Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Invisible Tax of Services Inflation
Transcript
- Lucas: If you look at the headline consumer price index number from early August, it sits at three hundred and thirty-four point one. That is up slightly from the previous month, but when you strip out food and energy, core CPI is holding steady around three hundred and thirty-seven point eight. The market seems to have priced that in, with the S&P five hundred climbing two and a half percent over the last week alone. Luna: Right, but does that stability actually match what people are feeling at the checkout counter? Because I keep hearing that even if the macro numbers are flat, the micro experience of spending money hasn't changed much. Lucas: That disconnect is exactly where we need to focus today. We often talk about inflation as a monolithic force, but the reality is that goods inflation has largely cooled while services inflation remains sticky. The reason your grocery bill might feel manageable compared to last year, yet your overall cost of living keeps rising, comes down to the labor component embedded in almost every service you buy. Luna: So the sticker shock isn't just about supply chains anymore; it's about who is doing the work and what they are getting paid? Lucas: Exactly. When you buy a physical product, you are paying for materials, shipping, and manufacturing overhead. But when you hire someone to fix your roof, consult on a project, or manage your insurance policy, you are paying for wages. And wages are slow-moving, contractual, and resistant to deflation. The effective federal funds rate is sitting at three point six three percent, which means borrowing money to expand operations is still expensive, forcing companies to pass those costs onto consumers through higher service fees. Luna: It feels like the economy is shifting from a goods cycle to a services cycle, and we haven't fully adjusted our expectations for pricing in that new environment. Lucas: Let's take a moment to acknowledge the listeners who keep this network running ad-free. If walking through the economy with us has made something click, consider supporting the show directly. You can find us at buy me a coffee dot com slash fexingo. It helps us dig deeper into these structural shifts without worrying about advertiser pressure. Luna: Yeah, it really does make a difference in keeping the research rigorous. Thanks for the support. Now, back to the data. Lucas: We were discussing the stickiness of service prices. Let's look at the PCE price index, which is the Federal Reserve's preferred gauge. As of July first, the core PCE was at one hundred and thirty point seven. It is rising, but slowly. However, the composition of that rise tells a different story than the headline CPI. Luna: How so? Is the Fed looking at a different basket of goods, or is it weighting services more heavily? Lucas: The PCE index allows for substitution, meaning if people stop buying beef and start buying chicken, the index reflects that shift in real-time. But more importantly, it accounts for changes in quality and the way consumers adapt their behavior. In the services sector, this substitution is harder. You cannot easily swap out your home insurance for a cheaper, lower-quality alternative without risking your entire asset base. That lack of substitutability is what keeps service inflation elevated. Luna: So essential services act like a floor under inflation because there is no good substitute for them, whereas discretionary goods can be traded down when prices get too high. Lucas: Precisely. Think about healthcare or education. These are not commodities you can arbitrage away. They are necessities with inelastic demand. When wages rise, providers in these sectors raise prices to maintain margins or attract talent. This creates a feedback loop where higher wages lead to higher service prices, which then require further wage adjustments to maintain purchasing power. Luna: That sounds like the old wage-price spiral theory, but the experts seem to say that's mostly a myth now. Where does the truth lie? Lucas: The myth part is true in the sense that we aren't seeing runaway hyperinflation driven by spirals. But the mechanism is real in specific sectors. It is not a general explosion of prices across all categories, but a targeted increase in labor-intensive services. The ten-year breakeven inflation rate is at two point three three percent, which suggests markets believe the Fed will eventually bring the average down to two percent. But that average includes the cooling goods sector, which masks the persistent heat in services. Luna: So the average is misleading because it blends two very different economic realities into one number. Lucas: It is. And this matters for personal finance because your portfolio allocation should reflect that divergence. If you are investing based on the idea that inflation is dead, you might be underweight in sectors that benefit from service growth. Healthcare, professional services, and even certain financial institutions see revenue growth tied to these sticky price increases. Luna: But for the average person, does this mean they are just stuck paying more for everything forever? Lucas: Not forever, but for longer than many expected. The normalization of service prices is slower because labor markets are tight. Unemployment is low, which gives workers bargaining power. Until productivity improvements in the service sector accelerate enough to offset wage growth, prices will remain elevated. We saw some of this in recent headlines about transport companies sounding alarms on fuel prices, but that is a input cost. The bigger issue is the human element behind the service delivery. Luna: I wonder if technology will finally break that cycle. AI and automation should theoretically reduce the need for human labor in many service roles. Lucas: That is the hope, and it is happening, but it is uneven. Automation works well for standardized tasks like customer service chatbots or basic accounting. But it struggles with complex, nuanced interactions like healthcare diagnosis or personalized financial advising. Those high-touch services will continue to command premium prices because they rely on human judgment and empathy, which are hard to scale. Luna: So we might see a bifurcation in the economy between cheap automated services and expensive human-centric ones. Lucas: That is a very likely outcome. The middle class has always relied on access to affordable professional services. If those services become luxury items due to labor costs, it changes the social contract. For now, however, most consumers are absorbing the cost because there is no immediate alternative. The interest on reserve balances is at three point nine zero percent, which keeps capital expensive for businesses trying to automate, slowing down that transition. Luna: It seems like the path to lower service inflation requires either a significant drop in wages or a massive leap in productivity, and neither is guaranteed in the short term. Lucas: Correct. A drop in wages would likely trigger a recession, which the Fed is trying to avoid. So the only viable path is productivity. We need to see software and AI tools become robust enough to handle a larger share of the service burden. Until then, the CPI will likely hover above the two percent target, driven by the services component. Luna: What about the international perspective? Does this problem exist everywhere, or is it unique to the United States right now? Lucas: It is global, but the timing varies. Japan recently raised rates after a long period of ultra-loose policy, which impacted their markets significantly. The Bank of England left rates unchanged, mirroring the Fed's caution. But the underlying dynamic of aging populations and tight labor markets is common across developed economies. An aging population reduces the supply of workers, which pushes wages up, which pushes service prices up. It is a demographic issue as much as an economic one. Luna: That connects the dots nicely. It is not just monetary policy; it is biology and demographics driving the price of a haircut or a nursing home stay. Lucas: Exactly. Monetary policy can cool demand, but it cannot create more nurses or teachers. If the supply of labor is constrained, prices must rise to allocate that scarce resource. This is why fiscal policy, such as immigration reform or education investment, becomes critical in managing long-term inflation expectations. Luna: It makes me think about how we plan for retirement. If service costs keep rising faster than goods, my retirement savings need to be allocated differently to protect against that specific risk. Lucas: That is a smart adjustment. Traditional portfolios might be overweight in tech or consumer staples, which are more sensitive to goods cycles. You might want to consider exposure to healthcare REITs or education-focused ETFs, assets that directly benefit from or hedge against rising service costs. It is about matching your assets to the structural reality of the economy, not just the headline number. Luna: So instead of fighting the trend, we position ourselves within it. That is a much more practical approach than waiting for inflation to vanish. Lucas: Precisely. Waiting for the old normal to return is a losing strategy. The new normal is characterized by higher service inflation and lower goods inflation. Understanding that split allows you to make better decisions about what to buy, what to invest in, and where to save your money. Luna: I am curious if consumer sentiment reflects this nuance. Are people aware that goods are cheaper but services are expensive, or do they just feel like everything is expensive? Lucas: Recent data from Goldman Sachs suggests consumer sentiment is in the dumps despite a solid economy, blaming 'lower happiness.' People feel the pinch of service costs more acutely because they are recurring and non-negotiable. A lower price on electronics is a one-time gain, but a higher monthly insurance premium is a permanent drag on cash flow. That psychological weight is heavy. Luna: It highlights the importance of budgeting for fixed costs rather than variable ones. If your fixed costs are rising, your ability to save shrinks, regardless of how much you save on groceries. Lucas: That is the key takeaway. Review your fixed expenses annually. Negotiate contracts, switch providers, or automate processes to mitigate the impact of service inflation. It is active management of your personal balance sheet, not just passive saving. Luna: Active management. I like that. It puts the agency back in the hands of the listener. Lucas: And it acknowledges that the economy is not a static backdrop but a dynamic system that responds to choices. Your choices matter more now than when inflation was purely a monetary phenomenon. Luna: Do you think the Fed realizes that their rate hikes are hitting the wrong lever, since they are trying to cool labor demand but labor is already tight? Lucas: They know it. That is why they are moving slowly. The Fed Funds rate is effectively at three point six three percent, and they are watching data closely. They understand that crashing the labor market to kill service inflation is too high a social cost. They are hoping for a soft landing where wages grow slowly enough to allow service prices to stabilize without mass unemployment. Luna: A soft landing sounds nice, but it requires perfect execution in a fragile environment. Lucas: It does. And if they misjudge, we could see a sharper correction. But for now, the data suggests a gradual easing. The key is patience and adaptation. We will see how the next few months play out, especially with the upcoming labor reports. Luna: I will be watching those JOLTS reports closely to see if the job openings are finally cooling off enough to ease wage pressures. Lucas: Good plan. And remember, whether the labor market cools or stays hot, the structural shift toward services is here to stay. Planning for it is the best defense. Luna: Thanks for breaking that down, Lucas. It is a lot to process, but definitely clearer than before. Lucas: Anytime, Luna. Let's see if the market reacts to the next set of data points tomorrow.