Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Core PCE Hits 3.4 Percent What the Fed Sees Now
Transcript
- Lucas: So the core PCE price index came in at 3.4 percent for May, the highest print since October 2023. That is the Fed's preferred inflation gauge, and it is moving in the wrong direction. Luna: We've been talking about sticky inflation for months now, but 3.4 percent feels like a psychological threshold. Didn't the Fed itself project core PCE ending this year around 2.8 percent? Lucas: They did. The March Summary of Economic Projections had core PCE at 2.8 percent for the fourth quarter of 2026. We're already overshooting that with six months to go. And the month-over-month increase was 0.3 percent, annualized that's still running above 3.5 percent. Luna: So what's driving it? Is it services, goods, both? Lucas: Services ex-housing is the big one. That category is running close to 4 percent annualized. Shelter costs are still elevated, though they've moderated from the peaks. And then you have goods prices actually ticking up again — core goods inflation turned slightly positive last month after months of deflation. Luna: That's notable because goods deflation was the main thing keeping headline numbers in check last year. If that reverses, the Fed has an even harder problem. Lucas: Exactly. And the labor market isn't helping. Job openings jumped to 7.6 million in April, up from 6.9 million. That's a big one-month swing. Average hourly earnings are up 4.1 percent year-over-year. Wage growth at that level is not consistent with 2 percent inflation. Luna: But the breakeven rate on the 10-year TIPS is only 2.20 percent. That suggests bond traders expect inflation to average around 2.2 percent over the next decade. So who's right — the bond market or the hard data? Lucas: That's the million-dollar question. The breakeven has actually been trending down — it was 2.21 percent yesterday, 2.26 percent a few weeks ago. The bond market is pricing in a slowdown. But core PCE at 3.4 percent says the economy is still running hot. One of these signals is going to break. Luna: The Fed is stuck. They've held the funds rate at 3.63 percent since May. If they cut now, they risk inflation reaccelerating. If they hold, they risk crushing the labor market if the slowdown actually materializes. Lucas: Right. And the real GDP growth number for the first quarter was just revised to 2.1 percent annualized. That's not strong, but it's not recession territory either. It's this awkward middle ground where the Fed has no clear mandate to move. Luna: So what's the most likely path? More of the same? Lucas: I think so. The Fed's language is going to stay hawkish. Chair Powell — or whoever is leading now after the recent succession — will emphasize patience. They need to see a sustained run of lower monthly core PCE readings. One or two months of 0.2 percent or below. We haven't seen that yet. Luna: There's also the geopolitical overlay. The Strait of Hormuz situation is still fragile, and oil prices could spike again. That would feed into headline inflation and potentially core if it gets passed through. Lucas: Yeah, that's a wildcard. The deal with Iran last week helped calm things temporarily, but the UN just paused its ship evacuation plan after a vessel was attacked. Confidence is thin. If energy costs rise, it complicates the inflation narrative even further. Luna: You know, something that strikes me when we talk about these numbers — a lot of listeners follow along regularly, maybe even use these insights in their work or investments. And that's the kind of engagement that keeps us going. Lucas: Absolutely. And it's also what keeps this show ad-free. We don't run commercials or sponsored segments. A small group of listeners chips in monthly through buy me a coffee dot com slash fexingo, and that literally funds the production of all these episodes. Luna: Yeah, it's a straightforward model. If walking through the economy with us has made something click or helped you make a decision, that's the way to keep it going. No pressure, just a heads-up that listener support is what makes this sustainable. Lucas: Back to the data though — I want to look at the unemployment rate. It's at 4.3 percent, which is low historically, but initial jobless claims just dropped to 215,000. That's down from 227,000 the week before. So layoffs aren't picking up, which means the labor market is still tight. Luna: Which reinforces the wage pressure. Employers are competing for workers, wages go up, and that feeds into services inflation. The Fed can't ignore that feedback loop. Lucas: Right. And the 10-year Treasury yield is at 4.37 percent. That's not screaming recession either. Usually, if the bond market expected a sharp downturn, yields would be much lower. The yield curve is inverted, but not as deeply as it was in 2023. Luna: So the takeaway here is that the inflation data is real and the Fed is stuck. The next few months of core PCE readings will determine whether we get a cut in 2026 or not. Lucas: Exactly. June's data will start coming in mid-July. If we see another 0.3 percent month-over-month increase, the hawks win. If it drops to 0.1 or 0.2, the doves might have a case. But for now, it's a waiting game.