Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Stuck Between Falling Inflation and Manufacturing Angst
Transcript
- Lucas: So here's the puzzle of the week: inflation is at its lowest in years, core PCE is running at 3.3 percent, CPI actually ticked down, and yet manufacturers are telling us their input costs are rising at a pace they describe as 'worse than pandemic era.' Luna: That does sound contradictory. If inflation is cooling, why are factories so spooked? Lucas: Right, and it's a real tension. The headline numbers look great — June CPI fell to 332.6 from 333.98, core PCE is basically flat — but that's backward-looking. The manufacturing survey from this week is forward-looking, and it's flashing serious warning signs about input prices and supply chain costs. Luna: So the Fed is stuck between a backward-looking cooling and a forward-looking heating? Lucas: Exactly. And that's why you saw the ten-year Treasury yield climb to 4.69 percent this week. Bond traders are reading the same tea leaves — they see the disinflation in the rearview, but they're pricing in higher inflation risk ahead. Luna: And the Fed? They've been on hold for months now, with Warsh at the helm. Lucas: Yeah, and they're clearly divided. The last few FOMC minutes showed a real split between those who want to cut to support a slowing economy and those who worry about the inflation psychology that manufacturing survey is picking up on. Luna: But the economy is slowing — GDP came in at just 1.5 percent annualized for Q2. That's a big drop from 2.1 percent. Lucas: It is a slowdown, but it's not a collapse. And look at the labor market — unemployment actually fell to 4.2 percent, and job openings ticked up to 7.59 million in May. That's not a red alert for a recession. Luna: So the Fed has room to wait, but manufacturers are screaming. What's driving their cost pressures? Lucas: A lot of it is tariffs. The administration's tariffs on generic drugs and other goods are filtering through supply chains. Even though core inflation is cooling, the cost of imported inputs is rising, and manufacturers are feeling it immediately. Luna: But if tariffs are pushing input costs up, wouldn't we see that in CPI eventually? Lucas: Probably, but with a lag. And that's the problem — by the time it shows up in the official data, the Fed might be behind the curve. That's what the bond market is worried about. Luna: So the yield curve steepening — the ten-year at 4.69 and the two-year at 3.70 — that's the market saying 'we don't trust the inflation narrative'. Lucas: Exactly. The spread is nearly a hundred basis points, which is historically a sign of growth expectations picking up, but here it's more about inflation risk. And that puts Warsh in a tough spot. Luna: Because if he cuts rates to boost growth, he risks fueling the very inflation manufacturers are worried about. Lucas: Right. And if he holds, he risks choking off a slowing economy. It's a classic policy bind. The data is genuinely mixed — core PCE is up slightly, but headline PCE is down. Jobless claims rose to 197,000 last week, but they're still historically low. Luna: So what does 'data-dependent' actually mean for Warsh right now? Lucas: Honestly, it means they're going to wait for more clarity. The next CPI print and the July jobs report will be crucial. But the manufacturing survey suggests the window for a 'soft landing' is narrowing. Luna: And speaking of windows, this feels like a good moment to mention something that keeps this show going without ads. If walking through the economy with us has made something click for you, a small coffee at buy me a coffee dot com slash fexingo goes a long way. Lucas: Yeah, honestly, it's what keeps us independent and ad-free. No pressure, but if today's episode gave you a useful lens, that's the link. Luna: And we won't belabor it. Back to the macro — what would a divided Fed actually mean for investors? Lucas: It means more volatility in rate expectations. When the Fed is split, every data point gets over-interpreted. Look at the last week — the S&P gained 2.3 percent, but the Dow barely moved. That's the market trying to figure out which faction wins. Luna: And the NASDAQ jumped 4.2 percent. That's a big divergence. Lucas: Because tech is more sensitive to rate cuts — if the doves win, growth stocks benefit. But if the hawks hold, the higher for longer narrative hits their valuations. The Russell 2000 only gained 0.6 percent, so small caps are not buying the rally. Luna: So the market is pricing in different scenarios, but the Fed is just... waiting. Lucas: Waiting, and watching. And the manufacturing survey is one of those things that could tip them. If input costs keep rising, that's going to show up in core goods inflation eventually, and the hawks will say 'we told you so.' Luna: But if the economy slows further, the doves will push for a cut. It's a stalemate. Lucas: Pretty much. And that's why the next few months are so interesting. We have the September FOMC, and by then we'll have two more CPI prints and a couple of jobs reports. The data will force a decision, one way or the other. Luna: And if they cut, but inflation ticks back up, that's the nightmare scenario. Lucas: Right, they'd lose credibility. That's probably why Warsh is leaning hawkish — better to overshoot on caution than risk a 1970s-style do-over. Luna: So the listener's takeaway: the Fed is stuck between a rock and a hard place, and the data isn't giving them an easy out. Lucas: Exactly. And the bond market is already voting with its wallet — long-term yields are going up because they expect inflation to be higher than the Fed's targets. That's not a vote of confidence in the 'transitory' narrative. Luna: So what should we watch for in the next few weeks? Anything specific? Lucas: Two things: the July CPI report, and any commentary from Warsh himself. If he starts using words like 'vigilant' or 'resolute,' that's a signal they're leaning hawkish. If he talks about 'supporting the labor market,' that's a dove signal. Luna: And the China factor — their factory activity unexpectedly contracted in July. That's a deflationary force globally, but it also could hit US exports. Lucas: Good point. Weak demand in China could actually help US inflation by lowering import prices, but it also drags on global growth. So it's another mixed signal for the Fed. Luna: It feels like every data point has a silver lining and a cloud right now. Lucas: That's the reality of a late-cycle economy. Nothing is clear-cut. But that's also what makes it interesting for us macro nerds. Luna: And for investors trying to position. What's your gut — do they cut in September? Lucas: I think it's closer to a coin flip, but if I had to bet, they hold. The manufacturing survey is fresh, and the hawks will use it to justify patience. But the market is pricing in a cut by December, so there's a gap between expectations and reality. Luna: So we might see some disappointment in the markets if they don't move. Lucas: Maybe, but the market has been wrong before. Either way, the next few months are going to be a masterclass in central bank communication. Luna: And we'll be here to break it down. Thanks for listening, everyone.