Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / How the Fed's New Inflation Measure Changes Your Wallet
Transcript
- Lucas: So, Luna, we talk a lot about the headline CPI number — the one that tells you prices went up two and a half percent last year. But there's a quieter, more structural shift happening at the Fed that might matter more for your wallet over the next decade. Luna: You mean the move to average inflation targeting? The thing they rolled out a few years back but nobody really talks about anymore? Lucas: Exactly. And it's not just a policy footnote. It changes how the Fed reacts to price spikes, which in turn affects your mortgage rate, your savings account yield, even how aggressively your employer gives raises. Let's start with the latest data. Lucas: As of June, the consumer price index stood at 332.6, down from 333.98 the month before. Core CPI, which strips out food and energy, was basically flat at 336.1. But the Fed's preferred measure — the core personal consumption expenditures index — actually ticked up, from 130.09 to 130.3. Luna: So the CPI says inflation is cooling, but core PCE says it's warming. That's confusing for listeners who just want to know if their rent is going up. Lucas: Right. And that's the whole point. The Fed doesn't target CPI. It targets PCE. And under average inflation targeting, it's not just the latest number that matters — it's the average over time. So even if CPI dips, the Fed looks at a broader picture. Lucas: Let me give you a concrete example. Imagine your grocery bill went up four and a half percent last year, because that's what food inflation has been running. But the overall CPI only rose two and a half percent. The Fed's target is two percent. If you're that shopper, you're feeling a much higher number than the Fed is aiming for. Luna: And the Fed's response is not to slam the brakes, because they're looking at the average. So they might keep rates where they are, waiting for the average to come down. Lucas: Exactly. And right now the federal funds rate is sitting at 3.63 percent — flat for months. The Fed is on hold. But that doesn't mean they're ignoring inflation; it means they're judging it over a longer window. Luna: So how does that play out in the real world? If I'm saving for a house, does this change what I should expect from my savings account? Lucas: It does. With the Fed on hold, short-term rates on savings accounts and CDs are probably near their peak. But because the Fed is willing to tolerate above-target inflation for a while, the real return on your savings — that's the interest rate minus inflation — might be lower than you think. Lucas: Take the ten-year break-even inflation rate. It's at 2.25 percent right now. That's what bond investors expect inflation to average over the next decade. It's down slightly from 2.26, but it's still above the Fed's 2 percent target. So markets are saying: the Fed will let inflation run a bit hot. Luna: And that's the average inflation targeting in action. The Fed isn't trying to get back to 2 percent right now; they're aiming for 2 percent on average, maybe over a few years. Lucas: Precisely. And this has real consequences for your mortgage. Long-term rates, like the thirty-year fixed, are heavily influenced by inflation expectations. If investors think the Fed will tolerate higher inflation, they demand higher yields on long-term bonds. That pushes mortgage rates up, even if the Fed funds rate stays put. Luna: So even though the Fed isn't hiking, my mortgage rate could still drift higher. That feels counterintuitive. Lucas: It is, but it's the market doing the work. And it's not just mortgages. Rents are a big part of inflation, and we've seen those cool off a bit — remember episode 147. But services like hotels and entertainment are still climbing. That mix is exactly why the Fed looks at core PCE, which gives more weight to services. Lucas: Now, let me tie this to something that just happened. The July jobs report shocked everyone — the economy lost 23,000 jobs. That's unexpected. And the unemployment rate ticked up. Normally, a weak jobs market would push the Fed to cut rates. Luna: But they didn't cut. They held steady. Why? Lucas: Because of average inflation targeting. They're not reacting to one month of jobs data; they're looking at the whole picture. If they cut now, they risk letting inflation expectations drift higher. And once those expectations get unanchored, it's very hard to bring them back. Luna: So they're willing to accept a weaker job market to keep inflation in check. That's a tough trade-off for everyday people who might be worried about their job. Lucas: It is, and it's a real tension. But here's the thing: the Fed's framework is designed to avoid the whiplash of the past. Remember the seventies, when they kept cutting rates too early and inflation came roaring back? Average inflation targeting is meant to prevent that. Lucas: It's a longer runway. And for you and me, it means the cost of living might not feel like it's cooling as fast as the headlines suggest. We keep seeing these CPI numbers dip, but your actual paycheck might not stretch much further. Luna: And that disconnect is exactly why we do this show. It's easy to get lost in the aggregate numbers, but what we care about is how it hits your wallet. Lucas: And if walking through the economy with us has made something click, you know what, we'd love it if you considered supporting us. We keep this show ad-free, and that's only possible because of listeners like you. If you've ever gotten value from one of these episodes, you can buy us a coffee at buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small gesture that goes a long way. We really appreciate it. Lucas: So, back to the framework. There's another layer to this that often gets missed: gold. Gold has been on a tear recently — up about four percent in the last five days alone. And people wonder, if inflation is cooling, why is gold rallying? Luna: I guess I'd think lower inflation would be bad for gold, since it's often a hedge against inflation. Lucas: That's the conventional wisdom. But what gold is really responding to is the real interest rate — that's the nominal rate minus expected inflation. With the Fed on hold and inflation expectations sticky at 2.25 percent, real rates are low. And low real rates make gold more attractive, because holding gold costs you less in foregone interest. Lucas: Plus, the weak jobs report raised fears of a slowdown. Gold tends to do well in times of uncertainty. So it's not a contradiction — it's a signal that the market sees a more complicated picture than a simple 'inflation is falling' story. Luna: So the gold rally is kind of a vote of no confidence in the Fed's ability to manage the economy? Lucas: I'd say it's a vote of no confidence in the clarity. With average inflation targeting, the Fed has given itself more room to miss on the high side. And markets are pricing that in. Lucas: Let me give you one more practical takeaway. If you're negotiating a raise, don't just look at the latest CPI. Look at the core PCE, look at the ten-year break-even. Those tell you what your employer might expect to pay, because they're what the Fed is watching. Luna: So I should walk into my performance review with a chart of break-even inflation rates? Lucas: Maybe not a chart, but at least an idea. If inflation expectations are 2.25 percent, a 2 percent raise is effectively a cut in real terms. You want to aim for that number, or you're losing purchasing power. Lucas: And that's the kind of thing that average inflation targeting makes more relevant, because the Fed is signaling they'll let inflation run above 2 percent for a while. So your raise needs to keep up with that average, not just the latest month. Luna: That's a great practical takeaway. And it ties back to why we started this show — to help people connect these macro concepts to their own lives. Lucas: So next time you hear 'inflation is cooling,' remember: the Fed is playing a longer game. And your wallet might not feel the cool down for a while. Luna: And that's a good note to end on. Thanks for listening, everyone. We'll see you next time.