Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Stuck at 364 While Inflation Creeps Higher
Transcript
- Lucas: So the Fed has held the policy rate at 3.64 percent since January. The effective fed funds rate hasn't budged. But the April CPI report showed prices are still climbing — headline CPI hit 332.4, up from 330.3 in March. That's a 0.6 percent monthly increase. Luna: And core CPI, excluding food and energy, went from 334.2 to 335.4. That's about 0.3 percent month-over-month. Not the kind of number that screams 'we've got inflation licked.' Lucas: Right. Which is the puzzle we want to drill into today. The economy is sending mixed signals — consumer sentiment hit a record low last week, small caps are rallying, but the bond market is pricing in a 10-year breakeven of 2.40 percent, up from 2.39 the day before. Luna: That breakeven is essentially the market's expectation for average inflation over the next decade. Two point four isn't alarming, but it's above the Fed's 2 percent target, and it's creeping up. Lucas: Look, I'll say it — if this show helps you make sense of what the Fed is actually doing, and today's episode made something click, there's a simple way to keep it ad-free and independent. It's buy me a coffee dot com slash fexingo. Luna: Yeah, it's the smallest ask possible. If today was worth a coffee to you, that's the link. And honestly, it matters. Lucas: So back to the data. The two-year Treasury yield is at 3.59 percent, almost exactly at the fed funds rate. That's the front end of the curve telling you the market doesn't expect the Fed to cut anytime soon. Luna: And the 10-year is at 4.56, down a bit over the past week. So the inversion is still there, but it's not deepening the way it was in late 2023. Lucas: Exactly. The yield curve inversion we talked about in episode 7 is still with us — the 10-year minus 2-year spread is negative — but it's shallower. The market is wrestling with two narratives: one where the economy slows enough to force cuts, and one where inflation stays sticky and the Fed stays put. Luna: Which narrative does the consumer sentiment data support? That May reading was the lowest on record, driven largely by inflation fears tied to the geopolitical situation. Lucas: That's the demand-side worry. If consumers pull back, that eventually cools inflation. But it's not happening yet. The April CPI print suggests demand is still strong enough to push prices up. Luna: So the Fed is in this holding pattern. Kevin Warsh gave a speech two weeks ago — he said the Fed needs to see 'consistent progress' on inflation before moving. Consistent progress, not just one good month. Lucas: And that's the key phrase. The core CPI has been bouncing around between 0.2 and 0.4 percent month-over-month for the past six months. That's not consistent progress toward 2 percent annualized. Luna: One number I keep coming back to is the interest on reserve balances — it's at 3.65 percent, basically the same as the fed funds rate. That's the Fed's main tool for steering the rate, and it hasn't moved since January. Lucas: Right. The IORB rate is the ceiling for the fed funds rate, and it's been flat. So the Fed is telegraphing: we're comfortable here for now. The question is whether the bond market forces their hand. Luna: The bond vigilantes — they showed up in February when the 10-year briefly touched 5 percent. But since then, yields have come down a bit. Are they satisfied, or just waiting? Lucas: I think they're waiting. The 10-year breakeven moving up from 2.39 to 2.40 is small, but it's a signal. The market is starting to doubt the Fed's commitment to its 2 percent target. Luna: And if that doubt grows, you could see yields spike again. That would tighten financial conditions without the Fed moving a muscle. Lucas: Which is actually what the Fed wants — tighter conditions to slow the economy. But it's a dangerous game. If yields spike because of a loss of confidence, not because of strong growth, that's a different problem. Luna: So the data this week — we've got the PCE price index for March at 130.3, up from 129.5. Core PCE is 129.3, up from 128.9. That's the Fed's preferred inflation measure, and it's heading the wrong way. Lucas: And the April PCE comes out next week. If that shows another uptick, the pressure on the Fed intensifies. But Warsh has been clear: they're not going to react to one data point. Luna: Which brings us back to the core question: how long can the Fed hold at 3.64 percent while inflation is running above 3 percent on a trailing basis? Lucas: Real rates are positive — the fed funds rate minus core PCE is about 2.5 percent. So policy is restrictive. But maybe not restrictive enough. The Atlanta Fed's GDPNow for Q2 is still showing growth above 2 percent. Luna: So the economy isn't crying out for cuts. And inflation isn't low enough to justify them. The Fed's hands are tied. Lucas: Unless something breaks. And that's what keeps me up at night — not a crash, but a slow erosion of credibility. If the market starts to believe the Fed will accept 2.5 percent inflation, then breakevens drift higher, then yields rise, then the Fed has to hike into a slowing economy. Luna: That's the 1970s playbook. Not a full repeat, but echoes. Lucas: Echoes are enough. Warsh is aware of that history — he wrote about it in his academic papers. But knowing the history and navigating the present are two different things. Luna: So what should listeners watch for in the next few weeks? Besides the April PCE. Lucas: Watch the five-year breakeven. It's at 2.26 right now, a bit lower than the 10-year. If that starts creeping up, it means the market expects inflation to stick around medium-term. Also watch the Fed's rhetoric — if any FOMC member starts talking about a hike, that's a sea change. Luna: Haven't heard that yet. The last few speakers have all been firmly in the 'wait and see' camp. Lucas: And that's the story for now. The Fed is stuck at 3.64, inflation is stuck above target, and the bond market is watching. We'll see who blinks first.