Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Consumer Price Index Hit 4.2 Percent What It Means for the Fed
Transcript
- Lucas: So the May CPI number landed this morning — 4.2 percent annual inflation. That's the highest reading in three years. Luna: Yeah, I saw the headline. And it's not just a blip. Core CPI, excluding food and energy, came in at 336.1, up from 335.42 the month before. That's persistent. Lucas: Exactly. And if walking through the economy with us has made something click — the way these data points connect to your own finances — that's the whole point of this show. We deliberately don't run ads. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small way to keep the conversation independent. Lucas: So the big question is what this means for the Fed. The effective fed funds rate is at 3.63 percent. With CPI at 4.2, the real rate is deeply negative for consumers. Luna: Right, real rates matter a lot. If you're earning 3.6 on cash but inflation is eating 4.2, you're losing purchasing power. The Fed has to consider that. Lucas: The bond market is already voting. The ten-year Treasury yield hit 4.54 percent this morning, up about a basis point and a half from yesterday. The two-year is at 4.26. The inversion is still there — two-year yielding less than ten-year is unusual, but it's actually steepening today. Luna: Steepening because long-term yields are rising faster than short-term. That's typically a sign that the market expects more inflation or more term premium, not a recession. Lucas: Right. The yield curve uninverted without a recession earlier this year, and now it's inverting again slightly. But the ten-year breakeven inflation rate is only 2.34 percent. That's way below the 4.2 CPI print. Luna: So the bond market is saying long-run inflation will settle around 2.3, but the real economy is seeing 4.2 today. That's a big gap. Lucas: It suggests the market thinks this inflation spike is temporary. But we've been calling it 'transitory' before, and that didn't age well. Luna: What's driving the May number? Shelter is still sticky. Energy had a bump too. Gas prices have been creeping up. Lucas: Shelter inflation is the stubborn one. Rent and owners' equivalent rent are still rising about 5 percent year-over-year. That's the biggest component of CPI, so it's hard to get the headline down without shelter cooling. Luna: And energy — the headline from CNBC yesterday was 'Energy prices take center stage as the ECB prepares to decide.' It's a global issue. Lucas: So the Fed is in a tough spot. The unemployment rate is 4.3 percent, which is low historically. But jobless claims just jumped to 225,000 from 212,000. That's a noticeable uptick. Luna: And the New York Fed's survey showed household financial anxiety hit the highest level since July 2022. People feel the pinch even if the data looks okay. Lucas: That's the disconnect. The macro numbers — GDP growth at 1.6 percent annualized, payrolls still adding — are decent. But real wages, after inflation, are barely keeping up. Average hourly earnings are $37.50, up about 4 percent year-over-year, but CPI is 4.2. Luna: So real wages are slightly negative. That's why households feel worse. The question is whether the Fed will acknowledge that or stay focused on their 2 percent target. Lucas: The fed funds daily rate is 3.62, and the interest on reserve balances is 3.65. They haven't moved rates since last year. But if inflation stays this hot, they might have to talk about a hike, not a cut. Luna: That would be a shock to markets. The S&P 500 is at 7,267, near highs. A hawkish Fed could spook equities. Lucas: The small-cap index, the Russell 2000, is down 2.3 percent over the last five days. That's a warning. Smaller companies are more sensitive to interest rates. Luna: So the inflation number today reinforces the 'higher for longer' narrative. The market was hoping for rate cuts this year. That looks less likely now. Lucas: I think the key takeaway is that the Fed needs to see a sustained decline in shelter and energy before they can ease. And that's not happening yet. Luna: And the consumer is getting squeezed. Real rates negative, wages barely keeping up, anxiety high. That's a recipe for slower spending down the road. Lucas: Which feeds back into GDP. So we might be looking at a period of stagflationary pressures — not full-blown stagflation, but slower growth with sticky inflation. Luna: It's a tricky environment for investors. Bonds are offering real yields that are negative, stocks are expensive, cash is losing value. Not many safe havens. Lucas: Commodities might be the one area that benefits. Energy and food prices are part of the CPI problem. But that's a volatile trade. Luna: So bottom line: the CPI print is a reality check. The Fed can't cut rates with inflation at 4.2. And households are feeling the pain. Lucas: We'll see how the market closes today. But the bond market's reaction this morning suggests this number changes the conversation for the next few months. Luna: Yeah, the ten-year at 4.54 is telling you something. The market is pricing in higher risk. Lucas: And that's the show. We'll keep watching the data and the Fed's language. Thanks for listening, and if you want to support ad-free economics, you know where to find us. Luna: Talk tomorrow.