Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Stuck Between Sticky Core Inflation and a Softening Jobs Market
Transcript
- Lucas: The latest jobs report landed with payroll growth of just 57,000 for June, and yet the unemployment rate actually ticked down to 4.2 percent. That combination is a puzzle for the Federal Reserve, and it's exactly what we're going to dig into today. Luna: Wait — payrolls come in soft, but the jobless rate drops? That usually means people are leaving the labor force. And we've seen that participation number fall to a 50-year low outside of the pandemic. Lucas: Exactly right. The labor force participation rate has been sliding, and that's one reason the unemployment rate can go down even when hiring slows. But the Fed is focused on the other side of the coin: inflation. And on that front, the data is not cooperating. Luna: You're talking about core CPI and core PCE, which both firmed up in the latest readings. Core CPI hit 336.1, up from 335.4 the month before. That's not a huge jump, but it's in the wrong direction for the Fed. Lucas: Right. And the core PCE price index, which is the Fed's preferred gauge, went from 129.67 to 130.1. So both measures are sticky. Meanwhile, the 10-year breakeven inflation rate — that's market-implied inflation expectations — crept up to 2.24 percent, from 2.23 a couple days ago. The market is starting to price in a little more inflation risk. Luna: So the Fed is stuck. They want to see inflation convincingly heading to 2 percent before they cut rates. But the jobs market is showing cracks, and participation is falling. Which way do they lean? Lucas: That's the million-dollar question. Let's look at what the FOMC has actually said. The effective federal funds rate is at 3.63 percent, and the rate on reserve balances is 3.65. They've held steady for months. Chair Powell has been clear: they need to see a sustained pattern of disinflation, not just a one-month dip. Luna: But the market is pricing in a cut later this year, right? I mean, the 2-year yield has been moving around, and the 10-year is at 4.57 percent, up a bit this week. That suggests the bond market is still expecting some easing. Lucas: It does. And the fed funds futures are implying about a 50-50 chance of a cut by September. But I think the Fed is going to be very cautious. Look at the composition of the jobs report: 57,000 payrolls is weak, but average hourly earnings rose to $37.60, up from $37.51. That's a 2.4 percent annualized increase — still above what's consistent with 2 percent inflation. Luna: So wage growth isn't cooling fast enough. And if core inflation is sticky because of services — rents, insurance, medical care — then cutting rates could reaccelerate demand and undo the progress. Lucas: Exactly. And there's another layer: the labor force participation rate falling. That's partly demographic — baby boomers retiring — but it's also people dropping out because they can't find the right job. That tightens the labor market and puts upward pressure on wages. The Fed has to consider that. Luna: Let's zoom out. Real GDP growth annualized was 2.1 percent in the first quarter, up from 0.5 percent in the previous quarter. The economy is still growing, albeit moderately. So it's not like we're in recession territory. That gives the Fed room to wait. Lucas: Right. Nominal GDP is $31.86 trillion, up from $31.42 trillion. The economy is still expanding. But the risk is that if they wait too long, the labor market could deteriorate more sharply. There's a lag effect. Some economists argue that the cumulative effect of high rates is still working through the system. Luna: And we've seen initial jobless claims tick down to 215,000, which is low historically. So layoffs aren't surging. But hiring is slowing. That's the classic 'cooling but not cracking' scenario. Lucas: Yeah, that's a good way to put it. The JOLTS data showed job openings at 7.594 million, up a tiny bit from 7.585 million. So demand for workers is still there, but it's not booming. The ratio of openings to unemployed workers is still above pre-pandemic levels, but it's normalizing. Luna: So what's the one thing you're watching that would signal the Fed's next move? Is it core PCE? Average hourly earnings? Or something else? Lucas: I think it's the combination of core PCE and the employment cost index, which we'll get later this month. If core PCE stays around 2.7 or 2.8 percent and employment costs are still rising at 3 percent or more, the Fed will stay on hold. But if we see a surprise drop in core PCE to 2.5 or below, and payrolls stay weak, then the conversation changes. Luna: And what about the breakeven rate? It's at 2.24 percent now. That's above the Fed's target, but it's not alarming. If it pushes above 2.5, that's a different story. Lucas: Yeah, the breakeven is a useful check. Right now it suggests the market expects inflation to average a bit above 2 percent over the next decade. That's not a panic signal, but it does mean the Fed hasn't fully anchored expectations. They need to be vigilant. Luna: Lucas, I want to step back for a second. If someone's listening and trying to make sense of all this — maybe they're planning a big purchase or investing — what's the key takeaway? Lucas: The key takeaway is that the Fed is in a holding pattern. They need to see more data before they move. For consumers and investors, that means interest rates are likely to stay where they are for a while. Mortgage rates, credit card rates, business loan rates — they're not coming down soon. So plan accordingly. Luna: And that actually ties into something I've been thinking about. If you found this breakdown useful — if walking through the economy with us has made something click — then I'll just say that the way we keep this show ad-free and independent is through listener support. It's a small thing, but it makes a big difference. Lucas: Yeah, absolutely. If today's episode helped you understand the Fed's dilemma a little better, you can show your appreciation at buy me a coffee dot com slash fexingo. That's all lowercase. And it genuinely helps us keep doing this every day. Luna: And now back to the data — one more thing I want to get your take on. The yield curve has been uninverting, but the 2-year and 10-year spread is still inverted. What does that tell us about recession risk? Lucas: Great question. The 2-year yield is at 3.69 percent, and the 10-year is at 4.57 percent, so the spread is about 88 basis points positive. That's actually normal — a steepening curve usually signals that the market expects growth to pick up or inflation to stay elevated. But it's not a clear recession signal anymore. Luna: So the curve is saying the economy is okay, but the labor market data is saying slow down. No wonder the Fed is confused. Lucas: Exactly. That's why we're in this 'wait and see' period. The next few months of data — especially core PCE and the employment cost index — will be critical. For now, the message is: rates stay higher for longer, and the labor market is cooling, but not collapsing. Luna: Alright, Lucas. Good conversation. We'll keep watching those numbers. Lucas: We will. Thanks for listening, and if you want to support us, you know where to find us.