Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What Falling Core PCE Tells Us About the Fed Rate Path
Transcript
- Lucas: So yesterday's CPI print came in at 3.5 percent annualized, a bit softer than the street was expecting. Energy prices eased, that helped. But the market's reaction was interesting—bonds rallied, but only for about an hour before giving back most of the move. Luna: Right, because the Fed doesn't target CPI. They target PCE. And core PCE is still running above their comfort zone. Lucas: Exactly. The June CPI data—headline at 332.6, down from 333.98 in May—looks good on its face. But when you dig into the components, a lot of the disinflation came from volatile categories like gasoline and used cars. The core services ex-housing, which is the Fed's big focus, barely budged. Luna: And the latest PCE print we have is for May, which showed core PCE at 130.1, up from 129.67 in April. So that's actually accelerating month over month. Lucas: That's the divergence that's driving the conversation right now. CPI says inflation is cooling. PCE says it's still sticky. And the Fed has been very clear: PCE is their preferred gauge. So when you look at the May core PCE number—up 0.4 percent month over month on an annualized basis—that's not the kind of data that lets Powell declare victory. Luna: It's also worth noting that the 10-year breakeven inflation rate just dipped to 2.25 percent. That's down from 2.26 the day before, but it's still above the Fed's 2 percent target by a quarter point. The bond market is basically saying: inflation isn't going away entirely, but it's not spiraling either. Lucas: And that's actually a pretty reasonable middle ground. The breakeven rate is the market's estimate of average inflation over the next decade. At 2.25, it suggests the Fed's framework is broadly credible, but that the last mile back to 2 percent is going to be slow. The real question is whether the Fed can afford to cut rates in that environment. Luna: Which brings us to the yield curve. The 2-year note is at 3.70 percent, the 10-year at 4.59. That's a pretty steep positive slope. The curve has been normalizing for a while now, but we're still not at the kind of inverted structure that historically precedes a recession. Lucas: Right. And the fed funds rate is at 3.63 percent, effectively unchanged since June. So the short end of the curve is basically pinned to the Fed's policy rate, while the long end is reflecting term premium and inflation expectations. That steepness tells you the market thinks the Fed will cut—but not imminently. Luna: Let's talk about what 'imminently' means. The next FOMC meeting is in September. CME FedWatch is pricing in about a 40 percent chance of a quarter-point cut. That's not a slam dunk. Lucas: No, it's not. And the data we have between now and then will decide it. We've got two more CPI prints, two more PCE prints, and the July employment report. If core PCE continues to tick up—even modestly—the hawks on the committee will have enough cover to hold steady. But if we see a repeat of yesterday's soft CPI, the odds could shift quickly. Luna: There's also the global context. China just reported its slowest quarterly growth since 2022, and India's inflation accelerated to 4.38 percent. Those are headwinds for global demand, which could put downward pressure on commodity prices and help the Fed's inflation fight. But it also complicates the growth picture for U.S. exports. Lucas: Yeah, the China number is a big deal. Their investment slump is dragging on the whole region. If Chinese demand weakens further, it could push down oil prices and imported goods prices, which would show up in both CPI and PCE. That's a tailwind for the Fed, but it's not something they can bank on. Luna: So where does that leave us? The Fed is data-dependent, but they're also forward-looking. They don't want to cut too early and reignite inflation, but they also don't want to keep rates too high and cause unnecessary damage to the labor market. Lucas: Right. And that balancing act is why the bond market has been so volatile. Every data point gets overanalyzed. But I think the key takeaway from this week is that the inflation narrative is shifting from 'how high will it go' to 'how sticky is the last mile.' And the answer to that question will determine the path of rates for the rest of the year. Luna: One thing I want to pull on: the divergence between CPI and PCE isn't just academic. It has real implications for anyone with variable-rate debt or a mortgage. If the Fed cuts based on soft CPI data, but then PCE stays hot, they might have to reverse course. That whiplash is dangerous. Lucas: Absolutely. And that's why we spend so much time on this show digging into the nuances. We want you to understand the framework, not just the headline. And honestly, the fact that we can have these conversations without any commercial interruption is something I'm grateful for. Luna: Yeah, it's a luxury. And it's only possible because a small group of listeners chip in over at buy me a coffee dot com slash fexingo. That's literally what keeps the lights on here. Lucas: No ads, no sponsors, no corporate overlords. Just people who find value in these daily episodes and want to keep them coming. If you've been listening for a while and it's made you a sharper investor or a more informed citizen, that's the community we're building. Luna: Exactly. And we're not going to guilt anyone. But if the show is part of your routine and you have the means, it's a small way to keep it sustainable. Back to the data—one more thing I want to highlight: the 5-year note yield is at 4.32, which is actually higher than the 2-year at 3.70. That's a pretty clear signal that the market expects the Fed to cut short-term rates but is still worried about medium-term inflation. Lucas: That's a great point. The 2s5s spread is positive and widening. Historically, that's been a decent predictor of a steepening curve, which usually happens when the market anticipates a cutting cycle. But the level of the 5-year matters too. At 4.32, it's still well above the fed funds rate, which means the market is pricing in term premium—uncertainty about the path. Luna: So to wrap up: we've got a Fed that's in wait and see mode, a bond market that's pricing in cuts but not immediately, and inflation that's stubborn in the Fed's preferred measure. The next big checkpoint is the July PCE report in late August, which will be the last major data point before the September meeting. Lucas: That's right. And we'll be here breaking it down as it comes. For now, the takeaway is: don't get too excited about one soft CPI print. The Fed is watching PCE, and PCE is still telling a cautious story. Thanks for being here. Luna: See you next time.