Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Two Speed Economy That Has the Fed Confused
Transcript
- Lucas: Consumer sentiment hit a fresh record low this month. The S&P 500 is at 7,511. The Russell 2000 just surged 3.6 percent in a week. And GDP is growing at two percent annualised. So which story is the real one? Luna: That's the puzzle. People feel awful, but the economy keeps humming. Markets are rallying, especially small caps. How do you square that? Lucas: Well, the sentiment index from the University of Michigan — it's been plumbing depths we haven't seen since the early 1980s. The headline this month was 'consumer sentiment hits record low as Iran war fuels inflation worries.' And that tracks: gas prices are up, food prices are up, rent is still high. Luna: But the hard data doesn't show a recession. Jobless claims are 209,000 — that's low. Nonfarm payrolls are still growing. Real GDP growth just doubled from 0.5 to 2.0 percent. Lucas: Right, and that's the disconnect. The macro numbers say expansion. The micro experience says pain. But here's what I find interesting: markets are actually pricing in that pain staying around. The 10-year breakeven inflation rate — that's the market's expectation for average inflation over the next decade — it's at 2.40 percent. That's above the Fed's two percent target. Luna: So bond traders think inflation isn't coming down fast. And the Fed is stuck at 3.65 percent on the funds rate, not cutting. Lucas: Exactly. The Fed's policy rate has been flat for months. They're in wait and see mode. And the yield curve is doing something weird — short-term rates are still below long-term rates, but the gap is narrowing. The 2-year is at 4.18, the 10-year at 4.49. That's a very flat curve. Luna: A flat curve usually means the market expects a slowdown. But we have growth. It's contradictory. Lucas: Unless growth is being driven by a few sectors while the rest of the economy slows. That's the two-speed story. Big tech and ai related spending are booming. The S&P 500 is being pulled up by a handful of mega-caps. But small caps — the Russell 2000 — they've been left behind for over a year. Now they're catching up, up 3.6 percent in five days. That could be a rotation. Luna: A rotation into value, into cyclicals. If the economy isn't falling apart, maybe those beaten-down small caps are finally attractively priced. Lucas: But the sentiment data says consumers are bracing for worse. And that matters because consumer spending is two-thirds of GDP. If people are hunkering down, that should eventually show up in the numbers. Luna: Has it shown up yet? Look at the JOLTS data — job openings slipped to 6.9 million in March. That's down from 6.9 million the month before. Still high historically, but the trend is cooling. Lucas: And average hourly earnings are up to $37.40 — that's about 3.0 percent year-over-year, roughly. Not accelerating, not collapsing. So the labor market is tight but not overheating. Luna: That's the sweet spot the Fed wants. But if inflation expectations stay sticky, they can't cut rates even if growth slows. Lucas: Right. The core PCE price index — the Fed's preferred measure — is at 129.3. Up from 128.9 in February. So inflation is still running above target. And the CPI is at 332.4, up from 330.3 a month earlier. That's about 2.7 percent annualised. Luna: So the real economy is growing, inflation is sticky, and consumers are miserable. That's the paradox of mid-2026. Lucas: And markets are trying to figure out which leg will break first. If sentiment stays low and spending falters, we could see GDP slowdown in Q2. If inflation doesn't ease, the Fed stays put, and that could squeeze small caps that need lower rates. Luna: But if you look at the bond market, it's not screaming recession. The 10-year is at 4.49, the 30-year at 5.02. Those aren't crisis levels. Lucas: No, they're not. But they're also not pricing in aggressive rate cuts. The market sees the Fed on hold through the summer at least. And that takes us back to the sentiment data — if people are this downbeat, maybe they're already adjusting their spending to a higher for longer rate environment. Luna: I want to zoom in on one thing: the record low sentiment. Is it really just inflation, or is there something else? Lucas: The Michigan survey breakdown shows inflation expectations have risen. One-year-ahead expectations are up. But there's also the geopolitical factor — the Iran war, energy price volatility. And the cumulative effect of three years of high prices. Even if inflation is slowing, the level of prices is still high. That wears on people. Luna: Right. It's not just the rate of change, it's the level. Eggs are still expensive compared to 2020. Lucas: Exactly. And this is where the macro data can feel disconnected from the lived experience. GDP growth is a quarterly number, but people face higher prices every week. Luna: So what's the market pricing in for the next year? Are we heading for a soft landing or a hard one? Lucas: The breakeven inflation rate at 2.40 suggests the market thinks inflation won't be tamed without some economic pain. But the equity rally, especially in small caps, suggests investors are betting on a soft landing — that growth continues, rates eventually come down, and earnings improve. Luna: Which one do you lean toward? Lucas: I think the two-speed economy continues. The ai driven sector keeps booming, but the consumer-facing side weakens. That would keep the Fed cautious. They won't cut until they see clear evidence that inflation is sustainably at two percent. Luna: And the next CPI print, due in a couple of weeks, could be a big test. If it shows inflation ticking up again, sentiment could sink even further. Lucas: And the bond market would react — yields would rise, and the equity rally could stall. But if it shows a continued gradual decline, that would support the soft landing narrative and maybe lift small caps further. Luna: It feels like we're in a wait and see moment. The data is too mixed to call. Lucas: Yeah, and that's actually the most useful takeaway for listeners. When the data is contradictory, the best strategy is to acknowledge the uncertainty and look for signals rather than trying to predict. Luna: Speaking of useful — if parsing through this data with us has made something click, the way we keep this podcast ad-free and independent is through listener support. Lucas: Yeah, it's a small way to say this kind of conversation matters. If you want to chip in, you can go to buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. No pressure, but it helps us keep digging into these numbers. Luna: And seriously, every bit helps. Now back to the puzzle: if consumer spending slows, does that change the Fed's timeline? Lucas: If we see a weak retail sales report or a drop in confidence that translates into spending, then yes, the Fed would have to consider a cut earlier. But they need to see it in the hard data, not just surveys. Luna: So what should listeners watch for in the coming weeks? Lucas: Three things: the next CPI report, the next jobs report — especially wage growth — and any commentary from Fed officials. If they sound more dovish, that could be a signal. If they stay hawkish, the status quo continues. Luna: And the small cap rally — if it sustains, that would be a vote of confidence in the soft landing. Lucas: Exactly. But if it fades and the yield curve inverts further, that's the opposite signal. Right now, the 2-year at 4.18 and the 10-year at 4.49 — that's not inverted, but it's close. The gap is only 31 basis points. Luna: So yield curve watch remains a thing. Lucas: It always is. For now, the macro story is one of resilience and anxiety coexisting. And that's not a comfortable place for markets or policymakers. Luna: But it's the reality. And understanding it is the first step. Lucas: Exactly. We'll keep tracking the data and bring you what we find. Until next time.