Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Hidden Cost of Fiscal Deficits on Your Wallet
Transcript
- Lucas: If you look at the headline CPI number right now, it looks manageable. But if you look at the U.S. budget deficit swelling to almost two trillion dollars for fiscal 2026, up twelve percent in a single year, the story gets much more complicated. We are talking about a structural shift in how this country pays for itself, and that has direct consequences for the price of bread. Luna: Right, but isn't the Federal Reserve supposed to be insulating us from that kind of fiscal noise? The Fed controls interest rates, not Treasury spending. Lucas: That is the textbook answer, and it is half right. The Fed sets the price of money, but the Treasury determines the quantity of debt. When the deficit hits two trillion dollars, you have massive amounts of new supply entering the bond market. That creates upward pressure on yields, which eventually trickles down into consumer credit costs. Look at the Fed Funds effective rate sitting at three point seven five percent. That is not an accident; it is a response to the underlying fiscal reality. Luna: So you are saying the high cost of borrowing is a tax on consumers because of government overspending? Lucas: I am saying it is a transmission mechanism. Let me give you a concrete example from this week. Wholesale prices jumped six point three percent annually in September, which was the biggest gain since twenty twenty-two. That is a signal that input costs for businesses are rising sharply. When businesses face higher financing costs due to debt issuance, they pass those costs to you. It shows up in the PPI before it shows up in the CPI. Luna: Six point three percent is huge for wholesale. Why did that spike happen all at once? Lucas: It is partly inventory restocking after a lean period, but it is also the cost of capital. Think about a mid-sized manufacturer who needs to borrow money to buy raw materials. If the yield on ten-year Treasuries is elevated because the government is flooding the market with bonds, that manufacturer's interest expense goes up. They cannot absorb that indefinitely. So, by the time those goods hit your local supermarket, the shelf price reflects that financial friction. Luna: That makes sense, but does the average person really connect their mortgage payment to the federal deficit? Lucas: They don't make the connection consciously, but they feel the result. Consider the thirty-nine basis point rise in the Fed Funds rate we saw recently. Even though the Fed holds rates steady for meetings, the daily rate hovers around three point eight eight percent. For anyone with a variable-rate loan or a new mortgage application, that difference between three percent and four percent changes the monthly payment significantly. It reduces disposable income, which makes every other purchase feel more expensive. Luna: So the deficit acts like a hidden tariff on credit availability. Lucas: Exactly. And here is where it gets tricky for investors and households alike. The IMF issued a warning about debt sustainability, and the U.S. Treasury dismissed it as messy forecasting. But markets do not dismiss them lightly. Look at the gold price holding near four thousand one hundred eighty-one dollars per ounce. Investors are buying insurance against fiscal dominance, where monetary policy is forced to accommodate fiscal reality. That hedging activity keeps commodity prices elevated, which feeds back into inflation. Luna: Is gold really a reliable indicator of what’s happening to my grocery bill though? Lucas: Not directly, but the logic applies to copper, lumber, and energy. When investors expect persistent inflation due to large deficits, they bid up commodities. Those are the inputs for everything from construction to food processing. If the cost of energy rises because of speculative demand driven by fiscal concerns, logistics costs go up. Trucking fees go up. Then your weekly shop at Walmart or Kroger goes up. It is a chain reaction starting in Washington. Luna: It feels like we are stuck in a loop where spending drives inflation, which drives rates, which slows growth, so they spend more. Lucas: That is the classic stagflation risk profile, although we are not quite there yet. The core PCE price index is at one hundred thirty point five, which is stable. But the ten-year breakeven inflation rate has ticked up to two point three five percent. That suggests long-term investors are worried about future price levels. They are pricing in the idea that this two-trillion-dollar deficit will keep pushing against capacity constraints in the economy. Luna: Two point three five percent seems low compared to the peaks we saw a few years ago. Lucas: It is lower than the peaks, but it is structurally higher than the zero-to-one percent range we enjoyed during the quiet early twenty-twenties. That baseline shift matters. If you plan your retirement or your child's education fund assuming two percent inflation, you might be underestimating the true cost of living over the next decade. The fiscal trajectory suggests a floor under inflation that didn't exist before. Luna: So we need to adjust our personal budgets for a higher baseline cost of money. Lucas: Precisely. And that brings us to a practical question for listeners. How do you protect your purchasing power when the government is effectively printing debt to cover its expenses? One strategy is focusing on assets that benefit from inflation rather than fighting it. Real estate, certain equities, and yes, even cash equivalents if you lock in rates early. But first, let's take a quick breath about how this show stays free. Luna: Yeah, supporting independent analysis helps us dig into these complex links without corporate pressure. Lucas: Honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It keeps the lights on and the fact-checking rigorous. Luna: Thanks for keeping the signals clear in a noisy market. Now, back to the mechanics of this deficit impact. Lucas: Let's drill into the services sector, which is often ignored in these deficit conversations. Services are labor-intensive, and labor costs are sticky. When the government borrows heavily, it competes for capital, driving up interest rates. Higher rates slow down investment in automation and technology, which means productivity growth stalls. If productivity stalls while wages rise to match inflation, you get wage-price spirals in services like healthcare and insurance. Luna: Do we have data showing services inflation accelerating because of these credit conditions? Lucas: We see it in the shelter component of the CPI, which sits at three hundred thirty-six point three. Shelter lags housing market data by about nine months, but the underlying trend is clear. As mortgage rates stay elevated due to fiscal pressure, new home construction slows. Supply tightens. Existing landlords raise rents to cover their own higher financing costs. So even if house prices flatten, rental inflation remains stubbornly high. Luna: That explains why my rent went up even though I heard home prices were cooling. Lucas: Exactly. You are paying for the lagged effect of tighter credit conditions. And this is where the disconnect happens. People look at the S&P 500 dropping nineteen percent over the last week and think the stock market is crashing, but they ignore that the real pain is in their monthly fixed costs. The equity market reacts to earnings growth, but your wallet reacts to interest expenses and service fees. Luna: It feels like the equity market and the real economy are decoupling again. Lucas: They are partially decoupling because tech companies can hedge their interest costs better than small businesses. A giant like Microsoft can issue bonds at fixed rates decades out, locking in cheap money. A local restaurant owner only has access to short-term commercial loans. When the deficit pushes long-term yields up, the small business suffers immediately. That is why wholesale prices matter so much—they hit the smallest players first. Luna: So the inequality of inflation is real. Big firms adapt, small ones get squeezed. Lucas: Yes, and that consolidation reduces competition over time. Fewer competitors mean less price discipline. When you walk into a store and see fewer brands competing on price, you pay more. It is a subtle but powerful effect of fiscal policy. The two-trillion-dollar deficit doesn't just increase national debt; it reshapes the competitive landscape in ways that favor incumbents who can afford higher financing costs. Luna: That is a terrifying thought. We are basically subsidizing big corporations through higher interest rates. Lucas: In a way, yes. Because the government must pay interest on its own debt, it indirectly supports the financial sector and large borrowers. Meanwhile, the rest of us bear the brunt of reduced public services or future tax hikes. It is a transfer of wealth from taxpayers to bondholders, mediated through the banking system. Luna: How should listeners view their savings accounts in this environment? Lucas: With skepticism. High-yield savings accounts offer decent returns now, but they are tethered to the Fed Funds rate. If the Fed cuts rates to stimulate growth amid this fiscal drag, those yields will drop. Meanwhile, inflation may remain sticky at two point three five percent or higher. You need assets that appreciate independently of interest rates. Stocks in sectors with pricing power, or physical assets like land, tend to hold value better than cash in a high-deficit regime. Luna: So diversification away from pure cash is key. Lucas: Absolutely. Cash is king only when inflation is falling rapidly. When inflation is persistent due to structural fiscal issues, cash becomes a melting ice cube. You want exposure to things that can raise prices without losing volume. That is why companies with strong brands and essential products perform well even when the deficit swells. Luna: Essential products. Like food and utilities. Lucas: Right. Utilities and staples have regulated or predictable pricing models. They pass costs through quickly. In contrast, discretionary spending gets cut first when credit gets expensive. So if you are investing, look at defensive sectors. If you are managing a household budget, prioritize paying down variable-rate debt before looking at investment opportunities. Eliminate the floaters. Luna: Practical advice. Pay off the credit cards, then invest. Lucas: Yes. And stop blaming yourself for inflation. It is not a moral failing; it is a macroeconomic outcome. Understanding the link between the two-trillion-dollar deficit and your grocery bill empowers you to make better decisions. You cannot control Washington, but you can control your leverage and your asset allocation. Luna: Empowerment through clarity. I like that takeaway. Lucas: Stay tuned for next week, where we will explore how global supply chains are adapting to these new fiscal realities.