Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Core PCE Is Sticky While CPI Cools
Transcript
- Lucas: There's a strange split happening in the inflation data right now that I think explains a lot about why the Federal Reserve is staying put. The headline consumer price index fell in June, but the Fed's preferred measure — the personal consumption expenditures index, or PCE — actually ticked up. Lucas: Specifically, core PCE, which strips out food and energy, rose to 130.1 from 129.67 the month before. That's a monthly increase of about three-tenths of a percent, which annualizes to nearly 4 percent — well above the Fed's 2 percent target. Meanwhile, core CPI was essentially flat. Luna: So the headline CPI looks cooler, but the Fed sees something still hot. What's driving the difference between the two measures? Lucas: The main culprit is services. Both CPI and PCE include housing costs, but they weight them differently. PCE gives a larger share to medical services and insurance, and it uses a different method for owner-occupied housing. That matters because rent and medical costs have been very sticky. Lucas: For example, owner's equivalent rent — what homeowners would pay to rent their own home — makes up a bigger chunk of CPI than PCE. That component finally started to decelerate. But PCE puts more weight on health insurance and hospital services, which are still rising fast. So the mix explains the gap. Luna: And the Fed targets PCE, not CPI. So even if CPI is showing progress, the Fed's eyes are on that core PCE number still running hot. That alone keeps them from cutting. Lucas: Exactly. And there's another layer: the breakeven inflation rate — the gap between nominal and inflation-protected Treasury yields — has fallen to 2.21 percent, down from 2.26 a week ago. That suggests bond traders expect future inflation to moderate. Lucas: But the Fed chair, Kevin Warsh, has been signaling patience. He recently homed in on three key phrases about 'waiting for data confirmation' and 'seeing actual inflation come down.' The bond market might be forward-looking, but the Fed wants concrete proof. Luna: And it's not just inflation. Jobless claims came in at 187,000 last week — that's remarkably low. So the labor market is still tight, which gives the Fed more room to hold rates steady at 3.63 percent without fearing a recession. Lucas: Right. The unemployment rate is 4.2 percent, down from 4.3 percent. Nonfarm payrolls continue to rise. So the economy is adding jobs, inflation is still above target in the Fed's eyes, and there's no immediate pressure to ease. The market is pricing in a cut later this year, but the data isn't cooperating. Luna: It's like the economy is sending mixed signals, but the Fed is choosing to focus on the one signal that hasn't improved: core PCE. If that number starts to fall, then we might see action. Lucas: Exactly. And that's the key variable to watch. The next PCE data comes out in a few weeks. If it shows the same stubbornness, the rate-cut timeline gets pushed further out. If it drops, then the whole conversation shifts. Luna: You know, it's conversations like this that make me appreciate a show that doesn't interrupt itself with ads. I find myself actually following the logic without breaking focus. Lucas: That's by design. We deliberately keep these episodes ad-free because the goal is to make the economy click. If that's valuable to you, there's a simple way to support it — buy me a coffee dot com slash fexingo. No pressure, just an option for people who want the show to stay exactly like this. Luna: Yeah, it's a small gesture that makes a big difference. Speaking of which, now let's get back to that PCE data. What specific services categories are you watching most closely? Lucas: I'm watching medical care services and housing utilities. Medical care has been accelerating at an annual rate near 5 percent. And while rent growth is cooling, it's still well above pre-pandemic levels. Those two categories alone could keep core PCE elevated for another quarter. Luna: So even if goods prices keep falling — which they have been, thanks to lower import costs — services inflation may prevent the Fed from declaring victory. That's a tough spot for policymakers. Lucas: It is. And the longer rates stay at 3.63 percent, the more pressure builds on sectors like housing and small business. But the Fed seems willing to tolerate that pressure until services inflation breaks. The next few months of data will be decisive. Luna: All right, so the takeaway: core PCE is the number to track, and until it drops meaningfully, the Fed stays on hold. Got it. Lucas: Exactly. Thanks for listening — and if you want to dig deeper into the data, we'll have more tomorrow.