Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Sticky Services Inflation Is Keeping Rates High
Transcript
- Lucas: Look at the August nonfarm payrolls number. One hundred sixty-two thousand jobs added, which sounds robust on paper, but if you peel back the layers, you see why the Fed isn’t rushing to cut rates just yet. The unemployment rate stayed flat at four point one percent, which means the labor market isn’t breaking, but it’s also not softening enough to give policymakers breathing room. Luna: Right, and when I look at those numbers, I’m less worried about the headline job count and more focused on where those jobs are coming from. It’s not manufacturing or goods production; it’s almost entirely in the service sector, right? Lucas: Exactly. And that is the crux of the problem we need to talk about today. Goods inflation has been tamed for a while now thanks to global supply chains normalizing and energy prices stabilizing. But services? That part of the economy is incredibly sticky because it is so tied to wages. If you are hiring more people in hospitality, healthcare, and finance, you have to pay them more, and then you pass that cost onto the consumer. Luna: So we are seeing this wage-price spiral play out in real time, specifically in areas like insurance and housing, which make up a huge chunk of the basket. Lucas: Let’s talk about the donation segment quickly. Honestly, if walking through the economy with us has made something click, buy me a coffee dot com slash fexingo keeps the lights on and lets us dig into these deeper dives without ads cluttering the conversation. Luna: Yeah, we appreciate every listener who supports the show directly. It helps us keep doing this work. Lucas: Back to the data. The latest Core PCE price index, which is the Fed’s preferred gauge, came in at one point three percent year-over-year. On the surface, that looks close to their two percent target, doesn’t it? Luna: It does, until you realize that one point three percent is actually higher than the last few months. It ticked up from one point two percent in July, which suggests the cooling trend might be stalling out exactly where we want it to go. Lucas: That stall is critical. When I look at the components driving that Core PCE number, housing stands out as the anchor dragging everything else down. Shelter costs are still rising at a pace that far exceeds general inflation. We are talking about rents and owners’ equivalent rent staying elevated because there simply isn’t enough new housing supply to meet demand in major metro areas. Luna: And insurance premiums are spiking too. Did you see the recent reports on auto and home insurance costs jumping double digits in many states? That is pure services inflation that feels very immediate to consumers. Lucas: I did. It’s frustrating because insurance is one of those bills that people can’t easily defer. You have to pay it, so even if they are cutting back on dining out or travel, that money is still flowing to insurers and repair shops. This creates a floor under inflation that prevents it from falling as fast as the Fed hoped. Luna: But here is the thing that worries me about the labor side. Average hourly earnings for private workers rose to thirty-seven dollars and eighty cents in August. That is still above what you would consider sustainable if you want to bring inflation down to two percent. Lucas: Thirty-seven dollars and eighty cents, yeah. That wage growth is keeping consumer spending alive, which is good for GDP, but it is feeding the very services inflation we are trying to cool. Companies in the service sector are using these profits to raise prices rather than just absorb higher labor costs, especially when demand remains resilient. Luna: So the Fed is stuck in a bind. Cut rates too early and you risk reigniting that services inflation. Keep them high too long and you risk choking off the labor market that is currently adding one hundred sixty-two thousand jobs a month. Lucas: Precisely. And notice how the bond market is reacting. The ten-year Treasury yield is sitting around four point seven eight percent. Investors are pricing in that the Fed will stay higher for longer because they don’t trust the disinflation process in services to hold. They know that once you get a taste of wage growth in the service sector, it is hard to give back. Luna: It reminds me of the mid-seventies. We had this same dynamic where oil shocks were replaced by wage demands in services, and inflation became entrenched for years. Are we seeing a similar structural shift here? Lucas: There are similarities, but I think the context is different. Today, productivity growth from technology, especially in AI and automation, is helping service firms manage costs better than they could in the seventies. A hospital can use software to reduce administrative bloat, for example. But that productivity gain is being absorbed by higher wages before it shows up as lower prices for the end consumer. Luna: So the benefit of efficiency isn’t translating to lower inflation for households yet. It’s just keeping companies profitable while they hire more people. Lucas: That is a fair way to put it. And this brings us to the gender gap in employment we saw in August. Women accounted for almost all the net job gains. Does that change the inflation picture? Luna: It definitely influences the type of services being consumed. More women in the workforce tends to increase demand for childcare, eldercare, and professional services, which are all highly labor-intensive and prone to wage-driven inflation. Lucas: Exactly. So as the demographic mix of the workforce shifts toward sectors that require more human interaction and less capital intensity, the underlying inflation rate likely moves higher structurally. The old model of relying on goods deflation to offset services inflation might be broken. Luna: Which means the Fed’s two percent target might need to be re-evaluated, or at least accepted as a much harder number to hit in the short term. Are they acknowledging that internal shift in their latest statements? Lucas: They are hinting at it. Chair Warsh has been emphasizing that the path to price stability is not linear and that they will watch labor market conditions closely. He isn’t saying inflation is gone; he is saying they need to see sustained evidence that services prices are moderating, not just slowing down. Luna: And with the election cycle heating up, there is political pressure to cut rates. Trump has already turned up the heat on the Fed, calling for action. How does that noise factor into their decision-making? Lucas: The Fed tries to ignore the noise, but politics always seeps in. If they cut rates in September or October, it will look politically motivated. If they hold, they risk looking stubborn while the economy slows. Given that Real GDP growth slowed to one point five percent in the second quarter, they have some cover to wait. They can afford to do nothing for another meeting. Luna: One point five percent growth is pretty weak for an expansion phase. Isn’t that usually when you want to stimulate, not restrain? Lucas: Normally, yes. But when growth is accompanied by sticky inflation, stimulus can feel like pouring gas on a fire. The Fed is prioritizing price stability over maximum employment in this specific window, betting that the labor market is strong enough to withstand higher rates for a few more months without collapsing. Luna: It is a risky bet. If those service sector wages keep climbing, businesses might start laying off workers to protect margins, which would suddenly spike unemployment and force a panic cut. Lucas: That is the downside risk. But right now, the data points to a slow grind rather than a cliff. Initial jobless claims are low at two hundred six thousand, and job openings are still high at seven million. The system is balanced precariously, but it is holding. Luna: So for listeners watching their portfolios, should we expect volatility to remain elevated as the Fed navigates this tightrope? Lucas: Absolutely. As long as the S&P 500 is hovering near seven thousand seven hundred with no clear direction from the Fed, markets will chop sideways. The VIX stays elevated because investors don’t know if the next move is a cut or a hike. Luna: It seems like patience is the only strategy right now. Wait for the next inflation report to confirm if services are finally cooling. Lucas: Patience and diversification. Don’t bet your whole portfolio on a single Fed decision. The economy is shifting, and the rules of engagement are changing. Luna: Agreed. We will see if the August data holds up in September, or if the services trap deepens further. Lucas: We will. For now, the message is clear: inflation isn’t dead, it’s just hiding in plain sight within the service sector, waiting for the Fed to make its next move.