Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Bond Markets See Low Inflation Despite Import Price Surge
Transcript
- Lucas: Import prices from China just hit their highest level since 2008. That sounds like a classic inflationary red flag. But here's the weird part — the bond market's 10-year breakeven inflation rate actually dipped to 2.20 percent this week. So traders are basically saying, 'We see the import surge, and we're not worried.' Luna: That's a pretty big disconnect. If I'm a consumer looking at rising prices on store shelves, I'd expect inflation expectations to go up. Why are bond traders so calm? Lucas: Because they're forward-looking — they're not reacting to the current CPI print, they're betting on the trend. And the trend is that tariffs and import price spikes tend to be one-time adjustments, not self-reinforcing cycles. Remember when steel tariffs hit in 2018? Prices jumped for a quarter or two, then stabilized. Bond traders expect something similar here. Luna: But the Fed has been hyper-focused on services inflation and the PCE gauge, which is still rising. Core PCE went from 129.67 to 130.1 last month. Doesn't that contradict the bond market's calm? Lucas: It does on the surface. PCE includes a lot of sticky services — rent, health care, insurance — that don't respond quickly to import prices. So you've got goods inflation maybe cooling or even negative, while services inflation stays elevated. The bond market looks through that noise and focuses on where inflation will settle once all the one-off shocks pass through. And right now, the 10-year breakeven at 2.20 percent suggests they see inflation averaging right around the Fed's 2 percent target over the next decade. Luna: So is the bond market basically saying the Fed won't need to cut rates anytime soon, because inflation is under control? Lucas: Not exactly. The Fed's current rate is 3.63 percent, which is well above that 2.20 percent breakeven. That means real interest rates — nominal minus expected inflation — are positive by about 1.4 percentage points. That's restrictive. If breakeven stays low and the economy slows, the Fed has room to cut without stoking inflation. The market is actually pricing in a couple of quarter-point cuts later this year. Luna: Right — lower breakeven gives the Fed more flexibility. But if import prices keep rising, could that eventually feed into core PCE and force the Fed to pause? Lucas: Possible, but historically the pass-through from import prices to core services is weak. The bigger risk is if the labor market tightens again and wages pick up. But today's data doesn't show that. CPI is down, breakeven is down, and the Fed's effective rate is on hold. The signal from the bond market is pretty clear: they think the inflation scare is over. Luna: That's a reassuring message for anyone worried about runaway prices. But I'm also hearing from listeners who say their grocery bills aren't coming down. How do you square that with falling CPI? Lucas: You're right to push on that — CPI is an average. Some categories like eggs and used cars are down, but services like rent and insurance are still up. The bond market's breakeven looks at the average trajectory, not the pain in specific pockets. So if you're still feeling inflation, it's because your personal consumption basket is heavy on services. That's a real thing. But the broader macro picture is that the worst of the inflation wave is behind us. Luna: And that's exactly why understanding breakeven inflation matters. It cuts through the noise and tells you what the smart money expects. You know, we get into these weeds because listeners tell us they want to make sense of the conflicting signals. And honestly, we couldn't keep doing this ad-free without the folks who support the show. Lucas: Yeah, it's been a great conversation. If you find these breakdowns useful, you can help keep the podcast independent and advertisement-free by supporting us at buy me a coffee dot com slash fexingo. No pressure — just a way to say thanks if the show adds value. Luna: Absolutely. And now back to the bond market — Lucas, you mentioned the Fed might cut. What would it take for them to actually move? Lucas: The Fed is data dependent. If the next few CPI prints show continued declines, and if the labor market softens — maybe unemployment ticks above 4 percent — then they'll have cover to cut. The bond market's falling breakeven is a green light, but the Fed wants to see it in the hard data first. They're watching core PCE especially, because that's their preferred gauge. Luna: But core PCE is still rising. So if the Fed waits for PCE to fall, we might be waiting a while. Lucas: That's the tension. PCE is sticky because it's weighted toward services. The bond market's breakeven is more forward-looking. So either the bond market is right and PCE will eventually follow, or PCE stays elevated and the bond market has to adjust. My bet is on the bond market — they've been surprisingly accurate over the past couple of years. Luna: Fair. So for a listener trying to plan their finances, what's the takeaway? Lucas: If you believe the bond market, you should expect inflation to average around 2.2 percent over the next decade. That means mortgage rates might ease a bit as the Fed cuts, but don't expect a return to the ultra-low rates of the 2010s. And if you have cash in savings, lock in a longer-term CD or bond now while yields are still decent, because they could come down. Luna: Solid, actionable advice. And hopefully this import price surge will fade as the bond market predicts, so we can all get some relief at the checkout. Lucas: Exactly. We'll keep watching the data. Until next time.