Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / How the Fed's Battle With Inflation Is Now a Two Front War
Transcript
- Lucas: So the July CPI report came out this week, and core inflation is still running hot at 3.6 percent year over year. But here's the thing—wholesale prices were completely flat. That's a two-front war for the Fed, and it's the most interesting part of the data. Luna: Two fronts? You mean the consumer side and the producer side? Because they usually move together. Lucas: Right, they've been tightly correlated for years. But right now, goods prices are actually falling, while services—especially rent and medical care—stay sticky. The producer price index, or PPI, was flat in July, below the expected 0.2 percent bump. That suggests the pipeline pressure is easing on the goods side. Luna: So if goods are getting cheaper, why is my grocery bill still high? I mean, lettuce prices plunged, but that's just one item. Lucas: That's exactly the disconnect. A lot of the goods disinflation is happening upstream—raw materials, shipping, that kind of thing. But the services economy is a different beast. Rent, insurance, healthcare—those are driven by wages and demand, not global supply chains. And the Fed watches core services very closely. Lucas: And here's the thing—the Fed has to fight both fronts at once. If they only look at headline CPI, they might think inflation is cooling faster than it is. But core PCE, which the Fed prefers, actually ticked up last month. So the two measures are telling slightly different stories. Luna: So they're juggling two inflation metrics plus the jobs market? That sounds like a lot. Lucas: It is. And the bond market is starting to price in more inflation risk because of it. The ten-year breakeven rate—that's the market's expectation for average inflation over the next decade—crept up to 2.27 percent from 2.24 percent just a few days ago. Luna: That's still below the peak, but it's moving in the wrong direction if the Fed wants to cut rates. Lucas: Exactly. And that's why you see the Fed holding rates steady at 3.63 percent. The effective fed funds rate hasn't budged in a month. They're waiting for more evidence that services inflation is actually cooling. Luna: Speaking of evidence—the PPI data might be telling us that goods deflation is spreading. But services just won't quit. How do you even measure that split? Lucas: The Bureau of Labor Statistics breaks down CPI into goods and services. Right now, core goods are running negative year-over-year, but core services are still above 4 percent. That's the two-front war in one sentence. Luna: So the Fed is trying to fight a war where one front is already cooling, but the other is still blazing. That's a tough spot. Lucas: It is. And it has real consequences for your wallet. Because if services inflation stays sticky, the Fed can't cut rates as aggressively. That means mortgage rates stay higher, car loans stay higher—everything that depends on borrowing gets more expensive. Luna: Right. And that's why, even though we're not in the podcast business to make money, a couple of dollars a month genuinely keeps these shows going. If walking through the economy with us has made something click, you can support us at buy me a coffee dot com slash fexingo. Lucas: Yeah, we keep the podcast ad-free, and listener support is what makes that possible. It's a small thing that adds up. Luna: And now back to the numbers. So the PCE price index actually fell last month—from 131.53 to 131.4. That's the Fed's favorite inflation gauge. But core PCE went up. How should listeners interpret that? Lucas: It means the headline number is being dragged down by falling goods prices, but the underlying trend is still elevated. The Fed looks at core because it strips out the volatile food and energy components. So even though headline PCE dropped, the core is still stubborn. Luna: So it's like a patient whose fever is down but the infection is still there. Lucas: Perfect analogy. And in this case, the infection is services inflation. The Fed's new framework—they've talked about this—is to focus on the 'supercore' services inflation, which excludes housing. That's still running hot, so they can't let their guard down. Lucas: Now, the breakeven rate moving up tells you bond investors are starting to demand more compensation for inflation risk. That's a market signal the Fed can't ignore. Luna: And that's why we saw the budget deficit surge in July. Higher interest costs on the debt, right? Lucas: Exactly. The deficit is partly a symptom of higher rates. But it also feeds back into inflation expectations, because investors worry the government will be tempted to inflate away the debt. Luna: So it's all connected. The two-front war, the bond market, the deficit—it all flows into what you pay for rent and groceries. Lucas: Right. And the takeaway for everyday people is this: don't be fooled by a cool headline CPI number. The services side of your budget—rent, insurance, healthcare—is still under pressure. And that's what the Fed is watching. Luna: So what should we expect in the coming months? More of the same? Or is there a turning point? Lucas: Hard to say. The July jobs report was weak, which might push the Fed toward cutting rates sooner. But if services inflation stays sticky, they'll hold off. It's a tug of war. Luna: I guess that's why the Fed keeps saying 'data-dependent.' They're waiting for the two fronts to align. Lucas: Exactly. And that's the best way to think about it: the Fed isn't fighting a single inflation number. They're navigating a complex economy where goods are cheap but services are expensive. And that's the reality for your wallet.