Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why Inflation Feels Worse Than CPI Shows
Transcript
- Lucas: So the April CPI came in at 332.4 — up from 330.29 the month before. That's a 2.6 percent year-over-year increase, more or less in line with expectations. And yet consumer sentiment just hit a fresh record low in May. That's the lowest reading ever, and it's being driven largely by inflation fears tied to the Iran conflict. Luna: Right — record low sentiment alongside inflation that looks, on paper, pretty moderate. That's a huge gap. What's going on? Lucas: It's the gap between the CPI basket and the actual basket people carry. The CPI assumes you substitute cheaper goods when prices rise — if beef gets expensive, you switch to chicken, and the index weights that. But in reality, many people don't substitute easily. Your rent goes up, your car insurance goes up, your streaming bundle goes up — you can't swap those out. Luna: And the substitution bias has been a known criticism forever, but right now it's especially acute because the price increases are concentrated in necessities — shelter, energy, food. Things you can't really trade down from. Lucas: Exactly. Core CPI, which strips out food and energy, came in at 335.4 — up from 334.17. That's still a 2.7 percent annual pace. But the real squeeze is in the stuff that fluctuates. The Iran conflict has pushed up oil and gas prices significantly. We're seeing that in the headlines — Putin and Xi reviving a gas pipeline deal, energy markets rattled. Luna: And the Fed's preferred inflation measure, the PCE price index, was at 130.3 in March. That's a 2.5 percent annual rate, but core PCE is 2.7 percent. So both measures are stuck above the Fed's 2 percent target, even with rates at 3.64 percent. Lucas: Right. The effective fed funds rate has been flat at 3.64 since April. The Fed hasn't moved, but the 10-year breakeven inflation rate is 2.40 — so the bond market is pricing in inflation stubbornly above target for the next decade. That's not a transitory story. Luna: It's interesting — the breakeven is actually down a bit from where it was a few months ago. But 2.40 is still well above where the Fed wants it. The market is basically saying the next couple of years are going to feel inflationary. Lucas: So why does it feel worse than the headline? Partly because the headline CPI is an average, and averages hide distribution. If you're a renter in a city where rents are up 8 percent, your personal inflation rate is much higher than the national shelter component, which shows about 5 percent. Luna: And the CPI shelter number is famously lagged — it captures renewals from months ago. So even if rents stabilize today, CPI shelter will keep rising for a while. That means the pain people feel now is actually understated in the data. Lucas: Exactly. And then there's the psychological effect. When gas prices spike due to geopolitical events, you feel it every time you fill up. That visceral hit colors your view of everything else. Even if your grocery bill only went up 2 percent, if gas is up 15 percent, your overall mood plummets. Luna: That's why consumer sentiment hit a record low. The University of Michigan survey captures that mood, and it's being driven by war-related uncertainty. People are worried about where prices go next, not just where they are now. Lucas: And the irony is that the bond market's inflation signal — the breakeven — has actually come down from its 2022 highs. But that doesn't matter if the guy at the pump is paying $5 a gallon. The macro picture and the micro experience are diverging. Luna: So what's the practical takeaway for listeners? How do you even know what your personal inflation rate is? Lucas: You can track your own spending categories. The Bureau of Labor Statistics publishes detailed CPI data by region and category. If you're spending heavily on rent, gas, and insurance — which most people are — your rate is likely 1 to 2 points above the headline. Some economists estimate the average household faces a personal inflation rate of 4 to 5 percent right now. Luna: That's a big gap. And it explains the disconnect — policy debates about 'inflation is cooling' while real people are still struggling. Lucas: It's also why the ECB is talking tough. The Bank of France governor said they'll 'do what is necessary' to tame inflation. Central banks globally are facing the same problem: the data says inflation is moderating, but the public doesn't believe it. Luna: And credibility matters. If people expect high inflation, they act in ways that make it self-fulfilling — demanding higher wages, pulling forward purchases. That's what the Fed is trying to avoid. Lucas: Exactly. The 10-year breakeven at 2.40 suggests the market expects inflation to stay above target, but not runaway. That's actually a decent scenario — not great, but not 1970s. The problem is the transition feels awful. Luna: It's worth noting that the equity market doesn't seem too fazed. The S&P 500 is at 7,510, up 1 percent in the last five days. The Dow is above 50,600. So investors are looking through this inflation noise to some extent. Lucas: Right. Stocks are pricing in a soft landing — inflation stays a bit sticky, but the economy doesn't crash. The Russell 2000 is up 3.6 percent in five days, so small caps are catching a bid. That suggests confidence in domestic growth. Luna: But gold is down — 4,478, off 1.4 percent in five days, and GLD is down 2.1 percent. That's interesting because gold is usually an inflation hedge. Why is it falling if inflation fears are high? Lucas: Probably a combination of dollar strength and rising real yields. The Fed isn't cutting anytime soon, so the opportunity cost of holding gold is higher. Plus, some of the geopolitical risk might be getting priced out as diplomatic channels open. Luna: So the picture is nuanced. Inflation is real, but not catastrophic. The disconnect between data and feeling is driven by basket composition, substitution bias, and the emotional weight of energy prices. Lucas: Honestly, if walking through the economy with us has made something click — and if today's episode was worth a coffee to you — that's the link. Buy me a coffee dot com slash fexingo. Keeps the show ad-free and independent. Luna: Yeah, it's a small gesture that goes a long way. And we really appreciate the listeners who do that. Lucas: So back to the inflation perception gap. One thing that could help bridge it is if the Fed starts communicating more about the distribution of inflation, not just the aggregate. Chair Warsh has been doing some of that, but there's room to go. Luna: The CPI data itself is incredibly rich. You can look at the detailed tables and see that medical care services are up 3.2 percent year-over-year, transportation services up 5.1 percent. These are big weights in most budgets. Lucas: And the shelter component alone is about one-third of the CPI. If shelter is running at 5 percent, that alone adds about 1.7 points to the headline. So even if everything else is at 2 percent, the headline stays elevated. Luna: That's why the Fed focuses on core PCE — it gives less weight to shelter. But that doesn't help the person paying rent. Lucas: Right. And there's a broader lesson here: when you see a headline number, ask 'whose inflation?' The answer changes everything. For a retiree on fixed income spending heavily on healthcare and rent, inflation might be 4 percent. For a remote worker in a low-cost area, it might be 1.5. Luna: That's a good way to think about it. So next time you hear 'CPI rose 2.6 percent,' you can mentally add a point or two if you're in a high-cost city or drive a lot. Lucas: Exactly. And that's what we'll keep tracking here. Next episode, we'll look at how the Iran conflict specifically is feeding into energy inflation and what that means for the summer driving season. Luna: Looking forward to it.