Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Cutting Despite a Strong Jobs Market
Transcript
- Lucas: So the unemployment rate just dropped to 4.2 percent, nonfarm payrolls hit a record high of nearly 159 million, and the Fed is still cutting rates. That's the conversation today. Luna: We saw that headline yesterday and it felt like the economy is on fire — but the Fed is acting like it's not. What's going on? Lucas: It's the inflation picture that's driving them. June CPI came in at 3.5 percent annualized, below expectations. And wholesale prices actually fell 0.3 percent last month, driven by a big drop in gasoline. Luna: So the headline jobs number looks great, but the Fed is laser-focused on the price data. Lucas: Exactly. They've been saying for months that they need to see sustained progress on inflation before easing. And now they're getting it. But the labor market is still historically tight. Luna: Is the worry that if they cut too fast, they reignite inflation? Or that if they don't cut, they choke off the expansion? Lucas: Both. The ten-year breakeven inflation rate, which is the market's expectation for average inflation over the next decade, has slipped to 2.23 percent. That's actually below the Fed's 2 percent target if you round it. So the market is betting inflation is under control. Luna: But the Fed's preferred measure, core PCE, is still running above target. Last reading was 130.1, up from 129.67. Lucas: Right. And that's the disconnect. Core PCE is sticky. But the Fed has started to emphasize wholesale prices more. They see the PPI decline as a leading indicator that consumer prices will follow. Luna: We did an episode on that a few weeks ago — why the Fed is watching wholesale prices more than CPI. It's because they think pipeline pressures are easing. Lucas: Exactly. And now we're seeing it play out. The Fed cut the fed funds rate by 25 basis points last week, bringing it to 3.63 percent effective. But the market had priced in a 50-basis-point cut a month ago. Luna: So they're being cautious. They cut, but not as aggressively as some wanted. Lucas: That's the balancing act. The labor market is strong, but there are soft spots. Job openings ticked up slightly to 7.594 million in May, but that's still well below the 2022 peak of over 12 million. Luna: And initial jobless claims dropped to 208,000 — that's very low. So layoffs aren't the issue. Lucas: No, the concern is more on the hiring side. The labor force participation rate has been declining. We talked about that in episode 114. People are leaving the workforce, and that's structural. Luna: So the unemployment rate is low partly because the labor force is shrinking, not because everyone has a job. Lucas: Bingo. The Fed sees that too. They don't want to overtighten and accelerate the labor force exit. So they're easing into a strong jobs market, which historically is unusual. Luna: What does this mean for the yield curve? The ten-year Treasury is at 4.57 percent, the two-year is at 3.70 percent. That's a positively sloped curve again after being inverted for so long. Lucas: The uninversion we talked about in episode 102. It's now firmly positive. The market is essentially saying the Fed is done hiking and will keep cutting. But the long end is still elevated because of term premium — investors want compensation for holding long-term bonds with inflation uncertainty. Luna: And the thirty-year is at 5.10 percent. That's a big number. Lucas: It is. The long bond is pricing in higher inflation risk or higher supply risk from Treasury issuance. The Fed can control the short end, but the long end is driven by global demand and fiscal outlook. Luna: So we have a Fed that's cutting into a strong labor market, a yield curve that's steepening, and inflation that's coming down but not all the way. What's your read on the next few months? Lucas: I think the Fed will cut again in September, but only 25 basis points. They'll want to see another CPI and PCE report before committing. The risk is that if energy prices spike again — the headline about Hormuz hostilities is worrying — then inflation could tick back up. Luna: And that would put the Fed in a tough spot. They'd have to pause or even reverse. Lucas: Exactly. So the path is data-dependent, but the direction is clear: lower rates, unless something breaks. Luna: It's a fascinating moment. I feel like we're watching the Fed navigate a soft landing in real time. Lucas: We are. And honestly, if walking through the economy with us helps make sense of it, that's exactly why we do this show. We keep it ad-free because of listener support — folks who chip in at buy me a coffee dot com slash fexingo. It's a small gesture that lets us keep the conversation independent. Luna: Yeah, it really does make a difference. And we appreciate every single one of you who helps keep this going. Lucas: So back to the data — one more number I want to highlight. Real GDP growth annualized came in at 2.1 percent for the first quarter of 2026. That's up from 0.5 percent in the prior quarter. So the economy is actually accelerating. Luna: That's a big jump. So growth is strong, jobs are strong, inflation is cooling. That's the soft landing script. Lucas: It is. But the market is still jittery. The S&P 500 is down 0.4 percent over the last five days. The NASDAQ is down a full percent. Investors are still trying to figure out if the Fed's next move is a cut or a pause. Luna: And the small caps — the Russell 2000 is basically flat. So the rally hasn't broadened out. Lucas: That's the key risk. If the Fed cuts and the economy keeps growing, maybe small caps catch up. But if we get a shock — geopolitical or energy — all bets are off. Luna: So the next CPI report in August is going to be huge. Lucas: Huge. That and the next FOMC meeting in September. We'll be watching every data point between now and then. Luna: And we'll bring it to you as it happens. Lucas: That's it for today. Stay curious, and we'll talk tomorrow.