Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why Bond Markets See Inflation Risk Despite Falling CPI
Transcript
- Lucas: So the June CPI came in at 332.6, down from 333.98 the month before — a clear softening. But here's the weird part: the bond market's 10-year breakeven inflation rate actually ticked up to 2.26%, from 2.20%. So investors are betting on higher inflation even as the headline number drops. Luna: That's a pretty striking divergence. What's driving the bond market's view? Lucas: A couple of things. First, the headline CPI is heavily influenced by goods prices, which have been falling — think used cars, some electronics. But services inflation, especially in categories like medical care and rent, remains stubbornly high. The core PCE, which the Fed prefers, actually nudged up in June. And that matters more for policymakers. Luna: Right, and there's also the tariff front. The Trump administration just announced a new global tariff citing forced labor concerns. That could push up import prices, which the bond market is likely pricing in. Lucas: Exactly. And on top of that, oil prices have been rising — Singapore actually tightened monetary policy this week because of that risk. Higher energy costs filter through to transportation, manufacturing, everything. The breakeven rate captures all those forward-looking fears. Luna: Let me jump in here — if people find this kind of economic detective work useful, a couple of dollars a month is genuinely what keeps these shows ad-free and independent. Buy me a coffee dot com slash fexingo. It makes a real difference. Lucas: Yeah, absolutely. No pressure, but if walking through the economy with us has made something click, that's the place. Now back to the divergence — the bond market isn't just looking at CPI. It's looking at what the Fed will do with core PCE still running at 3.3% year-over-year. Luna: So the Fed's preferred measure isn't falling as fast. That must complicate their messaging. Lucas: It does. The Fed is divided — we saw headlines this week about that internal debate. Some members see the softening headline and want to cut rates to support a slowing economy. Q2 GDP came in at just 1.5%, so growth is clearly decelerating. But others look at the bond market and sticky core inflation and say, 'Not so fast.' Luna: It's almost like the classic stagflation setup — slow growth plus elevated inflation — even if it's not full-blown stagflation yet. Lucas: Exactly. The bond market is basically saying, 'We don't believe the soft CPI story is durable.' And that's why the 10-year breakeven moved up. If the Fed cuts too early and inflation reaccelerates, they lose credibility. So they're likely to stay on hold even as the economy slows. Luna: How long can that hold? The effective Fed funds rate has been flat at 3.63% since June. Lucas: Right. The market is pricing in a cut later this year, but if the breakeven keeps rising, that expectation could vanish. The Fed's own projections show they're cautious. Kevin Warsh, who's seen as a key voice, has been signaling that they need to see sustained improvement in core PCE before moving. Luna: So the key number to watch isn't CPI anymore — it's the weekly core PCE releases and the breakeven rate. Lucas: Exactly. CPI is lagging and distorted by goods disinflation. The bond market is a real-time poll of where investors think inflation is headed. And right now, that poll says the risk is to the upside, not the downside. That should worry anyone hoping for rate cuts soon. Luna: What about the consumer side? Are people feeling this divergence in their wallets? Lucas: Yes, because services inflation — things like rent, insurance, medical costs — hits directly. The average person isn't buying a new car every month, but they are paying rent and buying groceries. Grocery prices have actually stabilized, but services like car insurance are still up over 10% year-over-year. So the headline CPI drop doesn't feel real to most people. Luna: That's the disconnect. The macro picture shows cooling, but the micro experience says 'still expensive.' And the bond market is siding with the micro experience. Lucas: Precisely. And if oil prices keep rising because of geopolitical tensions or supply disruptions, that goods disinflation could reverse. One reason the bond market is nervous is that tariff news plus oil equals a potential import price shock. Import prices already hit a 2008 high earlier this year. Luna: So is the breakeven rate now the single most important inflation indicator? Lucas: For predicting Fed policy, I'd say yes. The Fed watches the 5-year, 5-year forward breakeven closely. That's around 2.30% now, up from 2.15% a month ago. That's a meaningful move. If it goes above 2.5%, you'll hear hawkish Fed speakers very quickly. Luna: And all of this happens against a backdrop of slowing growth. Q2 GDP at 1.5% — that's not recession territory, but it's fragile. Lucas: Right. So the Fed is stuck between a rock and a hard place. Cut rates to boost growth and risk higher inflation. Or hold tight and watch growth slow further. The bond market is essentially telling them, 'Don't cut too soon.' That's the message in the breakeven rate. Luna: So what should an investor or a regular listener take away from this? Lucas: Two things. One, don't assume inflation is vanquished just because CPI ticked down. Look at the bond market's inflation expectations — they're rising. Two, pay attention to core PCE and the breakeven rates. Those are the real dials the Fed turns. And for anyone budgeting, expect services costs to keep climbing even if goods get cheaper. Luna: Good takeaway. So the next CPI print in July will be important, but the weekly breakeven data might actually tell us more about where we're heading. Lucas: Exactly. We'll be watching both. And if that breakeven keeps moving up, this conversation changes from 'when will the Fed cut?' to 'will the Fed need to hike again?' Luna: That would be a real surprise. But the bond market is signaling it's a possibility. Lucas: And that's why the Fed is divided. Because the data is sending conflicting signals. But the bond market has a good track record. So we'd be wise to listen to it.