Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / How the Fed Funds Rate Shapes Every Loan You Take
Transcript
- Lucas: The federal funds rate is 3.64 percent. Has been for months. And yet, if you check your credit card statement or car loan offer, that number feels completely disconnected from what you actually pay. Luna: Right — because most people don't borrow at the fed funds rate. They borrow at the prime rate, or SOFR plus a spread. Lucas: Exactly. And that gap between the Fed's rate and your rate is where the real story lives. So let's trace the chain. It starts with the Fed's main tool right now: interest on reserve balances, or IORB, currently at 3.65 percent. Luna: That's the rate the Fed pays banks on the cash they hold overnight. It sets a floor — no bank will lend to another at a rate lower than what they can get risk-free from the Fed. Lucas: Right. So the fed funds rate — the rate at which banks lend reserves to each other — trades in a narrow band around IORB. That's the rate you see quoted. But from there, banks mark up their prime rate. Typically prime is fed funds plus 300 basis points. So with fed funds at 3.64, prime is around 6.64 percent. Luna: And then your credit card or car loan is prime plus a spread based on your credit score. So for a car loan, you might see 6.64 percent for someone with excellent credit, or 10 or 12 percent for someone with average credit. Lucas: Let's put numbers on it. The average new car in the US costs about $49,000 as of last month. With a $9,000 down payment, you're financing $40,000. At 6.64 percent over 60 months, that's about $785 a month. At 10 percent, it's $850. That's $65 more per month, nearly $4,000 more over the life of the loan — all because of the spread, not the Fed's core rate. Luna: And the fed funds rate hasn't moved since early 2025. So if your rate feels stuck, it is. The transmission mechanism is working exactly as designed: the Fed sets a floor, and banks add their margin. Lucas: But here's where it gets interesting. While the Fed funds rate is flat, the bond market is pricing in cuts. The ten-year breakeven inflation rate — that's the market's expectation for average inflation over the next decade — is at 2.40 percent. That's down from 2.60 earlier this year. Luna: So the market thinks inflation is heading toward the Fed's target, which should mean lower rates ahead. But the Fed isn't cutting yet. Why not? Lucas: Two reasons. First, core PCE — the Fed's preferred inflation gauge — is still at 2.8 percent as of March. That's above the 2 percent target. But second, and maybe more important: the labor market is still tight. April's JOLTS report showed job openings at 8.3 million. Wages are still growing at 4.5 percent year-over-year. Luna: So the Fed is stuck. If they cut too soon, inflation could re-accelerate. If they hold too long, they risk slowing the economy more than needed. Lucas: And that's the bind borrowers are in. Your credit card APR isn't coming down until the Fed cuts. But the Fed won't cut until inflation is clearly trending to 2 percent. And wage growth and shelter costs are keeping core inflation sticky. Luna: Shelter costs specifically — rent and owners' equivalent rent — make up about a third of the CPI basket. And they're still rising at 4.9 percent year-over-year. That alone is keeping core CPI elevated. Lucas: So let's look at the actual numbers. April CPI came in at 332.4, up from 330.29 in March. That's about 2.4 percent annualized. Core CPI is 335.4, up from 334.17 — that's about 2.6 percent annualized. So headline inflation is cooling, but core is still above the Fed's target. Luna: Which means the fed funds rate stays where it is. And your borrowing costs stay elevated. It's a direct line: apartment leases signed in 2024 and 2025 are still rolling over into the CPI data, keeping that shelter component high. Lucas: And the Fed can't do anything about rent. That's not a monetary policy problem — it's a housing supply problem. But the Fed catches the blame because their tool affects everything else. Luna: Speaking of which, let's talk about how this affects small businesses. A lot of them have variable-rate loans tied to prime. If prime is 6.64 percent, and they borrowed at prime plus 200 basis points, they're paying 8.64 percent. That's a real cost that slows hiring and expansion. Lucas: Yeah, the NFIB small business optimism index is at 89 — that's below the 50-year average of 98. And the top concern? Inflation and interest rates. It's a double squeeze: higher input costs from inflation and higher financing costs from the Fed's rate. Luna: And yet, the stock market doesn't seem to care. The S&P 500 is at 7,519, up over 2 percent in the last week. Small caps — the Russell 2000 — are up over 6 percent in the last five days. That's a big rally. Lucas: Markets are forward-looking. They're pricing in rate cuts later this year or early next year. The bond market's implied fed funds rate for December 2026 is around 3.25 percent — about 40 basis points lower than today. Luna: So the market is betting the Fed cuts by year-end. But the Fed itself is saying 'higher for longer.' Who's right? Lucas: That's the $64 trillion question. The market has been wrong before — remember 2021, when they said inflation was transitory? But the Fed has also been wrong. They waited too long to hike in 2021. Luna: What's your read? Lucas: I think the market is half right. I think we'll see a cut by the fourth quarter, but not because inflation is tamed — because the economy slows. The consumer is showing cracks. Savings rates are down, credit card debt is up, and delinquencies are rising. Luna: Yeah, the New York Fed's household debt report showed credit card balances hit $1.2 trillion in the first quarter. And 60-day delinquency rates are at 6.3 percent — that's higher than pre-pandemic levels. Lucas: So the Fed might cut to prevent a recession, not because they've won the inflation fight. That's a different kind of cut. And it means your borrowing costs might come down a little, but not back to the zero percent days. Luna: Which, honestly, is probably healthy. Zero percent rates created a lot of distortions. But for someone carrying a credit card balance at 22 percent APR, every basis point matters. Lucas: Absolutely. And that's the bottom line: the fed funds rate is just the start of the story. The spread between that rate and what you pay is where the real cost of credit lives. And that spread is driven by bank margins, credit risk, and competition — not just the Fed. Luna: Walking through the economy with us, I hope this stuff starts to click in a way that helps you make better decisions with your money. Lucas: That's the whole idea. And we deliberately keep these episodes free of ads — no sponsors, no interruptions. If that's valuable to you and you want to support the show, there's a link: buy me a coffee dot com slash fexingo. No pressure, just an option if you find yourself getting something out of it. Luna: Yeah, it's a small way to keep this independent. And we really appreciate those who do. Lucas: So to bring it back: the fed funds rate is 3.64. Your car loan is 6.64 or more. That gap isn't arbitrary — it's the transmission mechanism at work. And until shelter costs cool or the economy slows enough for the Fed to cut, that gap is likely to persist. Keep an eye on the April CPI and PCE releases — they'll tell us if the stickiness is starting to fade. Luna: And maybe more importantly, look at your own borrowing costs. If you have variable-rate debt, you might want to consider locking in a fixed rate now, before any cuts — because the cuts might not come as fast as the market hopes. Lucas: Good advice. We'll be watching the May jobs report next week — that's always a big data point. Thanks for listening.