Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Hidden Cost of the Iran War in Your Utility Bill
Transcript
- Lucas: So the headline everyone's talking about is that core PCE stuck at 3.3 percent in April, right in line with expectations. But the number I can't stop thinking about is actually the 10-year breakeven inflation rate, which dropped to 2.38 percent. Luna: That is a weird disconnect — inflation expectations falling even as actual core inflation stays sticky. How do you square that? Lucas: I think the market is basically saying: the Fed's rate cuts are working to cool demand, but there's a specific supply-side shock that's keeping core elevated. And that shock is energy, specifically tied to the Iran war. Luna: If today was actually useful to you, the way these stay ad-free is listener support. Buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small thing that lets us keep digging into these data points without any sponsors. Appreciate it. Lucas: So let's unpack that energy piece. A CNBC headline this week said the average U.S. household is paying an extra $450 on gas and energy because of the Iran conflict. That's not just at the pump — it's in your utility bill, your home heating, even the cost of delivered goods. Luna: And that filters into core inflation through things like transportation services and home heating costs. So even if the market sees headline energy volatility as temporary, households are feeling it month after month. Lucas: Exactly. And listen to what Fed's Goolsbee told CNBC on Thursday — he said energy inflation has been 'more persistent than expected.' That's a Fed official essentially admitting that the supply shock is lasting longer than their models predicted. Luna: Then you've got Kashkari saying the inflation fight takes priority because the labor market is 'in decent shape.' Nonfarm payrolls at 158.7 million, jobless claims creeping up to 215,000 — still historically low, but the trend is upward. Lucas: Right. So the Fed is stuck between a labor market that's still generating jobs and an inflation rate that won't come down to 2 percent. The fed funds rate is at 3.64 percent, and the market is pricing in cuts, but not until later this year. Luna: But the bond market seems to be buying the story that inflation will eventually moderate. The 10-year yield fell to 4.45 percent this week, down almost a full percent from its peak last year. That's a big move. Lucas: It is. And the breakeven rate falling to 2.38 suggests investors expect inflation to average around that level over the next decade. But here's the rub — that's still above the Fed's 2 percent target. And if energy stays elevated, those expectations could re-anchor higher. Luna: So the market is effectively saying: we believe the Fed will eventually win, but not quickly. And in the meantime, households are paying the price. Literally. Lucas: Let's put some numbers on that. The CPI for April came in at 332.4, up from 330.29 in March. That's an annualized rate of roughly 3.4 percent. Core CPI at 335.4, up from 334.17. So the momentum is still there, even if it's slowing. Luna: And the core PCE price index, which is the Fed's preferred gauge, hit 129.6 in April, up from 129.32. That's a 3.3 percent annual rate. So we're stuck in a range between 3 and 3.5 percent for core inflation. Lucas: Which is exactly the zone where the Fed can't declare victory. And energy is the wildcard. The breakeven rate dropped partly because oil prices have eased from their war spikes, but utility costs are stickier. Those are regulated or long-term contracts. Luna: So the Iran war is creating this two-layer effect: a headline spike that fades, and a persistent cost increase in things like electricity and natural gas that takes months to work through. That's why Goolsbee used the word 'persistent.' Lucas: Exactly. And it's not just energy. The JOLTS data showed job openings fell to 6.866 million in March from 6.922 million. That's a decline, but openings are still above pre-pandemic levels. So the labor market is cooling, but not collapsing. Luna: That gives the Fed cover to keep rates higher for longer. They don't have to cut to save jobs right now. Kashkari's point about the inflation fight taking priority makes sense if you believe the labor market can handle it. Lucas: But here's the question I keep coming back to: if energy inflation is persistent and supply-side driven, can the Fed actually do anything about it? Raising rates doesn't drill more oil or end a war. Luna: No, but it does cool demand. And if demand for energy drops enough, prices should moderate. The problem is that energy demand is relatively inelastic in the short run — people still need to heat their homes and drive to work. Lucas: Right. So the Fed is left hoping that either the war ends or that the economy slows enough to reduce energy consumption. Neither is a sure bet. And in the meantime, the average household is feeling that $450 hit. Luna: That $450 number — is that purely gas, or does it include everything? Lucas: The CNBC report said gas and energy, so it's likely a blend of gasoline, heating oil, natural gas, and electricity. And it's an average, so some households are feeling much more. If you're in a cold climate or have a long commute, it could be double that. Luna: So that's a real headwind for consumer spending. And we already saw consumer sentiment hit record lows in prior episodes. This energy cost piece just adds another layer of pressure. Lucas: Exactly. And the bond market's optimism might be premature if the energy shock lingers. The 10-year breakeven at 2.38 percent is still above the Fed's target, and if energy costs stay high, that number could tick back up. Luna: So what's the takeaway for someone listening? How should they think about this? Lucas: I'd say: don't assume that falling breakeven rates mean inflation is conquered. Look at the components. Energy is the wildcard, and it's being driven by geopolitics, not by demand management. Until that resolves, the Fed is walking a tightrope. Luna: And for investors, that means rate cuts are likely later rather than sooner, and that bond yields might stay range-bound until we get clarity on energy. Lucas: Right. The market is pricing in cuts, but the data doesn't support it yet. I'd watch the weekly jobless claims and the next CPI release. If claims keep rising above 220,000, that might tip the balance. But if they stay around 215,000, the Fed can afford to wait. Luna: And keep an eye on those utility bills. If your own energy costs are going up, you're not alone — and it's a signal that the inflation fight isn't over. Lucas: Exactly. Thanks, Luna. We'll be back tomorrow with another angle on this economy.