Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why Gas Prices Are Becoming a Permanent Inflation Force
Transcript
- Lucas: So we keep hearing that inflation is cooling. Core PCE came in at an annual rate of 3.3 percent in April, right in line with expectations. But there's this one category that just refuses to cooperate — energy. Luna: And it's not just a blip anymore. The headline last week said the average U.S. household is paying $450 more on gas and energy because of the Iran conflict. That's not a rounding error. Lucas: Yeah, and that's the angle I want to drill into today. For a long time, the Fed and a lot of economists treated energy inflation as transitory — a spike that would reverse. But what if it's not reversing? What if energy costs are becoming a permanent structural force? Luna: That would change the whole inflation narrative. Because right now, the Fed is looking at core inflation — which strips out food and energy — and seeing progress. But households aren't living in 'core' world. Lucas: Exactly. Let's start with the numbers. The April CPI headline index hit 332.4, up from 330.29 in March. That's about a 2.3 percent annualized rate. But energy alone — within that — is running closer to 5 or 6 percent depending on how you measure it. And it's been accelerating since the Iran situation escalated. Luna: And it's not just gasoline at the pump. It's home heating oil, natural gas, even the cost of transporting everything else. That $450 figure from CNBC — that's the total extra energy cost per household. Lucas: Right. And that number comes from a combination of higher crude prices — gold's been surging too, by the way, up over 5 percent in the last week alone — and actual supply disruptions. The key question is whether those disruptions are temporary or whether they've permanently shifted the supply-demand balance. Luna: What does the data say about that? I mean, the ten-year breakeven inflation rate is sitting at 2.39 percent — basically flat. So bond markets don't seem to be pricing in a long-term energy shock. Lucas: That's the puzzle. The breakeven rate — which is the market's expectation for average inflation over the next decade — hasn't budged much. But that's an average. It could be that bond traders think energy spikes will be offset by disinflation elsewhere, like in goods or housing. Luna: But that's a risky bet if energy becomes stickier. Fed governor Goolsbee just said energy inflation has been more persistent than expected. And Kashkari said the inflation fight takes priority. So the Fed is watching this closely. Lucas: They have to. Because if energy keeps running hot, it seeps into core inflation over time. Higher transport costs mean higher prices for everything from groceries to furniture. The 'second-round effects' economists talk about. Luna: And that's exactly what households are feeling. The disconnect between official CPI and lived experience — we've talked about that in past episodes. But energy might be the biggest driver of that gap right now. Lucas: Totally. And if you look at the PCE price index — the Fed's preferred measure — it captures energy a bit differently. The April PCE came in at 130.9, up from 130.38. Core PCE was 129.6. So the gap between headline and core is actually narrower in PCE than in CPI, because PCE gives less weight to energy. But that doesn't mean the pain isn't real. Luna: So when people hear 'inflation is cooling' but they're still paying $4.50 a gallon, they feel gaslit. And they're not wrong to feel that way. Lucas: Yeah. And I think that's the central tension right now. The Fed is making progress on the stuff it can most directly influence — like demand through interest rates. But energy supply is geopolitical. The Fed can't drill more oil or end a war. Luna: Which brings us back to that structural question. If the Iran conflict drags on — and there's no sign it'll end soon — are we looking at a new normal where energy is permanently 10 to 15 percent more expensive? Lucas: That's the million-dollar question. And honestly, it's not just about Iran. It's about the whole energy transition, underinvestment in fossil fuels, and the fact that spare capacity is at historic lows. Even without a war, energy markets are tighter than they've been in decades. Luna: So the 'transitory' narrative might finally be dead. Not just for pandemic-era supply chains, but for energy specifically. Lucas: Right. And that has huge implications for Fed policy. If energy inflation is structural, the Fed might have to accept a higher overall inflation target — or keep rates higher for longer to squeeze out demand, which risks a recession. Luna: That's a tough trade-off. And it's the kind of thing that, if you found this breakdown useful, it's exactly why we do this show. If walking through the economy with us has made something click, the way these stay ad-free is listener support. You can do that at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that keeps us independent. No pressure, but if today's episode helped you think about energy inflation differently, that link is there. Luna: Alright, back to the bigger picture. So if energy is structural, what does that mean for the next Fed move? They've held rates steady at 3.62 to 3.65 percent on the effective fed funds rate. The market is pricing in maybe one cut later this year. But if energy stays hot... Lucas: Then that cut could get pushed into 2027. Or they might not cut at all. Because the Fed's dual mandate is price stability and maximum employment. Right now, the labor market is 'in decent shape,' as Kashkari said. So the inflation fight takes priority. Luna: And that means consumers keep getting squeezed. The $450 extra on energy — that's money that doesn't go into savings, doesn't go into restaurants, doesn't go into discretionary spending. It's a tax on the economy. Lucas: Exactly. And it's regressive. Lower-income households spend a much larger share of their income on energy. So this isn't just a macro story — it's a real inequality story. Luna: One thing I want to circle back to: the Fed's preferred gauge, core PCE, was 3.3 percent year over year. That's still above the 2 percent target. And if energy keeps adding to headline inflation, even if core comes down, the Fed can't ignore headline entirely. Lucas: That's right. Because expectations matter. If people see gas prices staying high, they start to expect higher inflation in general. And then they demand higher wages, and companies pass those costs on, and you get a wage-price spiral. That's the nightmare scenario. Luna: So far, we haven't seen that. Wage growth has moderated. But the risk is still there. Lucas: And that's why the Fed is being so cautious. They'd rather hold rates too high for too long than cut too early and reignite inflation. Especially with a geopolitical wildcard like Iran. Luna: Let's talk about one more data point: the S&P 500 hit 7,580 today, up 1.4 percent for the week. Markets are hitting new highs. So investors are betting that the Fed gets this right — that inflation comes down without a recession. Lucas: Yeah, but that optimism might be fragile. If next month's CPI shows energy inflation still accelerating, you could see a sharp repricing. The bond market is already flashing caution — the ten-year breakeven is flat, but that might just mean bond traders are skeptical about the Fed's ability to control energy. Luna: So what's the one takeaway you want listeners to remember from this episode? Lucas: That energy inflation is no longer a side note. It's a central character in the inflation story. And until the geopolitical situation stabilizes and supply chains adjust, it's going to keep putting upward pressure on prices. That means higher rates for longer, and more pain at the pump. Luna: And maybe a permanent shift in what we consider 'normal' inflation. Lucas: Exactly. That's the uncomfortable possibility we should all be watching.