lasts much longer than any single economic cycle. Luna: And unlike housing, which has physical constraints on building new supply, services can expand capacity quickly if the price is right. But currently, the price isn't high enough to justify the wage hikes needed to hire more staff. Lucas: Correct. The margin squeeze is real for many small business owners in this space. They are caught between rising labor costs and price-sensitive consumers who are finally feeling the pinch after years of savings accumulation. The nonfarm payrolls grew by only about one hundred sixty-two thousand in the most recent month, which is soft compared to previous years. Luna: Soft growth in payrolls suggests the economy is already slowing, yet prices aren't following suit. That is the scary part. Usually, when hiring slows, wage growth slows, and then inflation cools. Here, the lag is dragging on. Lucas: The lag effect is compounded by long-term contracts. Many service providers lock in rates annually. So even if the macro environment changes tomorrow, the price impact won't be felt until those contracts renew. This creates a floor under inflation that is very difficult to break. Luna: It makes the case for why the Federal Reserve has been so hesitant to cut rates aggressively. They know that cutting too soon could reignite the very wage-price spiral we are discussing. Lucas: Absolutely. And looking at the global context, the Bank of England recently left rates unchanged, defying the Fed's potential path. This suggests that central banks worldwide are watching these same sticky service metrics closely. Luna: It reinforces the idea that this is a synchronized global phenomenon, not just a us specific issue. Supply chains for services—think software development or medical staffing—are also constrained. Lucas: Exactly. We are entering a period where the distinction between 'good' inflation and 'bad' inflation blurs. When inflation is driven by necessary wage adjustments for essential services, it feels less punitive than inflation driven by speculative asset bubbles, but it still erodes purchasing power just as effectively. Luna: For the listener trying to navigate this, it means budgeting for services needs to reflect a permanent premium, not a temporary spike. There is no quick return to the low-price environment of the early twenties. Lucas: Right. And that requires a shift in how we view financial planning. We need to account for a baseline of three percent inflation in our service categories, regardless of what the headline CPI says. Luna: If walking through the economy with us has made something click, please consider supporting the show. Your contributions help us keep this analysis independent and ad-free, allowing us to dig into the data like this without corporate interference. You can find us at buy me a coffee dot com slash fexingo. Lucas: Thank you for keeping the signal clear. Now, let's get back to the data. Luna: Yeah, thanks for that. Back to the numbers. Lucas: Let's look at the consumer sentiment angle. Despite solid underlying economic activity, Goldman Sachs notes that happiness indices are dropping. Why? Because the quality of life is deteriorating due to these sticky costs. Luna: It is the paradox of the modern consumer. You have a job, you have income, but you feel poorer because your essential expenses are eating up a larger share of that income every year. Lucas: This psychological factor matters. When consumers feel poor, they cut back on discretionary spending, which further depresses economic growth. We saw real GDP grow by only one point five percent. That is barely above zero growth in practical terms. Luna: So we have low growth, high costs, and falling morale. It is a perfect storm for social and political friction. Lucas: Indeed. And businesses are responding by investing in capital rather than labor. If you can't hire easily, you buy robots. You buy software. You buy efficiency. This shifts the inflation dynamic away from wages and toward equipment costs, which can be volatile. Luna: But that transition takes time. In the interim, the wage pressure remains. We are stuck in this transitional phase for quite a while longer. Lucas: That is the takeaway for today. The trap is real, and it is sustained by the fundamental nature of service-based economies. As long as labor remains the primary input, inflation will remain sticky. Luna: Until productivity breakthroughs in AI or automation actually reach the service sector at scale, we are likely to see this pattern continue through the rest of the year. Lucas: Watch for the next JOLTS report. If job openings drop below seven million while wages stay flat, that might be the signal we need to see true disinflation in services. Luna: Or if they stay high, brace for another quarter of stubborn price hikes. Either way, the status quo is unsustainable. Lucas: True. The question is whether the economy can adjust gently or if we face a sharper correction later. Luna: Given the current momentum, gentle seems unlikely. But let's hope the data surprises us in the positive direction. Lucas: We will keep tracking it. Thanks for listening.