Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The GDP Rebound That Has the Fed Thinking Twice
Transcript
- Lucas: Luna, did you see the GDP revision that landed this morning? Luna: I did. Annualised growth came in at 2.1 percent for the first quarter, up from just 0.5 percent in Q4. That's a massive swing in three months. Lucas: Exactly. And the market didn't really react violently, but the bond market did. The 10-year yield pushed up to 4.68 percent, its highest in weeks. So the question is: what caused the rebound, and can it last? Luna: Start with the obvious one. Consumer spending has to be in there somewhere. We saw nonfarm payrolls hit 158.98 million in June, unemployment at 4.2 percent, and initial jobless claims dropping to 187,000 last week. That's a tight labor market. Lucas: Right, and wages are still climbing. Average hourly earnings hit $37.60 in June, up from $37.51. Not huge, but positive real wage growth because inflation is cooling. Meanwhile, the World Cup gave bars and restaurants a temporary boost — the Fed's own Beige Book flagged that. Luna: So we've got consumers spending, businesses hiring, and the economy accelerating. Normally, the Fed would be worried about overheating. But they're holding the funds rate at 3.63 percent and signalling no change. Lucas: That's the interesting part. The Fed is looking at the same data we are, and they're not flinching. I think they see this growth as partly one-time — inventory restocking, a World Cup bounce, maybe some catch-up from Q4's slow patch. The core CPI came in at 336.1 in June, basically flat from May. Core PCE is still creeping up but not alarming. Luna: So the Fed is betting on inflation continuing to ease even as growth picks up. That's a Goldilocks narrative. But the bond market seems less convinced. Why? Lucas: Because there are headwinds. Look at import prices: they posted a surprise gain in June, and the cost of goods from China hit its highest level since 2008. That's a direct input into inflation, and it's tied to the new tariff policies. Luna: Speaking of tariffs, the administration just announced a delay on generic drug tariffs until 2028. That's two years away, but it creates uncertainty for pharmaceutical supply chains now. Lucas: Exactly. Companies have to decide whether to onshore production or eat the cost. That uncertainty alone can dampen investment. And then there's the broader global trade picture — Trump's new global tariff drew rebukes from trade partners over forced labor justifications. Retaliation risk is real. Luna: So you've got a growth rebound that's partly artificial — propped up by one-time factors and a tight labor market — and a bond market that's pricing in higher term premiums because of fiscal and trade risks. That 10-year yield at 4.68 is telling you something. Lucas: Right. The steepening curve — the 2-year at 3.81, the 10-year at 4.68 — that's a big spread. Usually that signals expectations of stronger growth ahead. But this time, it might be inflation or deficit concerns. The Fed is looking through the noise. Luna: So is the Fed right to hold steady? Or are they ignoring the risk that this growth reignites inflation? Lucas: I think they're right to wait. The core PCE is still only 2.1 percent, and the 10-year breakeven inflation rate is actually down to 2.26 percent. That suggests the market doesn't see inflation jumping. Plus, we're seeing consumers lean on credit cards again — episode 120 covered that — and that's not a sign of robust organic demand. Luna: So the risk is that the consumer fades in the second half. If the World Cup boost was real, it'll show up in Q2 data soon. But if it was just a blip, then the GDP rebound might look like a one-quarter wonder. Lucas: Exactly. And that's why the Fed is comfortable staying pat. They want to see if the growth trend holds. If it does, they can always hike later. But if it fades, they've done no harm. Luna: Let's talk about what could break the Goldilocks scenario. What's the biggest risk you're watching? Lucas: I'd say the combination of tariffs and rising import costs. Chinese goods are getting more expensive, and if that passes through to consumer prices, it could stall the disinflation trend. The generic drug tariffs are delayed, but the uncertainty is immediate. Plus, the jobs market is tight, but wage growth isn't accelerating — that's actually a good sign for inflation. Luna: So the Fed is basically saying: 'We have time, let's see more data.' And the bond market is saying: 'We see inflation risk in the future.' Both could be right. Lucas: Right. And keep an eye on jobless claims — they just dropped to 187,000, which is extremely low. If that starts trending up, it could signal the labor market softening. But for now, the economy is in a sweet spot — strong growth, low unemployment, and cooling inflation. The question is whether that sweet spot has an expiration date. Luna: If today's conversation helped you connect the dots on what the Fed is actually looking at, that's exactly why we do this show ad-free. Listener support through buy me a coffee dot com slash fexingo keeps it that way. Lucas: Yeah, it's a small way to keep the macro deep dives coming without any sponsors. We appreciate everyone who chips in. Luna: Absolutely. So back to the data — what's the one data release you're waiting for next? Lucas: The next CPI report, of course. If core CPI stays flat or drops, the Fed can stay patient. If it ticks up, all bets are off. And the Q2 GDP advance estimate comes out next week — that'll tell us if the World Cup boost was real or just a flash in the pan. Luna: We'll be watching. For now, the economy is throwing us a curveball that looks a lot like a fastball. Enjoy it while it lasts. Lucas: Exactly. Thanks for tuning in to Episode 136 of The Macro Memo.