Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Bond Markets Expect Higher Inflation Despite Cooling CPI
Transcript
- Lucas: Luna, we've got a fascinating disconnect brewing. The 10-year breakeven inflation rate has ticked up to 2.26 percent, its highest in months. Yet the latest CPI headline fell to 332.6, down from 333.98. So the bond market is saying inflation is picking up, while the actual consumer price index says it's cooling. That's worth unpacking. Luna: Right, it feels like the market is betting against the official data. But what's driving that bet? Is it tariffs, oil, or something structural? Lucas: Good question. And before we get deep into that—if this kind of parsing of the economy is useful to you, the way we keep this ad-free is through listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. It genuinely makes a difference. Luna: Yeah, it's a small gesture that keeps the show independent. Thanks to everyone who already does. Lucas: So let's dig into why the bond market sees inflation differently. The 10-year breakeven is essentially the market's expectation for average CPI over the next decade. It rose from 2.20 to 2.26 in just a week. That's a meaningful move, especially when the headline CPI dropped. Luna: And it's not just the breakeven. We've seen oil prices creep up, and tariffs are back in the news. Singapore just tightened policy, citing inflation risk. That suggests global pressures. Lucas: Exactly. Trump's new global tariff, even with the two-year delay on drugs, is adding uncertainty. And oil prices have been rallying. But the bond market might be pricing in something else: the labor market. Unemployment fell to 4.2 percent, jobless claims hit 187,000, and average hourly earnings rose to $37.60. That's a tight labor market that could push wages and then prices. Luna: So even if CPI is cooling now, the bond market is looking ahead at wage-driven inflation. But core PCE is still rising—it hit 130.1. That's the Fed's preferred measure. Lucas: Right. Core PCE is up from 129.67 last month. So the official inflation data isn't uniformly falling. CPI fell partly due to energy base effects and some goods deflation, but services inflation remains sticky. The bond market might be saying that stickiness persists. Luna: What about the Fed? They're on hold at 3.63 percent, with a divided committee. Do you think this breakeven move pushes them toward a hike? Lucas: The market is now pricing about a 30 percent chance of a hike by September. The breakeven move is a signal, but the Fed has been data dependent. They saw GDP growth rebound to 2.1 percent annualized, and the labor market is strong. Some hawks are already worried about the tariff effects. Luna: But you've got doves pointing to the CPI decline. So it's a real split. How do you reconcile that? Lucas: I think the key is the timeline. The breakeven reflects expectations over 10 years, not just the next few months. Tariffs and wage pressures take time to feed through. The bond market is saying the disinflation we saw in CPI may be temporary. And with jobless claims at 187,000, the labor market isn't loosening. Luna: And we saw JOLTS job openings tick up to 7.594 million. That's more openings than hires. So companies are still looking for workers. Lucas: Exactly. That puts upward pressure on wages. Average hourly earnings are up 0.24 percent month over month. That doesn't sound like much, but annualized it's about 3 percent. Add in the tariff pass-through, and you've got a recipe for higher inflation down the road. Luna: So the bond market may be right to be wary. But what about the Singapore move? That's a small open economy, but it's a signal that central banks are still alert. Lucas: Absolutely. The Monetary Authority of Singapore tightened because of rising oil prices and rekindled inflation risk. That's a reminder that global commodity prices matter. Oil is above $80, and that eventually shows up in transportation and production costs. Luna: So the breakeven rise might be a composite of labor, tariffs, and oil. But CPI is still falling. How long can that disconnect last? Lucas: Historically, the bond market tends to lead. The breakeven rate has been a decent predictor of future CPI trends. If it stays elevated, we could see CPI bottom out and start rising again in the fall, especially with base effects fading. Luna: And the Fed has to watch that. They've been clear they're data dependent. If the breakeven keeps climbing, they might have to adjust their forward guidance. Lucas: Right. Fed Governor Waller recently said he's watching inflation expectations closely. And the breakeven is one measure. Plus, Kevin Warsh's three keywords—'patient', 'data dependent', 'transitory'—have been used in recent minutes. The Fed is threading a needle. Luna: So what's the takeaway for our listeners? Should they expect a rate hike, or is this just noise? Lucas: I'd say watch the breakeven. If it breaks above 2.35 percent, that's a clear warning. Also monitor jobless claims and wage data. For now, the Fed is on hold, but the bond market is telling us the next move is more likely up than down. Luna: And that's the kind of macro insight that's hard to find elsewhere. Good stuff, Lucas. Lucas: Thanks, Luna. We'll keep tracking it for you.