Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why Core CPI Matters More Than Headline Inflation Now
Transcript
- Lucas: So the April CPI came out a few weeks ago, and we're still in that weird place where headline inflation looks like it's calming down — but the core number is actually still creeping up. Luna: Yeah, I saw that. Headline CPI was 332.4, which is up from March, but the year-over-year rate has been easing for a while. But core CPI hit 335.4 — that's the highest it's been in months. Lucas: Exactly. And for anyone who's been following this, the gap between headline and core is widening. Headline gets pulled around by food and energy — and with the Iran war rattling energy markets right now, that's a huge swing factor. But core strips all that out. It's telling us something more structural. Luna: Right. So what's pushing core up? Is it shelter again? Lucas: Shelter is a big part of it. The shelter component of CPI — that's rent and owners' equivalent rent — makes up about a third of the index. And it's been sticky around 4 to 5 percent year-over-year for months. Even with new apartment supply coming online in places like Austin and Nashville, the national index just doesn't move fast. Luna: It's also a lagging indicator, right? Rent trends take six to twelve months to fully show up in CPI. Lucas: Exactly. So even if market rents are softening in some cities, CPI shelter costs can stay elevated. But it's not just shelter. Services inflation — things like car insurance, medical care, repair services — those are also running hot. That's the kind of inflation that's harder to squeeze out. Luna: And that's exactly why the bond market is now pricing in a potential rate hike. I saw the 10-year breakeven inflation rate dropped to 2.44 percent recently. That suggests bond investors think inflation will moderate longer-term. But at the same time, traders are talking about a hike as soon as July. Lucas: Yeah, the breakeven rate falling is actually a bit counterintuitive. If breakevens go down, it means the market expects lower inflation ahead. But if core CPI is still rising, what gives? Well, part of it is energy. The breakeven is based on nominal Treasuries minus TIPS, and energy volatility can distort it. Also, the Fed's preferred gauge is the PCE price index, not CPI. Luna: Right. PCE came in at 130.3 for March, up from 129.48. Core PCE was 129.3. That's still below CPI because of how it's weighted. The Fed really watches PCE. Lucas: And the Fed under Kevin Warsh — he's being sworn in this Friday — has a tough call. The last headline from Yardeni said the Fed will have to hike in July to appease the 'bond vigilantes.' That's a phrase we haven't heard much lately, but it's back. Markets are testing the Fed's credibility. Luna: So what would a July hike mean for the average person? Mortgage rates are already high, credit card debt is piling up... Lucas: It would tighten conditions further. The Fed funds rate is at 3.64 percent effective, and another 25 basis points would push it closer to 4 percent. That hits variable-rate debt — credit cards, home equity lines — pretty quickly. But the argument from the hawkish side is: if core inflation stays sticky, letting it fester is worse. You end up with a 1970s-style wage-price spiral. Luna: That's the nightmare scenario. But do you think core CPI really signals that kind of persistence? Or is it still pandemic-era noise? Lucas: It's a mix. Some of the services inflation is catch-up — like car insurance, which was underpriced during the pandemic. But shelter costs, once they rise, don't fall quickly. And with the labor market still tight — the last JOLTS report showed job openings well above pre-pandemic levels — wages are under pressure. That feeds into services prices. Luna: And that's the thing. If you look at the Fed's dual mandate, maximum employment is basically met. So the focus shifts to price stability. And with core CPI at these levels, they can't really cut. Lucas: No, cuts are off the table for now. The market has flipped from expecting cuts to expecting hikes. That's a huge sentiment shift in just a few months. You've got the S&P 500 down nearly 1 percent in the last five days, the Nasdaq off 1.4 percent. Rate-sensitive sectors are feeling it. Luna: I want to come back to the breakeven rate. If it's falling, doesn't that give the Fed cover to hold steady? Lucas: It could, but the breakeven is just one signal. The bond market is also pricing in the risk of a recession. If energy prices stay high because of the Iran situation, that's a supply shock — it slows growth and raises inflation. So breakevens might be falling because growth expectations are dropping, not because inflation is really under control. Luna: That's the stagflation worry. And it explains why gold is still above $4,500, even though it dipped a bit recently. And gold miners like GDX are down 8 percent in five days, which might be profit-taking or positioning for higher rates. Lucas: Right, gold's at $4,532. It's been volatile. But the bigger picture is that real rates — nominal rates minus expected inflation — are still relatively low. So gold has support. But if the Fed hikes, real rates go up, and gold could correct further. Luna: So where does that leave the average consumer? Grocery prices are still high, gas is up because of the Iran war, rents aren't coming down... Lucas: Yeah, the cost of living squeeze is real. The CPI basket doesn't perfectly reflect everyone's experience, but the trend is clear. People are cutting back on discretionary spending — we've seen that in retail earnings. And the savings rate has dropped. The pandemic-era cushion is gone for most households. Luna: It's interesting because one of the recent headlines said the AI economy is rewriting the American dream and blue-collar workers are poised to win. But if inflation sticks around, wage gains get eaten up. Lucas: Exactly. Productivity gains from AI could eventually lower costs, but that's a multi-year story. In the near term, sticky core CPI means the Fed has to keep pressure on. And that hurts the same workers who are supposed to benefit from the AI boom. Luna: So as we head into the summer, what are you watching for? The May CPI report, I assume. Lucas: Absolutely. May CPI comes out mid-June. I'm watching shelter costs specifically — if they start to moderate, that could change the narrative. Also, the PCE data for April will come out before the Fed's June meeting. That might be the deciding factor on whether they signal a July hike. Luna: And with Kevin Warsh taking over Friday, there might be a shift in communication style too. He's known to be more hawkish than Powell. Lucas: He is. Warsh was a critic of the late-2010s low-rate environment. He's likely to emphasize credibility and inflation fighting. So even if the data softens a bit, his rhetoric might lean hawkish. That alone could tighten financial conditions through the bond market. Luna: So bottom line: core CPI is the number to watch, not headline. And if it doesn't come down soon, we're looking at another rate hike. Lucas: Right. Core CPI above 335 is not consistent with the Fed's 2 percent PCE target. There's a gap there that needs to close. Until it does, the pressure to hike will remain. The bond vigilantes are circling, and the new Fed chair has to decide whether to take them on or join them. Luna: Interesting times. I guess we'll know more in a few weeks. Lucas: We will. And we'll break it down here as soon as the data drops.