Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Silent Tax of Sticky Core Inflation
Transcript
- Lucas: Look at the latest PCE price index numbers for July. Core PCE came in at one hundred thirty point seven, up from one hundred thirty point three four the month before. That might not sound like much on paper, but it tells a very specific story about where we are right now. Luna: It’s that slow creep rather than a spike that keeps policymakers up at night, isn’t it? Because markets have already priced in the volatility. Lucas: Exactly. The market has moved on, but the Federal Reserve hasn’t. We are sitting with the Fed Funds effective rate holding steady at three point six three percent as of early September, while core inflation refuses to break below that two percent psychological barrier. It’s a standoff between sticky service costs and a labor market that is still generating enough wage pressure to keep prices elevated. Luna: So you’re saying the 'last mile' of disinflation is actually the hardest part because it’s tied directly to wages? Lucas: Precisely. And if you look at average hourly earnings for the private sector in August, they rose to thirty seven dollars and eighty cents. That is an increase from thirty seven dollars and sixty five cents. When you combine that with a nonfarm payroll count of roughly one hundred fifty nine thousand jobs and an unemployment rate holding at four point one percent, the message is clear: employers are still paying up to retain talent. Luna: But isn’t that just normal market correction after years of pandemic-era disruption? Why is this considered 'sticky' instead of healthy adjustment? Lucas: Because healthy adjustment usually means productivity gains outpacing wage growth. Here, wages are rising, but real GDP growth for the quarter ending in April was only one point five percent annualized. That is down from two point one percent the previous quarter. We are seeing nominal GDP hit thirty two trillion four hundred eighty six billion dollars, but the real output component is stalling. That gap is where the inflation lives. Luna: So the economy is growing slower, but costs are still going up? That sounds like stagflation-lite. Lucas: Stagflation implies a broader collapse in confidence or energy shocks. This is more structural. It’s concentrated in services. Think about insurance, healthcare, and housing. These are sectors where supply constraints haven’t really eased. You can’t build houses overnight, and you can’t manufacture insurance capacity instantly. So when demand stays resilient, prices just keep ticking upward. Luna: And yet, the ten-year breakeven inflation rate is sitting flat at two point three five percent as of yesterday. Investors seem confident the Fed will get there eventually. Lucas: Investors are betting on the Fed’s credibility, but also on the idea that high rates will eventually crush demand. But look at the job openings data from JOLTS. There were seven thousand two hundred seventy-one thousand openings in July, up from seven thousand one hundred eighty-two thousand. That is an increase in vacancies. More vacancies mean more competition for workers, which means more wage pressure, which means more service inflation. Luna: That’s a counterintuitive link. Usually, people think low unemployment cools things down, but here it seems to be fueling the fire. Lucas: Right. The labor market is signaling tightness. Initial jobless claims ticked up slightly to two hundred six thousand, but that’s still near historic lows. When layoffs are rare, workers have leverage. They can demand higher wages without fear of being replaced immediately. And businesses, facing their own labor shortages, pass those costs onto consumers through higher prices for services. Luna: Does this mean the Fed is trapped? If they cut rates, inflation rebounds. If they hold, they risk choking off the fragile recovery. Lucas: They are definitely trapped. And notice how the S&P 500 is hovering around seven thousand seven hundred nineteen points. The equity market is pricing in a soft landing, but the bond market is whispering doubts. The ten-year Treasury yield is at four point seven eight percent. That’s higher than many expected given the slowdown in real GDP. Luna: So the bond market is effectively saying, 'We don't believe the inflation story yet.' Is that fair? Lucas: Fairer than that. The bond market is saying, 'Real growth is weak, so yields should be lower, but inflation expectations are anchoring us higher.' It’s a tug of war between growth fears and inflation persistence. And since the Fed controls neither fully, they are stuck managing the middle ground. Luna: What about the consumer? Are they feeling this pinch yet, or is savings cushioning the blow? Lucas: Savings buffers are largely depleted. We saw headlines about budget travelers getting thrifty and shifting from mystery vacations to hostels. That is a behavioral change. People are trading down. But essential services like healthcare and auto insurance are not discretionary. Those prices are rigid. You can skip a vacation, but you can’t skip your car insurance premium, which has been skyrocketing due to increased repair costs and litigation expenses. Luna: It’s interesting that you mention repairs. Supply chains have mostly normalized, so why are auto repair costs still driving inflation? Lucas: Because modern cars are computers on wheels. Repair shops need specialized software, diagnostic tools, and certified technicians. It’s a labor-intensive service sector with a shortage of qualified mechanics. So even if parts are available, the cost of labor to install them remains high. That is classic services inflation. It doesn’t respond to interest rates quickly because it’s driven by skill mismatches, not monetary policy. Luna: So the Fed is trying to solve a skills problem with a blunt instrument like interest rates. That seems inefficient. Lucas: It is inefficient, but it’s all they have. Monetary policy works with a long and variable lag. By the time rate hikes cool the labor market enough to reduce wage pressure, the damage to economic growth might already be done. That’s why the current pause at three point six three percent feels so precarious. They are waiting for the past decisions to take effect. Luna: Do you think the recent political noise, like the headlines about pressure on Warsh, is adding uncertainty to the Fed’s decision-making? Lucas: Political pressure is always a background factor, but the Fed is insulated enough to ignore the day-to-day noise. What matters more is the data. And the data is telling us that core inflation is not moving fast enough toward two percent. If anything, the uptick in job openings suggests the economy is hotter than the Fed would like. Luna: Hotter than they want, but cooler than last year. It’s a gradual cooling process that feels like standing still. Lucas: Standing still is exactly the risk. If real GDP stays at one point five percent while inflation hovers around two to two point five percent, we enter a period of stagnant purchasing power. That’s the hidden trap. Your income might go up five percent, but if everything you buy goes up four percent, you feel poorer. Luna: And that perception drives spending behavior, which in turn drives inflation. It’s a feedback loop. Lucas: A vicious one. Unless productivity jumps significantly, which AI promises but hasn’t delivered broadly yet, we are stuck in this grind. The best-case scenario is a slow drift back to target over the next eighteen months. The worst case is that wage pressures reaccelerate if the labor market tightens further. Luna: Given the current rate environment, do you see any sectors benefiting from this sticky inflation? Lucas: Financials and certain healthcare providers. Banks benefit from higher net interest margins, although loan growth is slowing. Healthcare providers have pricing power because demand is inelastic. But for most other sectors, margin compression is the reality. They can’t raise prices much more without losing customers, but they can’t cut costs much more without hurting quality. Luna: So it’s a squeeze play for corporate America. High input costs, limited pricing power, and a consumer who is starting to pull back. Lucas: Exactly. And that pullback is subtle. It’s not a crash. It’s just a hesitation. People are buying fewer big-ticket items and spending more on experiences, but even experiences are getting expensive. That’s why the services sector is so critical to watch. It’s the engine of current inflation. Luna: It makes sense that the Fed is cautious. They can’t afford to loosen too soon and let inflation become entrenched again. Lucas: Right. One misstep could reset the clock. And given how close they’ve gotten to two percent, resetting the clock would be politically and economically painful. So they will likely hold steady for a while longer, watching the core PCE and job openings data closely. Luna: It’s a game of inches then. Small moves, small data shifts, and a lot of patience required from investors. Lucas: Patience and precision. The market wants certainty, but the macro environment is giving us ambiguity. We are in a phase where the usual indicators are sending mixed signals. Strong payrolls but weak growth. Low unemployment but rising vacancy counts. It’s a complex puzzle. Luna: And the solution isn’t obvious. Which makes our job of tracking these nuances even more important for listeners trying to make sense of it all. Lucas: Absolutely. We’re here to decode the signal from the noise. And right now, the signal is that the economy is resilient but restless, caught between the hope of lower inflation and the reality of higher costs. Luna: If walking through the economy with us has made something click, we deliberately don't run ads on these shows. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Lucas: It keeps the research deep and the analysis independent. Thanks for helping us keep it that way. Now, back to the data. Luna: As we look ahead to the next CPI release, what’s the one number you’ll be staring at? Lucas: Shelter costs within the core index. If housing inflation starts to decouple from rents and actually reflect the lagged impact of home prices, that could be the catalyst that finally brings core PCE down to target. Until then, we’re just watching the clock. Luna: Here’s hoping the clock runs faster than the price tags. Lucas: Me too. Let’s see if August’s data confirms this trend or if we’re in for another surprise.