Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What the Fed Makes of Core PCE at 3.4 Percent
Transcript
- Lucas: So Core PCE came in at 3.4 percent for May. That is the highest reading since October 2023. And because this is the Fed's preferred inflation gauge, not CPI, this is the number that actually sits on the committee's table when they meet. Luna: Right. And CPI this month was also hot, but core PCE stripping out food and energy still hit that 3.4. Feels like the disinflation story has stalled. Lucas: Stalled is a generous word. Look at the trajectory: in February core PCE was at 2.8. March 2.9. April 3.1. Now 3.4. That is four straight months of acceleration. And the Fed's own dot plot from the June meeting still showed two rate cuts penciled in for this year. Luna: Which seems hard to justify if inflation is moving in the wrong direction. Unless they're looking through the noise. Lucas: They always say they look through short-term volatility, but four months is not short-term anymore. The question is what's driving it. And when you dig into the components, it is almost entirely services. Goods inflation has actually been pretty benign. Used car prices are flat. Apparel is down. But services — medical care, housing, financial services — those keep printing higher. Luna: Housing especially. Shelter costs in PCE are not as heavy as in CPI, but they still account for about 15 percent of the index. And that component has been sticky around 5 percent year-over-year. Lucas: Exactly. And the Fed's models predicted shelter would moderate by now because new lease data was softening. But the official measure lags by about a year, and what we're seeing is that the moderation hasn't fully flowed through. Meanwhile, medical care services jumped 0.4 percent month over month in May. Financial services and insurance were up 0.5 percent. Luna: Those are not the volatile categories you can just dismiss. That's structural. That's the kind of inflation that makes the Fed hesitate. Lucas: Right. And if walking through the economy with us has made something click, the way we keep this show ad-free and independent is listener support. If today was genuinely useful, buy me a coffee dot com slash fexingo. That's it — no pledge drives, no sponsor breaks. Just a way to keep these conversations going. Luna: Yeah. It makes a real difference. And we appreciate everyone who chips in. Lucas: Okay. So back to the data. The other thing that stood out in the release was the personal spending number. Consumer spending rose 0.3 percent month over month in May, which was slightly below expectations. That tells you the consumer is still spending, but maybe not at the torrid pace we saw in Q1. Luna: And real disposable personal income was flat. So consumers are spending more, but not earning more after inflation. That's not sustainable. Lucas: It's not. And the saving rate ticked down to 3.6 percent. That is below the pre-pandemic average of around 6 percent. People are dipping into savings to maintain consumption. That is exactly the kind of dynamic that eventually slows the economy. Luna: So the Fed is looking at sticky inflation and a consumer that is running on fumes. That puts them in a tough spot. Lucas: A very tough spot. Because if they cut rates now, they risk letting inflation become entrenched. But if they hold or even hike, they might break the consumer and cause a recession. The market is pricing in about a 40 percent chance of a cut in September, which feels optimistic to me given this data. Luna: But the Fed has been clear they don't want to overreact to one print. Chair Powell said at the last press conference that they need 'greater confidence' inflation is moving sustainably toward 2 percent. This print does not give them that. Lucas: No, it doesn't. In fact, if you look at three-month annualized core PCE, it is running around 4 percent. That is double the target. So the notion that the Fed is close to declaring victory is just not supported by the numbers. Luna: And yet the dot plot still shows cuts. How do you reconcile that? Lucas: I think the dot plot is a lagging indicator. It was based on data available before this release. The June meeting was June 16-17. This PCE data came out June 25. So the committee had not seen it. My guess is that if they voted today, the median dot would shift to one cut or even zero. Luna: So the market might be in for a repricing. The two-year yield has already moved up a bit this week. Lucas: Yeah, the two-year is at 4.13, up about 10 basis points since the PCE release. That is the market adjusting its expectations. And the ten-year is at 4.37, so the curve is still deeply inverted. That inversion has been in place for over three years now, which is historically unprecedented. Usually an inverted yield curve signals a recession within 12 to 18 months. Luna: But we haven't had a recession. The economy has been surprisingly resilient. Lucas: Resilient but slowing. GDP tracking for Q2 is around 1.5 percent annualized, down from 2.0 in Q1. And the labor market is softening — initial jobless claims have crept up to 240,000, which is the highest since late 2023. Luna: So you have this weird combination: inflation above target, but growth slowing and labor market loosening. That is the stagflationary vibe that people keep talking about. Luna: And their tools are blunt. They can't target services inflation specifically. Raising rates slows the whole economy. Lucas: Right. And that is why you hear more Fed officials talking about supply-side solutions. They are essentially saying fiscal policy and regulatory reform need to help. The Fed can only do so much. Luna: Which brings us back to the political dimension. This is an election year, and the Fed's independence is always questioned when rates are high. Lucas: It is. But I think the Fed is going to stick to its data-dependent mantra. They have been burned by forecasting errors before. They don't want to make a policy mistake based on a few months of data. So expect them to hold steady at the July meeting and see what the next few prints show. Luna: So the bottom line for our listeners: core PCE at 3.4 percent means rates are staying higher for longer. Don't count on cuts until at least the end of the year. Lucas: I would say that is the prudent view. And if you want to track the data yourself, the next key release is the July CPI on July 11, then the FOMC meeting on July 28-29. We'll be watching both closely.