Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What the Fed Makes of the May CPI Print
Transcript
- Lucas: So the May CPI print hit this morning: 4.2 percent annual headline inflation. That is the highest reading in three years. And the immediate question everyone has is — does this change the Fed's timeline? Luna: And the bond market's initial reaction was actually pretty telling. The ten-year breakeven inflation rate dipped a bit, to 2.33 percent. That's not what you'd expect if traders thought this number was a game-changer. Lucas: Right, because the market is looking under the hood. Headline CPI getting a big boost from energy — that part the Fed has always said it would 'look through.' The question is what core does. Core CPI came in at 3.8 percent annualized, up from 3.7 last month. That's still elevated, but it's not accelerating sharply. Luna: And I know a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo to keep this show ad-free and independent. That support is what lets us dig into numbers like this without having to worry about sponsors. So if you've gotten something out of these episodes, that's the place. Lucas: Yeah, honestly it makes a difference. So back to the data — the really interesting split is inside core services. Shelter costs are still running hot, but there are signs that owners' equivalent rent is starting to moderate. Meanwhile, core services excluding housing actually ticked up. That's the part the Fed watches most closely. Luna: Because that's the part tied to the labor market. Wages, demand, capacity. If that stays sticky, the Fed can't really declare victory. Lucas: Exactly. Chair Powell has said multiple times that they need to see sustained progress on core services ex-housing before they feel confident cutting. And right now, that progress is uneven. The three-month annualized rate on that metric is still above 4 percent. Luna: But the market-implied probability of a rate cut at the July FOMC meeting actually went up slightly after the release. How do you square that? Lucas: I think the market is betting that the Fed will focus on the fact that year-over-year core PCE — their preferred gauge — is running lower than CPI. The April core PCE was 2.8 percent. So the gap between CPI and PCE is widening, partly because of how they weight medical costs and used cars. The Fed uses PCE, and that number is closer to target. Luna: Still, 4.2 percent headline CPI is a big number for the public to digest. The New York Fed's household survey from last week showed financial anxiety at the highest since July 2022. People are feeling this. Lucas: And the Fed cares about that channel too — if households expect high inflation to persist, they change their behavior. That's why the breakeven rate matters. The fact that ten-year breakevens actually dipped today suggests that the bond market sees this as a temporary spike, not a new regime. Luna: But energy is a wildcard. The Iran situation has pushed oil up, and if that continues, headline inflation could stay elevated through the summer. Lucas: Which the Fed will factor in as a supply shock. They've been consistent that they don't react to one-off energy moves. But if it feeds into core through transportation costs or broader expectations, then it becomes a problem. So far, core goods inflation is actually negative year-over-year — falling prices for used cars, furniture, apparel. That's the offset. Luna: So what's your read on the Fed's next move? Are they still on hold through year-end? Lucas: I think this print keeps them on hold for now. The labor market is still tight — job openings are above 7 million, wage growth around 4 percent. They need to see more than one month of data to change course. The July meeting is still a 'live' meeting in theory, but I'd be surprised if they move. More likely, they use the press conference to emphasize patience and data dependence. Luna: And the dot plot? The last one showed two cuts priced in for 2026. Does that get revised down? Lucas: If the June CPI and PCE come in similarly elevated, yeah, I could see the median dot shifting to one cut or even zero. But Powell will resist being pinned down. He'll say the dots are individual projections, not a committee plan. Luna: One thing I noticed: the five-year breakeven actually rose a bit, even as the ten-year dipped. That suggests the market sees near-term inflation pressure but longer-term anchored expectations. Lucas: That's a healthy sign for the Fed. It means their credibility is intact. If the five-year had spiked along with headline CPI, that would be worrying. But the curve is steepening because the long end is coming down, not because the short end is blowing out. Luna: So to sum up: a hot headline CPI, but the internals are mixed enough that the Fed doesn't have to panic. The market agrees. Lucas: I think that's right. The risk is if core services ex-housing doesn't start to moderate in the next two months. That would put the Fed in a tough spot — cutting into a still-sticky core. But for now, they can hold their ground and wait. The data this morning doesn't force their hand. Luna: It also doesn't give them cover to cut. So the wait continues. Lucas: Exactly. And the next big checkpoint is the June CPI on July 11, right before the July 28 FOMC meeting. That print will matter a lot more than this one, because then you'll have two consecutive readings to assess the trend. Luna: And maybe some clarity on energy by then too. Lucas: Maybe. But as of today, the Fed's message is likely: we see the data, we're monitoring it, we're not overreacting. And honestly, that's probably the right call.