Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why the Fed’s Preferred Inflation Gauge Matters to You
Transcript
- Lucas: So Luna, the Fed’s favorite inflation gauge — the core PCE price index — came in at 3.3 percent for July. That’s not the CPI number most people hear about, but it’s the one the Fed actually targets. And it’s got a lot of people asking why their own bills feel so much higher than that number. Luna: Right, and that gap between what the data says and what we feel at the grocery store or when we pay rent — that’s what we should dig into today. Because the PCE is built differently than CPI, and that difference changes the story. Lucas: Exactly. And before we go deeper — if today’s conversation helps you make sense of the economy, the way these episodes stay ad-free is through listener support. If you find this useful, you can buy me a coffee at buy me a coffee dot com slash fexingo. It’s a small way to keep this going for people who want to understand the numbers behind the headlines. Luna: Yeah, that’s a nice way to put it. And it does make a difference — even a small contribution helps us keep doing this. Lucas: So, why does the Fed watch PCE instead of CPI? Well, one big reason is that PCE covers a broader swath of spending — it includes things like employer-paid health insurance and Medicare, which don’t show up in the CPI. And it also weights items differently, based on what consumers actually substitute when prices change. Luna: So if beef gets pricey and people switch to chicken, the PCE kind of captures that shift, while CPI might overstate the pain. That’s why PCE tends to run a bit cooler than CPI. Lucas: Right. And in July, core PCE rose three point three percent year-over-year, which is still above the Fed’s two percent target. But here’s the thing — the month-over-month change was only point one percent, which is actually the slowest pace in over a year. So the trend is cooling, but the level is still sticky. Luna: Sticky is the word. And that’s why the Fed isn’t rushing to cut rates, even though the effective fed funds rate has been sitting at three point six three percent for a while now. They want to see more sustained progress. Lucas: Exactly. And that’s where the bond market comes in. The ten-year breakeven inflation rate — which is what investors expect inflation to average over the next decade — ticked up to two point three three percent. That’s still below the current core PCE, but it shows that the market isn’t expecting a dramatic crash in prices. Luna: So expectations are kind of anchored, but not at target. And that’s a problem for the Fed, because if people expect inflation to stay around two point three, that can become a self-fulfilling prophecy. Lucas: Exactly. And that’s why the Fed chairs’ comments this week are so interesting. Chairman Warsh said he’s concerned about inflation and wants the central bank to be ‘quieter’ — meaning less forward guidance, more data-dependence. And another Fed official, Hammack, said ‘now is the time to act’ on rates. Luna: So there’s a hawkish tilt in the room, but also a desire to communicate less. That’s a delicate balance — you don’t want to spook markets, but you also don’t want to be behind the curve. Lucas: Right. And that affects you directly, because if the Fed raises rates again, borrowing costs go up — for car loans, credit cards, home equity lines. Even if you don’t have debt, it affects the yield on your savings account. So the direction of this policy matters for your wallet. Luna: And that’s why it’s worth understanding this PCE number, even if it’s not as famous as CPI. It’s the one that actually guides the Fed’s decisions. Lucas: Let’s get into the weeds a bit. The core PCE index level in July was one hundred thirty point seven, up from one hundred thirty point three four in June. That’s a monthly rise of point one percent. But services inflation — things like housing, medical care, and financial services — is still running hot, around four percent year-over-year. That’s the sticky part. Luna: And goods inflation is actually negative, right? So we’re seeing this split where stuff you buy at the store is getting cheaper, but services you need — like rent and healthcare — keep climbing. Lucas: Exactly. That’s the two-front war the Fed keeps talking about. And it’s why your grocery bill might feel lower, but your rent or your health insurance premium isn’t budging. The CPI actually showed a slight uptick in overall prices last month, but the core PCE is the one that matters for policy. Luna: So if someone’s listening and they’re thinking, ‘my rent went up five percent this year, but inflation is three percent’ — that’s not contradictory. It’s just that your personal basket is different from the average. Lucas: Right, and that’s a key takeaway. The PCE is an average, and your experience can be very different. If you’re a renter in a city where rents are still rising, your inflation is higher than the headline. If you’re a homeowner with a fixed mortgage, your housing costs might be flat, so you’re feeling less pressure. Luna: And that’s why the Fed’s job is so hard. They have to set one interest rate for a country with very different inflation experiences. Lucas: Absolutely. And that brings us to what’s next. The FOMC meets again in September, and the market is pricing in a roughly fifty-fifty chance of a rate cut or a hold. But if core PCE stays around three percent, the hawks will push for a hike. That’s the tension we’re watching. Luna: And that’s not just a Wall Street thing — it affects your next mortgage refinance, your car loan, even your credit card APR. So the stakes are real. Lucas: One more thing to keep in mind: the PCE uses a different source for healthcare costs. It includes what Medicare and Medicaid actually pay, not just what consumers pay out of pocket. That’s part of why it runs lower than CPI in health-heavy months. Luna: So it’s not just a different basket, it’s also a different set of prices for the same services. That’s a subtle but important difference. Lucas: Exactly. And that’s why the Fed prefers it — it’s a more accurate reflection of the actual cost of living across the whole population, not just urban wage earners, which is what CPI covers. Luna: So for someone who wants to track the economy themselves, the core PCE number is the one to watch. And you can find it on the Bureau of Economic Analysis website, usually a few weeks after the month ends. Lucas: Right. And that’s what we’ll keep doing — unpacking these numbers and connecting them to your daily life. Thanks for listening, and if this was useful, remember you can support the show at buy me a coffee dot com slash fexingo. We’ll be back tomorrow with another episode. Luna: Until then, keep your eyes on the data — and your wallet on your mind.