Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Inflation Gap Between What You Pay and What CPI Shows
Transcript
- Lucas: So the core PCE reading for May came in at 3.4 percent on Thursday. That's the highest since October 2023. And I keep hearing people say, 'Well, that's still above the Fed's target, but it's coming down.' And I think, is it, though? Because if you look at what people are actually paying for things like rent and insurance, it doesn't feel like inflation is cooling at all. Luna: Right. And that gap between what the official numbers say and what our wallets feel — that's the real story. My own rent just went up 8 percent year-over-year on my lease renewal in Austin. But the CPI's owners' equivalent rent component — that's up only about 4.5 percent over the same period. Lucas: Owners' equivalent rent, or OER, is the single biggest chunk of the CPI. It accounts for roughly a quarter of the whole index. And here's the thing — it doesn't measure what renters actually pay. It asks homeowners, 'If you rented your home, how much do you think you'd get?' And then it uses that imputed rent as a proxy for what all housing costs. Luna: So it's basically asking people to guess what their house would rent for. That seems like a recipe for a lagging, smoothed-out number that misses real spikes. Lucas: Exactly. And the BLS does that because they want to capture the cost of shelter consistently over time, regardless of whether you own or rent. But the consequence is that OER tends to be slow to rise and slow to fall. In a market where rents are surging due to low vacancy, OER can understate the true burden for renters for months, sometimes years. Luna: And that's exactly what's happening now. The CPI headline for May was 334.0, up from 332.41 in April. That's about 2.4 percent annualized. But core PCE — which the Fed watches — hit 3.4 percent. So which number is right? Lucas: Both are right, in their own way, for their own purpose. CPI measures a fixed basket of goods out of pocket. PCE adjusts for substitution — if beef gets expensive, PCE assumes you switch to chicken. And PCE includes things like employer-paid health insurance, which CPI doesn't. But neither captures the rent spike that you and millions of other renters are experiencing right now. Luna: So what's the practical impact? If the Fed is watching PCE and it's at 3.4 percent, they're unlikely to cut rates soon. But if the 'real' inflation for a typical renter is closer to 5 or 6 percent, then the Fed's policy is even tighter than it looks. Lucas: That's the key insight. The effective federal funds rate is 3.63 percent — that's down a bit from last month. But if real inflation for renters is higher than the official number, the real interest rate — nominal rate minus inflation — is lower than it appears. That means monetary policy isn't as restrictive as the Fed thinks. Luna: And that could explain why housing hasn't cooled despite higher rates. People are still willing to pay these rents because they have to live somewhere, and the supply just isn't there. Lucas: Exactly. And the 10-year breakeven inflation rate — that's the market's expectation of average inflation over the next decade — is at 2.22 percent, up slightly from 2.20. So bond markets are signaling that inflation will stay above the Fed's 2 percent target. That's not a vote of confidence in rapid disinflation. Luna: Speaking of confidence — or lack thereof — I want to go back to the methodology. The BLS also uses something called 'rent of primary residence' for actual renters. That's separate from OER. And even that component, which should be more accurate, has been criticized for sampling issues. Lucas: Yeah, the rent of primary residence index is based on a survey of rental units, but it only samples units that are currently occupied. So if a landlord renovates a unit and doubles the rent for a new tenant, that increase doesn't show up until the next survey cycle — and only if the new tenant is surveyed. It's inherently lagged. Luna: So the data we're getting is basically rearview mirror. By the time the CPI shows a rent spike, it's already happened. And by the time it starts to fall, the real market may have already bottomed. Lucas: Precisely. And that's why you see a disconnect between the official inflation narrative and what people are experiencing. The Fed's favorite gauge, core PCE, hit 3.4 percent in May. That's high. But if you're a renter in a hot market, your personal inflation rate might be 5 or 6 percent. And that gap erodes trust in the data. Luna: So what's the solution? Should the BLS change how they measure housing costs? Lucas: There's been debate about that for years. Some economists argue that the CPI should use a 'rental equivalence' approach for homeowners but supplement it with a separate, more timely renter index. Others say the problem isn't the methodology but the sample size. The BLS surveys about 6,000 rental units per month. In a country with 44 million renter households, that's a tiny slice. Luna: And that's before you get to the fact that the CPI doesn't capture quality adjustments well. If your landlord replaces the carpets and raises the rent, the BLS tries to account for that, but it's imperfect. Lucas: Right. And on the PCE side, the Bureau of Economic Analysis uses a different source — they rely on business surveys and other administrative data. That can be more accurate for some categories, but it also has its own lags. The core PCE for May came out on June 25, so there's about a one-month lag. For rent, the lag can be longer. Luna: You know, this reminds me of something. I was reading that the Fed's own staff economists have been looking at alternative measures like the 'trimmed mean PCE' from the Dallas Fed. That strips out the most extreme price changes. And even that measure has been sticky. Lucas: Yeah, the trimmed mean PCE for May was around 3.2 percent. So even when you cut out the outliers, inflation is still running hot. The problem is concentrated in services — especially housing, but also insurance and medical care. Luna: And goods inflation has actually been negative for a while. So the Fed is really fighting a services inflation battle. And services are much harder to bring down because they're tied to wages and rents. Lucas: Exactly. And that brings us back to the rent gap. If official measures understate rent increases, the Fed might think they have more room to cut rates than they actually do. That could be dangerous. Luna: And just to tie it all together — for the listener who's feeling squeezed, the takeaway is that the official inflation numbers, while useful, don't fully capture your personal experience. The CPI says 2.4 percent, PCE says 3.4, but your rent might be up 8. That doesn't mean the data is wrong — it means you need to look at the components, not just the headline. Lucas: Right. And if you're making financial decisions — like asking for a raise or negotiating a lease renewal — you should probably use a higher inflation assumption than the CPI. Maybe 4 or 5 percent, depending on where you live. Luna: That's good advice. And speaking of making decisions, I want to circle back to something you said earlier about the Fed's reaction function. If the Fed is looking at PCE at 3.4 percent, they're probably on hold for a while. But if they were looking at a more accurate rent measure, they might be even more cautious. Lucas: That's the irony. The data that the Fed relies on might be underestimating the persistence of inflation, which means they could keep rates higher for longer than necessary — or, alternatively, cut too soon if they think inflation is falling faster than it really is. Either way, the housing measurement issue creates a blind spot. Luna: So what should the Fed do? Should they adjust their target to focus on a different measure? Lucas: I don't think they'll change the target. But they could pay more attention to alternative data — like real-time rent indices from Zillow or Apartment List. Some Fed officials have mentioned looking at those privately. But officially, they're still anchored to PCE. And that's a problem if PCE is missing the story. Luna: You know, this is exactly the kind of conversation that makes me think — if you found this valuable, it might be worth supporting the show. We keep it ad-free, and listener support is what makes that possible. If today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: Yeah, it really helps us keep doing deep dives like this without any sponsor interruptions. So if you're able, we appreciate it. Luna: Alright, back to the inflation gap. One more thing I want to touch on: the bond market. The 10-year breakeven at 2.22 percent suggests investors expect inflation to average above target for the next decade. That's not a disaster, but it's not the 2 percent the Fed wants. Lucas: Right. And if you look at the actual yield on the 10-year Treasury — it's been hovering around 4.2 percent. That means the real yield is about 2 percent. That's actually fairly high historically, which suggests the bond market is pricing in a prolonged period of restrictive policy. Luna: So the market doesn't believe the Fed will cut aggressively anytime soon, and that aligns with the inflation data we've been discussing. Lucas: Exactly. And for the average person, that means mortgage rates aren't coming down in a hurry, car loan rates will stay elevated, and credit card debt will keep costing more. The inflation we feel in housing is directly feeding into the cost of borrowing. Luna: So to recap: official inflation measures understate rent increases, the Fed is stuck watching a flawed gauge, and the bond market is betting on stickier inflation. That's the real picture as of mid-2026. Lucas: And the takeaway: don't take the CPI headline at face value. Look under the hood. Your personal inflation rate is probably higher, and you should plan accordingly. Luna: Good advice. And on that note, I think we've covered the rent gap pretty well. Thanks for listening, everyone. Lucas: Yeah, thanks. We'll be back next week with another angle on what's really driving the numbers.