Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How the Fed's Rate Pause Is Widening the Inflation Gap
Transcript
- Lucas: So the CPI came in at 334 for May. That's up from 332.41 in April. And the Fed is sitting on a rate of 3.65 percent, which is effectively unchanged from where it was two months ago. Luna: So the pause is still on. And that creates a gap—the real rate is negative again, isn't it? Lucas: Exactly. If inflation is running at, say, 2.5 to 3 percent based on core PCE—which was 129.6 in April, up from 129.32—and your cash is earning 3.65 percent, you're barely treading water. But if you're in a regular savings account paying 0.5 percent? You're losing ground every day. Luna: And that's the part that frustrates me. The Fed is essentially paying banks 3.65 percent on reserves via IORB—interest on reserve balances—but those same banks are paying depositors almost nothing. Lucas: Right. That's the mechanism. The Fed raises the IORB rate to keep short-term rates anchored, but banks don't have to pass it through. So there's a subsidy flowing from the central bank to the banking system, and depositors are left out. Luna: And that's not even the whole story. Look at gold—down 5.5 percent in the last five days. If inflation is sticky, why would gold be dropping? Lucas: That's the puzzle. Gold is at $4,099, off its highs. The usual narrative is that gold is an inflation hedge. But what's happening now is that real yields—even if negative—have stabilized. The 10-year breakeven inflation rate is 2.34 percent. That's actually up slightly from 2.33. So the market isn't panicking about runaway inflation. Luna: Meaning the inflation scare that drove gold up has faded, but actual inflation hasn't come down as much as hoped. Lucas: Bingo. The market is pricing in that the Fed will eventually cut, but not because inflation is vanquished—because growth might slow. Gold is forward-looking. It's pricing in a lower real rate environment, but also less fear. So it's pulling back. Luna: So for the average listener, what's the practical takeaway? If your cash is in a big bank savings account earning 0.5 percent, you're losing purchasing power at, what, roughly 2 percent a year? Lucas: At least. And with CPI still at 334, the erosion is real. One concrete move is to look at high-yield savings accounts or money market funds. Some online banks are offering 4 percent or more. That at least keeps pace with inflation, or close to it. Luna: But then you're still at risk if inflation stays sticky and rates don't move. What about TIPS? Treasury Inflation-Protected Securities. Lucas: TIPS are interesting right now because the breakeven is 2.34. If you think inflation will average above that over the next ten years, TIPS are cheap. If you think the Fed will get it under control, maybe not. But for a saver who just wants to preserve purchasing power, a short-duration TIPS ETF can be a solid hedge. Luna: So the message is: don't assume the Fed's pause means inflation is solved. The gap between policy and prices is still there. You have to act. Lucas: Exactly. And that's the theme of this whole show: protecting your purchasing power. The Fed is waiting. You shouldn't be. Luna: And honestly, if today's conversation helped you think about where your cash is sitting, maybe it was worth a coffee to you. If so, you can find us at buy me a coffee dot com slash fexingo. No pressure—just if it added value. Lucas: We keep the show ad-free, and listener support is what makes that possible. So thanks for considering it. Now, let's dig into one more number: the Fed's IORB rate is 3.65, but the effective fed funds rate is 3.62. That tiny spread tells you something about how much excess liquidity is still in the system. Luna: Because banks are parking money at the Fed rather than lending it out. Lucas: Right. The IORB is a floor. Banks earn 3.65 by leaving reserves at the Fed. So why would they lend to consumers or businesses at a rate that's barely above that? It's a disincentive to lend. That's part of why credit is tight even though the Fed hasn't hiked in months. Luna: So the pause isn't neutral. It's actively distorting the lending market. Lucas: It is. And that's the deeper point. The inflation gap isn't just about CPI minus the Fed Funds rate. It's about the transmission mechanism breaking down. The Fed's tools are blunter than they used to be. Luna: One last thing—the small-cap index, the Russell 2000, is down 2.3 percent in five days. That's more than the S&P 500. Smaller companies are more sensitive to tight credit conditions. Lucas: Good catch. The Russell at 2,835 is telling you that the pain is concentrated where it hurts most. Large caps have pricing power, global diversification, and access to capital markets. Small companies rely on bank loans. When banks would rather earn 3.65 on reserves than lend at 6 percent to a small business, that's a headwind. Luna: So the inflation gap is also a credit gap. And that's why the Fed's next move matters so much—not just for inflation, but for the real economy. Lucas: Absolutely. And we'll keep tracking it. For now, check those savings rates. Don't let your cash rot at 0.5 percent. Luna: And if you want to support the show, you know where to find us. Thanks for listening.