Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / How Falling Inflation Is Reshaping Consumer Behavior
Transcript
- Lucas: So the headline this morning is that consumer prices rose 3.5 percent annually in June, which is a little bit below what economists had penciled in. And energy prices were the main driver on the downside. Luna: Right — the market seemed to take it as a bit of good news. But I wonder, is this actually changing how people spend, or is it just a data point that the Fed leans on? Lucas: That's exactly the question. The CPI number itself matters for policy, but the real economy story is about consumer behavior. And there's this term you're seeing pop up more — 'funflation'. Luna: Yeah, I saw that CNBC headline. 'Why staying in isn't the cost-saver it used to be.' It's almost ironic — as inflation moderates, certain categories like entertainment and dining out are still sticky. Lucas: Exactly. The core CPI actually barely budged — it was 336.1 in June, essentially flat from the prior month. So the 'core' story is one of stubbornness. But the headline got a boost from falling energy. Luna: And that's where the consumer disconnect lives, right? Gas prices drop, people feel a bit more flush, and they go spend on experiences. But the cost of those experiences hasn't come down. Lucas: Right. Service inflation is still running hot — things like concerts, travel, dining out. So the 'funflation' angle captures this paradox: you're paying more for the things you want to do, even as the overall inflation rate cools. Luna: And it's not just a US story. India's inflation accelerated to 4.38 percent in June, which was above forecasts. China's consumer price growth weakened, but producer inflation there hit a near four-year high. Lucas: That China number is interesting because it feeds into the global disinflation wave we talked about in an earlier episode. But domestically, the Fed is watching the PCE price index more closely. The core PCE is at 130.1 — up from 129.67 in April — so it's still creeping. Luna: And the 10-year breakeven inflation rate is at 2.26 percent, up a couple of basis points from last week. That suggests the market still expects inflation to settle above the Fed's target for a while. Lucas: Right. The fed funds rate is at 3.63 percent, and with inflation still above 3 percent, real rates are barely positive. That's a tricky spot for the committee — they don't want to cut too early and reignite demand, but they also don't want to keep rates high if the economy softens. Luna: Speaking of softening — the unemployment rate ticked down to 4.2 percent, and jobless claims fell slightly. So the labor market is still tight, even if it's not as hot as last year. Lucas: Yeah, the JOLTS data showed job openings actually rose a bit in May to 7.594 million. So the demand for labor isn't collapsing. But average hourly earnings are only up to $37.60 — that's about 3.1 percent year-over-year, which is below the current CPI rate. Luna: So real wages are still negative? That's tough for households. Even if headline inflation is cooling, if your paycheck isn't keeping up, you feel it. Lucas: Exactly. And that's the puzzle for the Fed. If consumers are feeling squeezed, they might pull back on spending, which would help cool inflation. But so far, spending has been resilient — partly because people are dipping into savings or using credit. Luna: There's also this behavioral thing — you mentioned funflation — where people prioritize experiences over goods. So even if they're cutting back on appliances or new cars, they're still spending on concerts and travel. That keeps service inflation sticky. Lucas: Right. And as long as service inflation stays sticky, the Fed has to remain cautious. The market is pricing in maybe one cut by the end of the year, but it's not a sure thing. Luna: Before we get deeper into the rate path, I just want to mention something — and this is a bit of a behind the scenes thing. You know, we do this show every day, and it's completely listener-supported. There are no ads, no sponsors. Lucas: Yeah, it's a small team, and the economics of it work because a handful of listeners chip in monthly through Buy Me a Coffee. It's at buy me a coffee dot com slash fexingo. That's literally what funds making this many episodes. Luna: If walking through the economy with us has made something click, that's the way to keep it going. No pressure — just a fact. Lucas: Exactly. And now back to the rate path. So with core inflation still elevated, the Fed's preferred measure is the PCE, not CPI. The latest core PCE reading was 130.1, up slightly. That's still above their 2 percent target if you annualize it. Luna: And the 10-year Treasury yield is at 4.58 percent, with the 2-year at 4.32. So the yield curve is still inverted, but less deeply than before. That's a sign that the market expects rates to come down eventually. Lucas: Right. The 2-10 spread is about 26 basis points inverted. That's not screaming recession, but it's still a warning signal. The fact that the 10-year is above 4.5 percent tells you the bond market is demanding a term premium for uncertainty. Luna: Uncertainty about what, specifically? The path of inflation, or the fiscal outlook? Lucas: Both, I think. But in the near term, it's about inflation persistence. The breakeven rate at 2.26 percent says the market expects inflation to average a bit above 2 percent over the next decade. That's not a disaster, but it means the Fed's job isn't done. Luna: And then there's the global side. ECB President Lagarde left the door open to an early exit from negative rates — I mean, they're not negative anymore, but she hinted at a potential rate cut sooner than expected. That could affect the dollar. Lucas: If the ECB cuts while the Fed holds, the dollar strengthens. That would put downward pressure on commodity prices, which helps inflation. But it also hurts US exports and corporate earnings abroad. Luna: So it's a mixed bag. For the average consumer, a stronger dollar might mean cheaper imported goods, which is a good thing if you're shopping for electronics or clothes. Lucas: Right. But the big picture is that inflation is moderating, but not fast enough for the Fed to declare victory. And the consumer is adapting — spending on experiences, using credit, and feeling the pinch of still-high prices in services. Luna: One thing I'm watching is the 'at-home' cost. The funflation article pointed out that even staying in costs more because grocery prices are still elevated, and streaming services have raised prices. So you're kind of squeezed either way. Lucas: That's the thing — the CPI headline going down to 3.5 percent doesn't mean prices are falling. It means they're rising more slowly. And for categories like rent and services, the level is still high. That's what consumers feel. Luna: So where does that leave us for the second half of 2026? Are we looking at a 'soft landing' or something bumpier? Lucas: I think the soft landing is still the base case. GDP growth is at 2.1 percent annualized, the labor market is stable, and inflation is trending down. But the path is narrow, and there are risks — especially if service inflation doesn't cooperate or if global shocks hit. Luna: And the consumer is the wildcard. If they keep spending, the Fed may have to hold. If they pull back, the economy could slow faster. Lucas: Right. So the next few CPI and PCE reports really matter. The market will be watching for any sign that core inflation is breaking lower. If we see a sustained move below 3 percent on core, then the conversation shifts to when, not if, the Fed cuts. Luna: For now, it seems like we're in a holding pattern. The data is improving, but slowly. Lucas: Exactly. And that's the macro story of mid-2026 — gradual improvement, but no all-clear signal yet. Thanks for being here, and we'll see you next time.