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 you look at the headline CPI number for September, it’s sitting at three hundred thirty-six point three, which is up from the previous month. But if you strip out food and energy, that core CPI figure is actually higher, hovering around three hundred thirty-eight point nine. That divergence is where the Federal Reserve’s headache lives right now. Luna: Right, because goods prices have been relatively stable or even dropping due to supply chain normalization, so the entire burden of that inflation print is falling squarely on services. Are we seeing that play out in the labor market specifically? Lucas: We are. And here is the specific detail that matters for this week’s FOMC meeting context: jobless claims just hit their lowest levels since the nineteen sixties. The labor market isn’t crashing; it’s hyper-tight. When you have that few people filing for unemployment, employers in the service sector—think healthcare, hospitality, personal care—have to raise wages just to retain staff. Those wage increases get baked into the prices you pay for a haircut or a hospital visit. Luna: So the Fed is essentially watching a labor market that is too hot for comfort, while trying to cool down a services sector that is pricing in those labor costs. Does the bond market agree with the idea that they need to keep rates high? Lucas: The bond market is sending mixed signals, but the ten-year Treasury yield is currently sitting at four point ninety-nine percent. It dropped slightly over the last five days, but it’s still near five percent. That tells me investors are still demanding a significant premium for holding long-term debt, largely because they don’t trust that inflation is permanently tamed. If the Fed cuts too soon, those yields could spike again as inflation expectations rebound. Luna: But if they hold rates high for too long, aren’t we going to see a hard landing in the housing market? I saw headlines yesterday warning that housing is flashing signs of trouble just as the Fed weighs more hikes. Lucas: That is the classic dilemma. The interest on reserve balances is at three point ninety percent, which keeps money in the banking system but also makes borrowing expensive for everyone else. Mortgage rates track the ten-year yield closely, so with yields near five percent, monthly payments for homebuyers are unaffordable for a huge segment of the population. This creates a liquidity freeze in real estate, which technically slows down economic activity, but it doesn’t necessarily lower the price of existing homes because nobody wants to sell. Luna: It’s a paradox. High rates hurt buyers, but no sales means sellers don’t drop prices, so inflation in the shelter category stays sticky. Is that why the Fed seems hesitant to make any bold moves right now? Lucas: Exactly. They are paralyzed by the data. On one side, you have the PCE price index, which is the Fed’s preferred gauge, sitting at one hundred thirty-one point six. Core PCE is at one hundred thirty point five. Both are still above the two percent target. On the other side, you have that historic low in jobless claims. If they cut rates to help the housing market, they risk reigniting wage spirals in the services sector. So they wait. Luna: Wait for what? For the labor market to finally crack? Because if jobless claims stay this low, that crack might never come. Lucas: That’s the fear. We’ve seen this pattern before where the labor market defies gravity. The key metric to watch next is not just the total number of claims, but the average hourly earnings in the services sector. If those continue to rise faster than productivity, then every dollar the Fed injects into the economy just gets absorbed by higher labor costs rather than creating new growth. It’s an inflationary loop. Luna: And yet, the stock market is barely reacting. The S&P five hundred is down only half a percent this week. Investors seem more concerned with geopolitical risks or tech valuations than the Fed’s indecision. Lucas: The equity market is forward-looking, so it’s pricing in a soft landing scenario. But the fixed income market is looking at the present reality. When you compare the ten-year yield at four point ninety-nine percent against the short-term fed funds effective rate of three point seventy-five percent, you have an inverted yield curve that is slowly steepening. That steepening suggests markets believe the Fed will eventually have to cut rates, but they aren’t sure when or how fast. Luna: So the tension is between the immediate pain of high borrowing costs and the future promise of rate cuts. Where do you think the Fed lands in their next statement? Lucas: I think they stay patient. They are going to emphasize that they are data-dependent, which is code for waiting for one more bad jobs report or one more dip in inflation. But given that jobless claims are near sixty-year lows, I doubt they see that coming anytime soon. So they likely hold steady. Luna: It feels like we’re stuck in a holding pattern. What’s the practical takeaway for someone listening who is trying to manage debt or investments right now? Lucas: Don’t bet on a sudden drop in mortgage rates. Keep cash on hand if you can, because the opportunity cost of holding cash is lower when yields are near five percent. And diversify away from pure rate-sensitive plays, because the services sector inflation is structural, not cyclical. Luna: Smart advice. Before we go deeper into the specifics of the services wage squeeze, I want to pause for a second. If walking through the economics with us has made something click for you, please consider supporting the show directly. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. — and that's literally what funds making this many of these episodes possible without ads. Lucas: Yeah, it really does keep the research sharp. No advertisers telling us what to say, just listener support that lets us dig into the actual data. Thanks for keeping this independent. Luna: Absolutely. It allows us to focus on the nuance rather than the noise. Now, back to that services wage squeeze. Lucas: Let’s zoom in on the care sector specifically. Healthcare staffing shortages are driving up wages in nursing and elder care at a rate that exceeds general inflation. This is a structural issue, not a temporary glitch. You cannot simply import more nurses overnight to fix this gap. Luna: So this is a demographic problem masquerading as an economic one. An aging population requires more care, which drives up demand for workers, which drives up wages, which drives up prices. Lucas: Precisely. And the Fed’s tool is blunt. Raising interest rates doesn’t create more nurses. It just makes it more expensive for hospitals to borrow money to build new facilities or upgrade technology. So the cost push comes from the labor side, and the Fed can’t really address the root cause. Luna: This makes the 'sticky' part of inflation so frustrating for policymakers. They can kill demand, but they can’t force supply to expand quickly enough to meet it in these specific sectors. Lucas: That’s right. And notice how this interacts with consumer behavior. People are still spending on services because they have to. You can’t stop needing healthcare or basic hospitality. So even if consumers pull back on discretionary goods, the baseline cost of living continues to rise due to these service-sector wage pressures. Luna: Which brings us back to the housing market. If my cost of living is rising because of services, but my mortgage payment is also high, I’m squeezing myself elsewhere. How does that feedback loop work? Lucas: It reduces disposable income, which should theoretically lower demand for other goods. But because the labor market is so tight, wages are rising to compensate. So consumers are earning more but paying more for essentials. It’s a wash that leaves the underlying inflationary pressure intact. The Fed is essentially pushing on a string that is already taut. Luna: It sounds like the only way out is a recession that forces wage moderation. Is that the only lever they have left? Lucas: Historically, yes. The Volcker shock was painful because it broke the wage-price spiral by breaking the labor market. But today, the political environment makes a Volcker-style approach impossible. The approval ratings on the economy are at all-time lows, as we saw in recent surveys. The Fed has very little political capital to spend on a aggressive tightening cycle. Luna: So they are trapped between political constraints and economic reality. They can’t hike enough to stop the services inflation, but they can’t cut because the inflation is still there. Lucas: Exactly. They are stuck in the middle. And that stalemate is likely to persist until one of the variables changes dramatically. Either jobless claims rise significantly, indicating a weakening labor market, or inflation drops clearly below target. Luna: Given the current trajectory of those jobless claims, which variable do you think breaks first? Lucas: I think we’ll see a gradual erosion in the labor market before we see a decisive drop in inflation. The lag effect of monetary policy usually hits employment first. So expect to see job numbers soften in the next quarter or two, even if prices remain stubbornly high. Luna: A softening labor market with sticky inflation is a tough combination for households. It means less job security and higher costs simultaneously. Lucas: It is. And that’s why the Fed’s patience is so critical. If they move too early, they lose credibility. If they move too late, they break the labor market. They are walking a tightrope over a very deep pit. Luna: One final thought on this: does the global picture offer any relief? With UK inflation jumping to three point five percent, are international pressures adding to our domestic stickiness? Lucas: Global factors are secondary right now. The US services sector is largely domestic. Shipping costs and global commodity prices matter less when the bottleneck is local labor availability. So while international inflation is a concern, the domestic wage dynamic is the primary driver. Luna: So we’re watching our own backyard closely. Thanks for breaking this down, Lucas. It’s a complex landscape, but understanding the services wage link helps explain why the Fed is moving so cautiously. Lucas: Anytime. The key is to remember that inflation isn’t just about prices; it’s about the people behind those prices. Until that changes, the Fed has no easy answers.