Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What Falling Core CPI Means for the Fed Despite Sticky Services
Transcript
- Lucas: So the June CPI data landed last week, and headline CPI came in at 332.6 — down from 333.98 in May. That's a noticeable drop, about 0.4 percent month over month. Core CPI, stripping out food and energy, was essentially flat at 336.1. Luna: Flat after months of declines. I think a lot of people saw that headline number and thought, okay, disinflation is back on track. But the core number tells a different story. Lucas: Exactly. And this is the kind of mixed signal the Fed really has to wrestle with. On one hand, the headline drop was driven by falling energy prices — gasoline specifically. Wholesale prices fell 0.3 percent in June on that big drop in gas. That's good for consumers at the pump, but it's not the kind of durable disinflation the Fed wants to see. Luna: Right. You look under the hood and services inflation is still sticky. Shelter costs, medical care — those components aren't budging much. Lucas: And that's the core of the core, so to speak. The Fed's preferred measure is the PCE, but CPI gives us a real-time snapshot. The fact that core CPI barely moved tells me the Fed is going to stay cautious. They're not going to declare victory yet. Luna: It reminds me of something you said a few episodes back — that the last mile of inflation is the hardest. This feels like that last mile. Lucas: It really does. And you know, a quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making as many of these episodes as we do. No ads, no sponsors, just people who find this stuff useful. If walking through the economy with us has made something click, that's where you can help keep it going. Luna: Yeah, it's a small group, but it makes a big difference. And we really appreciate it. Lucas: Alright, back to the data. The 10-year breakeven inflation rate ticked up to 2.26 from 2.25. That's basically unchanged, but it's worth noting that breakevens have been hovering around 2.25 for weeks. Luna: Which is right around the Fed's target. So market participants seem to think the Fed has inflation under control, at least in the long run. Lucas: But the Fed itself is looking at something else — import prices from China posted a surprise gain in June, hitting levels not seen since 2008. That's a potential headwind. If goods prices start rising again because of tariffs or supply chain shifts, that could reverse some of the progress on core goods. Luna: And there's that headline from this week about tariffs on generic drugs starting in 2028. That's further out, but it signals the administration is serious about onshoring production. That could mean higher import prices in the near term. Lucas: Right. So the Fed is in this tricky spot where headline inflation is coming down, but some underlying pressures persist. The services sector is still showing price increases, especially in housing. Shelter costs are still running above pre-pandemic levels. Luna: What about the Fed's reaction function? How do you see them interpreting this data ahead of the next FOMC meeting? Lucas: I think they're going to hold steady. The fed funds rate is at 3.63 percent, and they've been on hold since early this year. The data is mixed enough that they don't need to rush. They want to see a few more months of declining core inflation before they even think about cutting. Luna: And the 10-year Treasury yield is at 4.63 percent — that's up almost 2 percent in the last five days. The market is pricing in some uncertainty. Lucas: Yeah, the yield curve is still inverted, which historically signals recession risk. But the economy has been surprisingly resilient. The World Cup gave bars and restaurants a boost, per the Fed's own Beige Book. So there are pockets of strength. Luna: But also warning signs — consumers are flashing caution. That same Fed report mentioned that. Lucas: Right. So the Fed is walking a tightrope. They don't want to tighten too much and cause a recession, but they also don't want to ease too early and let inflation re-accelerate. The core CPI flatlining is a reason to be patient. Luna: What about the PCE data? That came out for May — the PCE price index was 131.5, up from 130.94. Core PCE was 130.1, up from 129.67. So that also shows some stickiness. Lucas: Exactly. The Fed's preferred measure is the PCE, and it's still running above their 2 percent target. The breakeven rate suggests the market expects inflation to average around 2.26 percent over the next decade, which is close but not quite at target. Luna: So the bottom line: the Fed is likely to stay on hold for now, watching for more confirmation that inflation is sustainably moving lower. Lucas: I think that's right. And the wildcard is what happens with import prices. If those continue to rise, it could put upward pressure on core goods inflation, which would complicate the picture. The Fed will be watching that closely. Luna: And the services sector. Shelter costs, healthcare — those are the sticky components that are hard to bring down. Lucas: Yeah, services inflation is the last mile. And it's proving to be the toughest mile. The Fed's job isn't done yet. Luna: So the takeaway for listeners: don't get too excited about one month of headline CPI decline. The details matter. Lucas: And the details say the Fed is going to remain cautious. We'll be watching the July data closely. That's all for this episode — thanks for sticking with us.