Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why Falling Breakeven Rates Give the Fed Cover Despite Sticky PCE
Transcript
- Lucas: Luna, did you catch the ten-year breakeven rate this morning? It dropped to two point two one percent. That's the lowest since March. Luna: I did. And at the same time, core PCE just ticked up to its highest level since February. Seems like two completely different stories. Lucas: Exactly. And that divergence is actually the key to understanding where the Fed's head is at right now. The breakeven rate — that's the difference between the nominal ten-year yield and the ten-year TIPS yield — is the market's best guess for average inflation over the next decade. When it falls, it tells you bond traders think the Fed is winning. Luna: But actual PCE is still running above two and a half percent. So how can the market be so confident? Aren't they looking at the same data? Lucas: Right, and that's the puzzle. The market seems to be looking through the most recent PCE prints. They're seeing the CPI numbers decline, the core CPI actually dipped a bit in June. And they're factoring in that tariffs and one-time price shocks will fade. The breakeven suggests they expect inflation to drift back to two percent over time. Luna: So the Fed can afford to be patient because the bond market is doing the tightening for them, in a sense? Lucas: That's one way to put it. When long-term inflation expectations remain anchored, the Fed doesn't have to raise rates to prove their credibility. They can wait and see. But there's a risk: if actual inflation stays sticky, that market confidence could evaporate quickly. And then you'd see the breakeven spike, which would force the Fed to act. Luna: And speaking of other central banks acting — did you see Singapore's surprise tightening yesterday? They're worried about oil prices reigniting inflation. That seems like the opposite of what the Fed is doing. Lucas: It is a useful contrast. Singapore is a small, open economy that's extremely sensitive to imported inflation, especially oil. They can't afford to wait. The Fed, on the other hand, has the luxury of a large domestic economy and more insulated core inflation measures. Still, if oil keeps rising, it could eventually show up in core PCE. Luna: True. And speaking of things that help us keep bringing you this kind of analysis — if today's conversation made something click for you, we'd appreciate if you considered supporting the show. It's what keeps us ad-free. The link is buy me a coffee dot com slash fexingo. No pressure, just if it was worth your time. Lucas: Yeah, we really appreciate that. And we mean it — the smallest gesture goes a long way. So, back to the breakeven — what does this mean for the September FOMC meeting? Lucas: Right now, the fed funds futures are pricing in zero chance of a hike. The breakeven is cooperating. But if we see another uptick in core PCE when the July data comes out, and oil stays elevated, those odds could shift. The Fed's dot plot from June already showed a higher neutral rate — around three point six percent. They're already in restrictive territory. Luna: So the real debate is less about whether to hike and more about how long to stay at this level. The breakeven gives them cover to hold through year-end. Lucas: Exactly. And let's not forget the import price data from last week. Goods from China hit their highest level since 2008. That's a direct result of the new tariff regime. But the breakeven barely budged, because the market sees tariffs as a one-time price level shift, not a sustained inflation driver. The Fed says the same thing in their minutes. Luna: But what if the market is wrong? What if tariffs end up being more persistent, or if oil spills into core services? Lucas: That's the million-dollar question. If the breakeven starts to climb again, the Fed will have to reassess. For now, the bond market is voting that inflation is headed down. The Fed is happy to let them have that opinion. Luna: So we're in a waiting game, watching the data and the market signals. The breakeven is one to keep an eye on. Lucas: Absolutely. Next time the breakeven moves a few basis points, you'll know why it matters.