Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why the Fed Is Watching Services Inflation Not Goods
Transcript
- Lucas: Luna, I have been watching the May CPI data that came out a few weeks ago, and there's a pattern I think a lot of people are missing. Luna: Okay, I'm listening. What's the pattern? Lucas: So headline CPI for May came in at 334.0 — that's up from 332.41 in April. And core CPI, which strips out food and energy, hit 336.1, up from 335.42. But the real story is the split between goods and services. Luna: Right, because goods prices have been flat or even falling in some categories, but services keep climbing. Lucas: Exactly. Think about it: the cost of a new TV or a couch might be roughly the same as a year ago. But your rent, your car insurance, your streaming subscriptions — those are all still going up. And that's the part the Fed is really watching. Luna: And they have a new chair now, Kevin Warsh, who just had his first FOMC meeting last week. I'd imagine he's looking at that services number very closely. Lucas: Absolutely. The Fed funds rate is at 3.63 percent right now, and the market is pricing in a cut maybe later this year. But if services inflation stays sticky, they might hold off. The 10-year breakeven inflation rate — which is basically the market's expectation for inflation over the next decade — has actually ticked down to 2.25 percent. That's below where it was a few weeks ago. Luna: So the bond market is saying inflation will cool, but the actual CPI data is still showing it's persistent in services. That seems like a conflict. Lucas: It is. And I think the key is understanding what's driving services inflation. It's not supply chains or commodity prices. It's labor costs. Haircuts, doctor visits, restaurant meals — these are all labor-intensive. And wages have been rising, especially in low-wage service sectors. Luna: So if the Fed cuts rates too soon, they risk reigniting wage-price spiral dynamics? Lucas: That's exactly the fear. And Warsh, in his first meeting, emphasized that the Fed is data-dependent and focused on core services. They're not going to rush. Meanwhile, consumers are feeling it every month. Your rent renewal notice, your insurance premium, your Netflix bill — those are the inflation signals that matter in your daily life. Luna: And those are exactly the ones the official CPI captures, but with a lag. I know my own rent went up 4 percent this year, and that's right in line with the shelter component of CPI. Lucas: Shelter is the biggest chunk of services inflation — roughly one-third of the CPI basket. And it's been rising at around 4.5 percent year-over-year. Until that starts to decelerate meaningfully, the Fed is going to be cautious. Luna: Okay, so let's talk about what could change that. What would make services inflation come down? Lucas: A couple of things. One is a slowdown in the labor market. If hiring cools and wage growth moderates, that takes pressure off services. We saw some headlines about job growth in Nevada and other states, but nationally, the job market is still pretty tight. Luna: Another factor could be productivity gains. If businesses find ways to deliver services more efficiently, they don't have to pass on higher labor costs. Lucas: That's a good point. But services are inherently harder to automate than goods production. You can't replace a plumber or a nurse with a robot easily. So the stickiness is structural. Luna: And it's worth noting that the Fed's preferred inflation measure is the PCE price index, not CPI. Core PCE in April was at 129.6, up from 129.32. That's a slower pace of increase than CPI, but still above the 2 percent target. Lucas: Right, PCE tends to run a bit cooler because it accounts for substitution — when people switch to cheaper alternatives. But even PCE is showing that services inflation is persistent. The core services ex-housing component has been particularly stubborn. Luna: So if I'm a listener trying to make sense of this, what's the one thing I should take away? Lucas: I'd say: watch the services numbers, not the headline. Headline inflation can drop because oil prices fall or used car prices decline, but if your rent and insurance keep going up, that's the real story. And that's what the Fed is watching. Luna: That's a great framing. And if today was actually useful to you, the way these stay ad-free is listener support — buy me a coffee dot com slash fexingo. Lucas: Yeah, it really does help us keep going. A small contribution from listeners who find value in this makes a big difference. Luna: So back to services inflation — one area I've been watching is auto insurance. It's been surging way above the overall inflation rate. Why is that so sticky? Lucas: Great question. Auto insurance premiums are up something like 15 to 20 percent year-over-year. That's driven by higher repair costs, more expensive parts, and more claims severity. Cars are packed with sensors and cameras now, so even a minor fender bender can cost thousands to fix. Luna: And that's not something the Fed can fix with interest rates. It's a structural issue in the insurance industry. Lucas: Exactly. Similarly, health insurance and medical care costs are climbing. Those are heavily regulated and tied to labor costs. So when people ask 'why is inflation still high even though the Fed raised rates so much,' the answer is often: because a big chunk of the economy is driven by factors rates don't directly affect. Luna: And that's why the breakeven rate dropping to 2.25 percent might be misleading. The market might be pricing in lower inflation based on goods, but services could keep it elevated. Lucas: That's a real risk. If the Fed cuts rates based on the headline numbers and then services inflation reaccelerates, they'd have to reverse course. That would be a policy error. Luna: So what's your read on Warsh's first meeting? Did he signal anything about the timeline? Lucas: He was careful — said they need 'greater confidence' that inflation is moving sustainably toward 2 percent. I think that means they want to see several months of declining core services inflation before they act. So a rate cut in September or later is possible, but not guaranteed. Luna: That feels very 'wait and see.' But for everyday people, waiting means higher costs on services for longer. Lucas: It does. And that's the tension. The Fed's job is to balance inflation and employment. If they cut too soon, inflation stays high. If they wait too long, the economy might slow too much. It's a tightrope. Luna: All right, Lucas. So the bottom line: services inflation is the new frontier, goods are old news, and the Fed is watching wage data and rent like hawks. Lucas: That sums it up. And we'll keep tracking those numbers as the summer goes on. Thanks, Luna. Luna: Thanks, Lucas. Until next time.