Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Core Inflation Is Falling at Different Speeds
Transcript
- Lucas: So the headline CPI number in June fell for the second straight month, and if you just glance at that, it looks like the inflation fight is basically over. But the core number—the one that strips out food and energy—is behaving very differently. Luna: Right, I saw that. Core CPI barely budged. It's like the headline is moving one way, and the core is stuck. Lucas: Exactly. And that gap is the story today. Headline CPI dropped to 332.6 in June, down from about 334 the month before. Core CPI? It held at 336.1. So the gap between them is actually widening. Lucas: And you know, this is the kind of thing that confuses people. They hear 'inflation is easing' and then their rent goes up again. They assume the data is lying. But it's not—it's just that headline CPI is being dragged down by things like gas prices and used cars, while the stuff you pay for every month—rent, insurance, medical care—is still climbing. Luna: Yeah, I mean, my landlord just raised my rent 4 percent in April. CPI says inflation is like 3 percent. I feel like I'm living in a different economy. Lucas: And that's the point. The average consumer doesn't buy a basket; they buy a lifestyle. And services are where the stickiness is. Look at the PCE price index, which is the Fed's preferred measure. Core PCE actually ticked up in June, from 130.09 to 130.3. It's tiny, but it's going the wrong direction. Luna: So the Fed is looking at this and thinking, 'we can't just declare victory'? Lucas: Right, and that's exactly why they've held rates steady. The Fed Funds rate has been at 3.63 percent for weeks now. They're waiting for core to come down, and it's not cooperating. Luna: Before we get deeper into this, I want to be honest about something. This show is completely ad-free, and that's because a small group of listeners chip in a few dollars a month through buy me a coffee dot com slash fexingo. That's literally what keeps us making these episodes. Lucas: Yeah, it's not a big pledge drive, but it covers the editing and the hosting and the coffee. So if you've been getting value from this, that's the way to keep it going. Lucas: Anyway, let's get back to the numbers. The bond market is sending a really interesting signal here. The 10-year breakeven rate—that's the market's expectation of average inflation over the next decade—is at 2.28 percent. That's slightly up, not down. Luna: So even the bond market doesn't believe inflation is dead. It just thinks it'll settle around two point three percent. Lucas: Right, which is above the Fed's two percent target. And that's the tension. The Fed wants to see expectations anchored at two. But the market is saying, 'we'll accept a little more.' Luna: What's driving that? I mean, if goods prices are falling, why would expectations stay high? Lucas: It's the services side. Rent is still rising, medical costs keep climbing, and there's a lot of momentum in those categories. Services inflation is just stickier than goods. Goods can get cheaper because of supply chains and import prices, but services are tied to wages and labor costs, which don't fall easily. Luna: And wages? Are they keeping up? Lucas: Wage growth has cooled, but it's still running above pre-pandemic levels. And as long as workers are getting raises, services inflation is going to have a floor under it. The Fed knows this. That's why they're not in a hurry to cut rates. Luna: So what does this mean for the average listener? Like, if they're trying to budget for the next year, should they expect their rent to keep going up? Lucas: Probably. Rent inflation has slowed from the crazy 2022 levels, but it's still positive. And the broader services category—haircuts, plumbing, dining out—that's all still rising faster than the headline number. So the cost of living is still going up, just not as fast as it was. Luna: But there is some good news for consumers, right? I mean, gas prices are down, used cars are cheaper. Lucas: Absolutely. The goods side is deflating in places. Used car prices have been falling for months. And that's a real relief for households that were stretched when prices spiked. But it's a one-time adjustment. It's not something that can keep pulling inflation down forever. Luna: So the Fed might be stuck with core inflation above three percent for a while. Lucas: That's the scenario the bond market is pricing in. The 10-year breakeven at 2.28 percent implies that the market expects core to stay elevated for years, not months. And that's actually a problem for the Fed, because their credibility is tied to hitting that two percent target. Luna: But if the Fed keeps rates high, doesn't that risk pushing the economy into recession? I saw that Q2 GDP growth was only one point five percent. Lucas: That's the tightrope. Growth is slowing, but core inflation is still sticky. The Fed has to balance that. And you've got internal disagreement about how to weigh those risks. Some members are more worried about growth, others about inflation. That's why you see these headlines about a divided Fed. Lucas: And it's not just the Fed. Singapore just tightened policy because of oil price concerns. So globally, central banks are still on edge about inflation. Luna: So what should the average person do? Like, if they're planning for the next year, should they expect prices to keep rising at three percent or less? Lucas: I'd say plan for about three percent on the services you buy, and maybe less on goods. And keep an eye on the core CPI number, not the headline. If you see core start to drop below three, then you can feel more optimistic. But right now, it's holding steady. Luna: But it's weird because the headline is falling, so people think inflation is falling across the board, but they're still feeling the pinch. That's got to be frustrating for policymakers. Lucas: It is. And that's why the Fed is stuck. They can't say 'job done' when core is running at three point three percent or whatever it is. And they can't cut rates without risking that sticky service inflation reaccelerates. So they're just holding, waiting for more data. Luna: Is there any scenario where core starts to fall more quickly? Lucas: If there's a serious recession, then yes, services prices would weaken because demand would drop. But that's a painful way to get inflation down. The Fed is hoping for a soft landing, where the labor market cools just enough without a big spike in unemployment. Luna: And so far, that seems to be what's happening. The job market hasn't collapsed, but it's definitely cooled from a couple years ago. Lucas: Right. And that's actually the best-case scenario. But it takes time. So for the rest of this year, I'd expect core inflation to stay in that three to three and a half percent range. And that means the Fed is on hold. Luna: So what you're saying is, don't hold your breath for a rate cut. Lucas: Exactly. The market is pricing in maybe one cut by the end of the year, but even that's uncertain. The Fed wants to see core PCE moving down consistently, and right now it's not. Luna: But the 10-year breakeven being 2.28 percent suggests the market thinks the Fed will eventually succeed, just not to two percent. Lucas: Right. And that's actually a healthy sign. It means long-term inflation expectations are anchored, even if they're a bit above target. The worst outcome would be expectations drifting up to three or four percent. That would force the Fed to tighten much more aggressively. Luna: So the bottom line: inflation is falling, but it's not falling fast enough for the Fed, and services are the reason. Lucas: That's the takeaway. And the next time you see a headline saying 'inflation eases,' check the core number. If it's not moving, the story is more complicated than it looks. Luna: And that's why I love this show. It's like having a decoder for economic data. Lucas: Glad you find it useful. We'll be back tomorrow with another breakdown. Until then, keep an eye on the core.