Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Core PCE Hits 3.4 Percent Highest Since 2023
Transcript
- Lucas: So the core PCE inflation number came out yesterday at 3.4 percent — that's the highest since October 2023. And I think this is one of those numbers that feels like it should be a bigger deal than the headline CPI, because it's the Fed's preferred gauge. Luna: Right, the Fed has been saying for months they need to see 'greater confidence' that inflation is heading back to 2 percent. This number does not give them that confidence. Lucas: Exactly. And look, CPI was already running hot — May CPI came in at 3.3 percent year-over-year, core CPI at 3.4. But the PCE tends to run a bit cooler because it weights things differently. So seeing core PCE hit 3.4 percent, matching core CPI, that's a signal that inflation is sticky across both measures. Luna: And the market reaction? We saw the S&P down about 1.3 percent over the past five days, but the Dow actually up. That's a bit of a split. Lucas: Yeah, the Dow is holding up because it's more value and industrials — companies that might benefit from a still-strong economy. The Nasdaq got hit harder, down almost 3 percent in five days. Tech stocks are more sensitive to rate expectations. Luna: So what does this mean for the Fed? They've got the Fed funds rate at 3.63 percent right now. Are they going to hike again? Lucas: That's the billion-dollar question. The bond market seems to be saying no. The 10-year breakeven inflation rate is at 2.21 percent — that's actually down from where it was a few weeks ago. It was around 2.26 percent back in May. Luna: So the bond market is essentially betting that this inflation spike is transitory, or at least that the Fed won't overreact. Lucas: Right. The breakeven is the market's expectation for average inflation over the next decade. At 2.21 percent, it's still above the Fed's 2 percent target, but it's not screaming 'we're heading back to 1970s levels.' And if you look at the components of PCE, there's a story there. Luna: Goods versus services, I'm guessing? Lucas: Exactly. Goods inflation has actually been moderating. Supply chains have healed, shipping costs are down — the Strait of Hormuz situation is a wildcard, but for now, goods prices are behaving. The sticky part is services. Things like rent, medical care, insurance — those are still running hot. Luna: And services inflation tends to be more persistent because it's tied to wages. The job market is still tight — we've got 159 million nonfarm payrolls, unemployment at 4.3 percent, job openings bouncing back to 7.6 million. Lucas: Yeah, the JOLTS data from April showed a big jump in openings — up to 7.6 million from 6.9 million. That's a huge month-over-month increase. And initial jobless claims just dropped to 215,000, which is very low. So the labor market is still creating enough demand to keep upward pressure on wages. Luna: But real GDP growth is at 2.1 percent annualized — that's not booming, but it's solid. So we've got this scenario where the economy is growing, jobs are plentiful, but inflation is above target. That's the textbook definition of a 'no landing' scenario. Lucas: Right — the economy isn't crashing, but it's not cooling enough to bring inflation down to 2 percent. And the Fed is stuck. They've held rates at 3.63 percent for a while now. If they cut, they risk inflation reaccelerating. If they hike, they risk tipping the economy into recession. Luna: And the data is mixed enough that they can justify either decision. Core PCE at 3.4 percent says 'hold tight.' But the breakeven at 2.21 says 'maybe you can ease a little.' Lucas: Exactly. And I think that's why the market reaction has been relatively muted — no panic selling. The sell-off in tech is more about rotation than fear. Investors are trying to figure out which scenario plays out. Luna: So what's your read? Do you think the Fed hikes again this year? Lucas: I think they hold. My base case is that this core PCE reading is a data point, not a trend. We had one month of 3.4 percent — let's see if it's repeated. If it is, then yeah, maybe a hike is on the table. But for now, the Fed's bias is to wait and see. Chair Powell has been pretty clear that they want to avoid over-tightening. Luna: And the bond market is pricing in a cut by the end of the year, right? The 2-year yield is at 4.13 percent, the 10-year at 4.38 percent — that's an inverted yield curve, which historically signals a recession. Lucas: It does, but the curve has been inverted for over two years now without a recession. So maybe this time is different, or maybe the recession is just delayed. The inversion is partly a reflection of the market expecting the Fed to cut rates in response to a weakening economy. Luna: But if the economy is still growing at 2.1 percent, why would the Fed cut? Unless they see something we don't. Lucas: That's the tension. The bond market is betting on a slowdown. The equity market is more mixed — small caps are flat, large caps are down, but not crashing. It's a market that's trying to price in a lot of uncertainty. Luna: And we haven't even talked about the geopolitical stuff — the Strait of Hormuz situation, the Iran deal, the Venezuela earthquakes. Those could easily tip the inflation outlook one way or the other. Lucas: Absolutely. If oil prices spike because of supply disruptions, that flows straight into headline inflation. But the PCE measure strips out food and energy, so it's less sensitive. Still, a sustained oil shock would affect consumer spending and confidence. Luna: So on balance, the core PCE at 3.4 percent is a wake-up call, but not a crisis. It reinforces the 'higher for longer' narrative. Lucas: Yeah, 'higher for longer' is the phrase that keeps coming back. The Fed has been saying it, and the data keeps supporting it. Every time inflation seems to be cooling, we get a hot reading. It's like the last mile of inflation is the hardest. Luna: And that's what makes this show useful — walking through the numbers and understanding what they actually mean. If today's breakdown helped clarify things for you, we want to mention something. Lucas: Sure. We keep this podcast ad-free because we think that's the best way to deliver clear, unfiltered analysis. The way that works is listener support — people who find value here and want to keep it going. If that's you, you can help at buy me a coffee dot com slash fexingo. Luna: It's a simple way to chip in, and it directly keeps us independent. No pressure, just an option if you've gotten something out of the episodes. Lucas: And we're back to the data. So one more thing I want to highlight: the 10-year breakeven at 2.21 percent is actually down from 2.26 percent a month ago. That's interesting because core PCE went up. So the bond market is essentially saying 'we don't think this is the start of a new inflation trend.' Luna: Right — the market is looking through the noise. They're focused on the trend, not the month to month volatility. Lucas: And that's probably the right approach. If you look at the broader picture, inflation has come down from its peaks in 2022. The question is whether it gets stuck at 3 percent or continues down to 2 percent. The next few months of data will be critical. Luna: We've got the June CPI and PCE data coming in July. That'll be the next big test. Lucas: Exactly. And then the Fed meeting at the end of July. If we get another hot reading, the discussion about a rate hike will get louder. But my bet is still on a hold. Luna: I think that's a reasonable bet. The Fed hates to reverse course, and they've been burned before by premature tightening. Lucas: Yeah, they're scarred by the 2022 experience where they had to hike aggressively. They don't want to overdo it. So they'll err on the side of patience. Luna: Alright, that's a good place to land. Thanks for joining us on this episode of The Macro Memo. We'll be back tomorrow with another angle. Lucas: Until then, keep an eye on those breakevens.