Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / The Fed's New Problem With Sticky Services Inflation
Transcript
- Lucas: If walking through the economy with us has made something click, we appreciate it because this show runs entirely on listener support, not ads. Lucas: A handful of people chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Luna: It keeps the lights on and the research sharp without any corporate interference. Lucas: That's right, and if you want to help keep that independence going, head to buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. Luna: We really do need that community backing to keep digging into the data like this. Lucas: Thanks for listening, but let's get back to the hard part of today's chart. Luna: Yeah, let's dig into the numbers. Lucas: Look at the ten-year Treasury yield right now, sitting at four point nine nine percent as of this morning on October twenty fifth, two thousand twenty six. Luna: It's barely below five percent, which feels like a psychological ceiling for a lot of borrowers. Lucas: Exactly, and that yield isn't just reacting to growth expectations; it's pricing in the fact that the Federal Reserve is stuck between a rock and a hard place regarding services inflation. Luna: Because goods inflation cooled off so nicely, everyone assumed the war was won, but services tell a different story. Lucas: Right, look at the Core PCE price index for August, which came in at one hundred thirty point five, up from one hundred thirty point one three the previous month. Luna: That's a persistent uptick when you strip out food and energy, and it suggests the underlying pressure hasn't broken yet. Lucas: And it gets more interesting when you look at the CPI headline number for September, which jumped to three hundred thirty six point three from three hundred thirty four point one three. Luna: So prices are still climbing, even as the Fed debates whether to pause or hike again. Lucas: The real issue here is that services inflation is sticky because it's tied to wages, and wages are sticky because the labor market is unusually tight. Luna: I saw those headlines about jobless claims hitting levels near the lowest since the nineteen sixties earlier this week. Lucas: Yes, that low-fire trend means employers are struggling to find workers, which keeps wage growth elevated, which keeps service prices high. Luna: It creates a feedback loop that the Fed can't easily break without causing massive unemployment. Lucas: Think about the housing sector specifically, where shelter costs make up a huge chunk of both CPI and PCE. Luna: Housing is flashing warning signs right now, with affordability hitting brutal lows as rates stay higher for longer. Lucas: When rents and owner equivalent rent don't fall, the Fed looks cautious, even if other parts of the economy are slowing down. Luna: So they're waiting for a lag effect that might never fully arrive in the way markets expect. Lucas: That's the dilemma, and it explains why the effective federal funds rate is holding steady at three point seven five percent while the daily rate ticks up to three point eight eight. Luna: The spread between the official rate and the overnight market rate shows how sensitive banks are to every hint of policy change. Lucas: And if the FOMC cuts rates too early, we risk reigniting that services inflation, which would be a disaster for purchasing power. Luna: But if they wait too long, they might crush the housing market and small businesses that are already bleeding under high borrowing costs. Lucas: Let's look at the breakeven inflation rate on the ten-year note, which is sitting at two point three four percent as of last Friday. Luna: That's up slightly from two point three two, meaning investors are starting to worry that inflation might stick above the two percent target. Lucas: When market participants start repricing inflation expectations upward, it forces the Fed's hand, regardless of what their internal models say. Luna: It's a self-fulfilling prophecy if consumers start demanding higher wages based on those expectations. Lucas: That's exactly why the S&P five hundred is wobbling, dropping nearly zero point nine percent over the last five days while tech takes a harder hit. Luna: Tech stocks hate uncertainty, and a Fed that can't commit to a clear path forward is the definition of uncertainty. Lucas: Meanwhile, small caps like the Russell two thousand are actually up one point seven percent, suggesting some rotation into value plays. Luna: Investors might be betting that smaller companies can survive the high-rate environment better than high-growth tech. Lucas: Or maybe they think small caps are due for a rebound after years of underperformance, but that doesn't change the core inflation problem. Luna: No, it doesn't, and the UK inflation jump to three point five percent last week shows this is a global struggle with services prices. Lucas: Global supply chains have stabilized, so goods aren't the bottleneck anymore; it's domestic labor costs driving everything else. Luna: So the Fed is essentially fighting a battle against its own success in tightening credit conditions, which took time to filter through. Lucas: Precisely, and with midterm politics heating up, the political pressure to cut rates is likely to increase despite the economic reality. Luna: Trump's approval rating on the economy hitting an all-time low in recent surveys adds another layer of complexity to the backdrop. Lucas: But the Fed has to ignore politics and focus on the data, which currently says inflation is still too hot in the services sector. Luna: Until we see a sustained drop in wage growth, the case for further tightening or a prolonged pause remains strong. Lucas: That's the key takeaway for listeners managing portfolios right now: assume rates will stay higher for longer than you hope. Luna: And prepare for volatility as the market slowly realizes that the easy money era is truly over. Lucas: Agreed, so watch those jobless claims closely, because any sudden spike could signal the soft landing is finally happening. Luna: But until then, patience is your best asset in this interest rate environment. Lucas: Let's see if the next employment report confirms that trend or if the labor market proves even tougher than expected. Luna: Either way, the Fed will be forced to react, and the markets will pay the price. Lucas: Stay tuned for the next update, and remember to check our notes for the full breakdown of those shelter cost metrics. Luna: We'll be back tomorrow with another deep dive into the numbers that matter. Lucas: Thanks for listening, and good luck with your decisions this week.