Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What Sticky Core PCE Means for the Fed's Next Move
Transcript
- Lucas: So yesterday the Bureau of Economic Analysis dropped the May PCE report, and the headline number is really something. Core PCE — the Fed's preferred inflation gauge — hit 3.4 percent year over year. That's the highest since October 2023. Luna: Yeah, I saw that. And it's not just the level — it's the direction. It's been creeping up for months now. The market seemed a bit shaken. Lucas: Right. The S&P 500 was down nearly 2 percent over the past five days, and the Nasdaq got hit even harder — down over 4 percent. The 10-year Treasury yield is at 4.39 percent. So there's clearly a repricing happening. Luna: Before we dive deeper — I'll just say, if parsing this data with us helps make sense of the noise, the way the show stays ad-free is listener support. It's buy me a coffee dot com slash fexingo. Short, simple, and it keeps us going. Lucas: Absolutely. And speaking of noise — let's talk about what's actually inside this PCE number, because it's not a broad-based spike. The breakdown matters. Luna: Goods versus services, right? That's where the story is. Lucas: Exactly. Goods prices have actually been falling — down about 0.2 percent month over month. Think used cars, furniture, electronics. The deflation in goods that we saw through 2024 and early 2025 is still there, though it's slowing. Luna: So the culprit is services. And that's the sticky part the Fed has been worried about for over a year now. Lucas: Services inflation ran at about 0.3 percent month over month in May, which annualizes to around 3.6 percent. The big components are housing — rent and owners' equivalent rent — plus health care, insurance, and recreation. Those don't respond quickly to interest rate changes. Luna: And that's the problem for the Fed. They've held the fed funds rate at 3.63 percent effectively — the effective rate was 3.63 as of June 24, flat for weeks. But services inflation isn't budging. Lucas: Right. The interest on reserve balances is 3.65 percent, so the corridor is essentially unchanged. And the market is pricing in rate cuts later this year, but this PCE print makes that look premature. Luna: I want to look at the 10-year breakeven inflation rate, which ticked up to 2.21 percent on June 25 from 2.18. That's still below the current core PCE, but it suggests that long-term inflation expectations are creeping up too. Lucas: That's a key point. The breakeven is the market's expectation of average inflation over the next decade. When it rises, it means bond investors are demanding more compensation for inflation risk. If the Fed cuts rates while breakevens are moving up, they risk losing credibility. Luna: So what does the data tell us about the next FOMC meeting? The next one is in late July. Do you think they'll hold again? Lucas: I think a hold is the base case. The fed funds rate is already restrictive — the real rate, if you subtract core PCE, is barely positive. But cutting now would be a gamble. You'd be easing while inflation is still above target and ticking up. Luna: And the labor market? We saw that headline about factory job cuts nearing financial crisis levels. That's a countervailing force. Lucas: Yes, that S&P report on factory job cuts was striking. June cuts were near the levels of 2008 and 2020. So the Fed has a dual mandate conflict: inflation is sticky high, but the labor market is showing soft spots in manufacturing. Luna: But services employment is still strong. The overall unemployment rate is low. So it's not a broad labor market weakness — it's a sectoral shift. Lucas: Exactly. And the Fed has been clear that they're watching for broad-based weakness, not just one sector. So factory job cuts alone probably won't trigger a cut. Luna: Let's talk about the international spillovers. The show has covered that before, but it's relevant here. With the Strait of Hormuz situation, energy prices could spike, which would feed into headline inflation. Lucas: That's a wildcard. The UN agency paused the Hormuz ship evacuation plan after the first vessel attack under the peace deal. Iran warned ships that transit without approval is 'unacceptable and dangerous.' If oil prices jump, that's a supply shock that the Fed can't address with rate policy. Luna: Right. They'd be stuck — higher inflation from oil, but slowing demand from already-high rates. That's a stagflationary scenario, which is the worst case for central bankers. Lucas: And it's not just oil. The headline about Trump pledging rapid US response for Venezuela after earthquakes — that region is a major oil producer too. So you have multiple geopolitical risks that could push inflation up. Luna: So the bottom line from this PCE report is that the Fed's path is still higher for longer. The market wants cuts, but the data isn't cooperating. Lucas: I'd put it this way: the core PCE number is a reminder that the last mile of inflation is the hardest. Goods disinflation is largely done. What's left is services, and that's driven by rent, wages, and health care — all slow-moving. The Fed needs to see sustained improvement in services inflation before they can ease. Luna: And the breakeven rate at 2.21 suggests the market isn't fully convinced the Fed will succeed. That's a credibility challenge. Lucas: It is. The Fed has been saying they're data-dependent, and the data keeps coming in hot. The next CPI and PCE reports before the July meeting will be crucial. If we see another 0.3 percent month-over-month in core services, I think the hawks on the FOMC will dig in even more. Luna: So what should listeners watch for between now and the July meeting? Lucas: Two things. First, the monthly core PCE print for June, which comes out in late July. Second, any commentary from Fed speakers — we've got several appearances scheduled. If they start emphasizing the need for 'restrictive policy for longer,' that's a signal that cuts are off the table. Luna: And if oil spikes from Hormuz, all bets are off. That would complicate everything. Lucas: Absolutely. We'll be watching. For now, the data says: inflation is sticky, the labor market is mixed, and the Fed is on hold. That's the reality as of late June 2026.