Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the FOMC Is Watching Real Wages More Than Headline CPI
Transcript
- Lucas: So the FOMC minutes from last month are out, and there's a line that keeps getting glossed over. The committee is now explicitly watching real wage growth as a primary indicator — not just headline CPI. Luna: That's interesting. They've always talked about wages in the context of inflation, but you're saying this is a shift in emphasis? Lucas: Yeah, exactly. Historically, the Fed looks at core PCE — that's their preferred inflation gauge. But in the latest minutes, they spend three full paragraphs on real wage growth. And the numbers justify it. Average hourly earnings are up to $37.60 as of June, which is about 3.9 percent year-over-year. Luna: Right, so nominal wages growing almost 4 percent. But core PCE is at 2.71 percent. So real wages are actually positive. Lucas: Exactly. For the first time in a couple of years, workers are seeing real purchasing power gains. And the Fed is worried that if those gains persist, they could feed into services inflation — the stickiest part of the basket. Luna: But wait — the unemployment rate dropped to 4.2 percent, and jobless claims are still low. If the labor market is tight, isn't wage growth kind of expected? Lucas: It is expected, but the participation rate is falling again. The headline says 4.2 percent unemployment, but that's partially because people are leaving the labor force. The labor force participation rate is at levels we haven't seen outside of COVID. Luna: So the Fed sees a tight labor market but not a growing one. That's the kind of thing that keeps them stuck at 3.63 percent on the fed funds rate. Lucas: Right. And that's the puzzle. The fed funds rate is flat at 3.63 percent, and the ten-year Treasury is at 4.57 percent. The yield curve is steepening, which usually signals expectations of growth or inflation. Luna: But the breakeven rate is stuck at 2.24 percent. So the market isn't pricing in runaway inflation. It's pricing in sticky, moderate inflation. Lucas: Exactly. And that's where the Fed's real wage concern comes in. If nominal wages keep growing at 3.9 percent and productivity doesn't accelerate, unit labor costs rise. That eventually shows up in core services inflation. Luna: So the Fed is effectively trying to keep wage growth in check without crushing the labor market. That's a narrow path. Lucas: Narrow and getting narrower. Chair Powell's language has shifted from 'data dependent' to 'outcome dependent.' That's a subtle change but it matters. Outcome dependent means they're looking at the final inflation print, not just the inputs. Luna: Meaning they won't cut rates just because CPI ticks down a bit. They need to see sustained improvement in the actual inflation outcome. Lucas: Right. And the latest CPI data from May shows all items at 334.0, up from 332.41. That's a 0.5 percent monthly increase. Core is similar. So inflation is still running above target. Luna: But if real wages are positive, isn't that a good thing? Why does the Fed see it as a risk? Lucas: Because the Fed's job is to keep inflation low and stable. If workers have more purchasing power, they spend more. That demand can push prices up further, especially in services like rent and healthcare. Luna: So the Fed is essentially fighting its own success. The economy is generating real income gains, and that creates a new inflation risk. Lucas: Exactly. And it's a tricky communication challenge. If Powell says 'wages are rising too fast,' that sounds anti-worker. So they frame it as 'we need to ensure wage gains are sustainable.' Luna: I get that. But look at the JOLTS data — job openings actually ticked up to 7.594 million in May. That's still above pre-pandemic levels. So the labor market is still hot. Lucas: Yeah, and the quits rate is stable. So workers feel confident enough to leave jobs. That tends to push wages up as employers compete for talent. Luna: So where does that leave us? The Fed is stuck, wages are growing, inflation is sticky, and the yield curve is steep. Lucas: It leaves us in a waiting pattern. The market is pricing in no rate cuts for the rest of 2026. And honestly, if the Fed is watching real wages, they're probably not going to cut until they see those wage gains moderate or productivity jumps. Luna: Speaking of waiting patterns, Lucas, I have to say — this podcast has become part of my daily routine to make sense of all this. And I know a lot of listeners feel the same way. If you've been following along and finding these conversations useful, there's a small way to help keep it going. Lucas: Yeah, we keep the show ad-free, and that's entirely because of listeners who chip in. So if today's episode made something click, the link is buy me a coffee dot com slash fexingo. That's all. Luna: It genuinely helps. And we mean it when we say even one coffee's worth makes a difference. Not a big deal, just if it feels right. Lucas: Alright, back to the yield curve. So the steepening we're seeing — two-year at 3.69 percent, ten-year at 4.57 percent — that's a spread of almost 90 basis points. That's a normal curve again. Luna: But it's steepening because the long end is rising faster than the short end. That suggests investors are demanding more term premium, probably because they see inflation risk. Lucas: Exactly. And the breakeven rate at 2.24 percent supports that. The market expects inflation to average above the Fed's target over the next decade. Not dramatically above, but above. Luna: So the Fed's real wage concern is really about that breakeven rate. If they let real wages run too hot, breakevens could push higher, and then long-term rates would rise further. Lucas: That's the chain. And it's why I think the Fed is going to stay on hold for a while. They're waiting to see if the real wage gains get absorbed by productivity or if they pass through to prices. Luna: One thing I'm curious about — how does the ECB factor into this? Because Lagarde just left the door open to an early exit from negative rates, and the euro is still falling. Lucas: The euro is dropping despite higher ECB rates. That's a weird dynamic. Usually higher rates strengthen a currency. But the market is pricing in political risk from France and economic weakness in China. Luna: Right, China's CPI came in weak again, but PPI rose to a near four-year high. So they have their own inflation mix problem. Lucas: And that matters for the Fed because a weaker euro makes the dollar stronger, which suppresses U.S. import prices. That's actually disinflationary for the U.S. So the Fed might get some help from abroad. Luna: So the global picture reinforces the wait and see approach. The Fed can afford to be patient. Lucas: Exactly. And the data supports patience. Real GDP growth annualized at 2.1 percent — that's not booming, but it's solid. The economy isn't screaming for rate cuts. Luna: It isn't screaming for hikes either. So the Fed is in a sweet spot of doing nothing, and that's actually a policy choice. Lucas: It is. And Powell's communication has been carefully boring — no drama, no surprises. That's probably the best we can hope for given the complexity of the real wage picture. Luna: Alright, so the key takeaway: the Fed is watching real wages, they're stuck at 3.63 percent, and they're not moving until they see either a productivity miracle or a wage slowdown. Lucas: That's it. And if you want to bet on which happens first, I'd say wage slowdown. But that means a cooler labor market, and that's its own kind of pain. Luna: We'll be watching the next jobs report closely. For now, thanks for sticking with us. Lucas: And as always, if you want to help keep this ad-free, you know where to find us. Talk tomorrow.