Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Core PCE Sticky at 3.3 Percent Matters for Rate Cuts
Transcript
- Lucas: So the big number landed yesterday — core PCE for April came in at 3.3 percent annualized. Right on the nose of what economists expected. And the market reaction? Basically a shrug. S&P 500 up a bit, the ten-year yield down a couple of basis points. Luna: Which feels almost anticlimactic after weeks of inflation anxiety. But I think that 'as expected' part is exactly what we should dig into. Lucas: Exactly. Because when you look past the headline, this is the fourth month in a row that core PCE has been hovering between 3.2 and 3.4 percent. It's not accelerating, but it's not decelerating either. It's just — stuck. Luna: The dreaded plateau. And the Fed's preferred gauge, not the CPI that gets all the headlines. Lucas: Right. The Fed targets PCE, and specifically core PCE. So when it sits at 3.3 percent for months while their policy rate is at 3.65 on the interest on reserve balances, the real rate of return is basically zero. They're not restrictive enough to push inflation down the last mile. Luna: But we also had Goolsbee on CNBC yesterday saying energy inflation has been more persistent than expected. That's a direct headwind for core, because energy feeds into transportation services, airfares, delivery costs. Lucas: It's the double scar. Consumers are still traumatised from the inflation spike of 2021-2022, and now you add the Iran war premium on oil — not a full-blown spike, but enough to keep gasoline prices elevated. The CNBC headline this morning actually used the phrase 'double scar of past inflation woes and geopolitical shocks.' That's real. Luna: And yet the labor market is still in decent shape, as Kashkari put it. Jobless claims ticked up to 215,000 — not alarming. Nonfarm payrolls are still growing, albeit slowly. So the Fed has this tension: the economy isn't falling apart, but inflation isn't falling fast enough. Lucas: Let's put some numbers on that. Real GDP growth annualised came in at 1.6 percent for Q1 2026. That's up from 0.5 percent the prior quarter, so the economy is accelerating modestly. But 1.6 percent real growth with 3.3 percent core inflation — that's a nominal economy running at almost 5 percent. The Fed is supposed to be leaning against that. Luna: So the case for a July rate cut — which some in the market are still pricing in — depends on inflation showing meaningful progress between now and then. Lucas: Exactly. And the thing is, the May CPI and PCE reports won't come out until mid-to-late June. So the Fed has almost no new data before their June meeting. They're flying blind on the next inflation print. Luna: But they do have the JOLTS data, which came out a few days ago — job openings fell to 6.866 million. That's down from 6.922 million. The labor market is cooling, just slowly. Lucas: Right. And that's the kind of data that gives doves ammunition. If job openings keep drifting lower, wage pressures ease, and that feeds into services inflation — which is the stickiest component of core PCE right now. Luna: So the story of this episode is really about the gap. The gap between where inflation is and where the Fed needs it to be, and the gap between market expectations and Fed communication. Lucas: And it's worth noting that the ECB is in a similar spot. The Bank of France governor was on CNBC yesterday saying they'll 'do what is necessary' to tame inflation. So it's not just a US problem — central banks globally are stuck in this high-for-longer phase. Luna: If walking through the economy with us has made something click, or if you just appreciate having a daily show that stays independent and ad-free, listener support is what keeps it going. We're at buy me a coffee dot com slash fexingo. Lucas: Yeah, it genuinely helps. No pressure ever, but if you've gotten value from these conversations, that's the place. And it's because of that support that we can keep digging into numbers like core PCE without any sponsors pulling the strings. Luna: Alright, back to the plateau. So what would it take for core PCE to actually break below 3 percent? Lucas: I think you need two things. One: energy prices have to stabilise or fall. The Iran war premium is uncertain, but if there's any de-escalation, that would help. Two: the labor market needs to soften just enough that wage growth in services — think healthcare, hospitality — comes down. Average hourly earnings are still at 37.4, up 3.5 percent year-over-year. That's above what's consistent with 2 percent inflation. Luna: So the Fed's preferred path is probably a gradual cooling, not a crash. They don't want to trigger a recession, but they need a little more slack. Lucas: Exactly. And that's why the market's focus on every data release is so intense. Because we're in this zone where a 0.1 percent miss one way or the other could shift the probability of a September cut from 60 percent to 40 percent. Luna: And meanwhile, the yield curve is still inverted on the short end — the 2-year yield is 4.13, the 10-year is 4.43, so it's actually a positive slope now. The un-inversion happened a while back, but the message isn't crystal clear. Lucas: Right. A positively sloped yield curve typically signals growth expectations. But with inflation sticky, it could also signal that the market expects the Fed to cut too late. That's the worry. Luna: So bottom line: the 3.3 percent core PCE is a yellow flag, not a red one. But it's persistent enough that the Fed can't declare victory. Lucas: And the danger is that if they wait too long to cut, they might be cutting into a slowdown. That's the classic policy error — keep rates high until something breaks, then scramble. Luna: Kashkari basically said that yesterday: inflation fight takes priority, labor market is in decent shape. So they're willing to risk a bit of over-tightening. Lucas: Which is a bet. And it's a bet that the next few months of data will either validate or punish. For now, we're watching the May CPI on June 11, and then the May PCE on June 26. Those will be the next big signposts. Luna: Let's hope the plateau breaks one way or the other. Because stuck inflation is its own kind of headache. Lucas: It really is. For the Fed, for markets, and for anyone trying to plan a budget or a business. So we'll keep tracking it. Luna: Thanks for listening, and we'll be back tomorrow.