Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How the Fed Weighs Slowing GDP Against Sticky Core Inflation
Transcript
- Lucas: So the headline GDP number for Q2 came in at 1.5 percent annualized. That's down from 2.1 percent in Q1, and it's the slowest quarter since the first half of 2024. Luna: And yet core PCE inflation is still sitting at 3.3 percent for June. That's exactly the kind of mix that makes the Fed's job uncomfortable. Lucas: Right. The economy is clearly losing steam, but inflation isn't falling fast enough to declare victory. If walking through these numbers with us has made something click for you, honestly, if it was worth a coffee, you can find us at buy me a coffee dot com slash fexingo. Keeps this thing ad-free and lets us keep digging into the details. Luna: Yeah, and it's a small way to support what we do. So anyway, back to the Fed — how do they even start to think about easing when core inflation is still well above target? Lucas: Well, the fed funds rate is at 3.63 percent right now, and the interest on reserve balances is 3.65. So the policy rate is roughly flat since June. But the market is starting to price in a higher chance of a cut later this year. Luna: Even with core PCE at 3.3? That seems like a disconnect. Lucas: It does. But look at the two-year yield — it's at 3.67 percent, down sharply over the past week. That's the market betting that the Fed will have to respond to the growth slowdown. The ten-year breakeven rate actually ticked up to 2.26 percent, which suggests inflation expectations aren't collapsing. Luna: So the bond market is sending mixed signals. The short end says cuts are coming, the long end says inflation is sticky. Lucas: Exactly. And that's where the internal divide at the FOMC comes in. There's a camp that wants to hold until core inflation shows more progress, and another camp that's worried about overtightening. Luna: A headline from this week said 'What a divided Fed means for investors.' That divide seems to be widening. Lucas: It is. At the June meeting, the dot plot showed a median expectation for two cuts by year-end, but several members were arguing for staying on hold. Now with GDP slowing to 1.5 percent, the doves have more ammunition. Luna: But the hawks can point to core PCE still at 3.3 and say, 'We're not done yet.' Especially with oil prices creeping up and Singapore tightening policy yesterday. Lucas: Right, Singapore surprised markets with a tightening move, citing rising oil prices and rekindled inflation risk. That's a reminder that global inflationary pressures haven't vanished. Luna: So the Fed is caught between a weakening domestic economy and external inflation risks. That's the classic stagflation-lite scenario. Lucas: I'd be careful with the 'stagflation' label because the labor market is still relatively strong. But the GDP print definitely raises the question of whether the economy is more fragile than the Fed's models assume. Luna: And the consumer side? We've seen some softness in retail sales and consumer sentiment. Lucas: Yeah, the July data on consumer stress — which we talked about a few episodes back — hasn't improved much. If the consumer pulls back further, that could accelerate the slowdown and give the Fed cover to cut even if inflation is a bit sticky. Luna: But would a cut risk re-igniting inflation? That's the fear. Lucas: That's the fear. The ten-year breakeven moving up to 2.26 suggests the market is already expecting higher inflation over the long run. If the Fed cuts too early, they could lose credibility. Luna: So what's the timeline? The next meeting is in September. Do they have enough data by then? Lucas: They'll get two more CPI and PCE prints before that meeting. If core PCE stays above 3 percent, I think the hawks will resist any move. But if GDP continues to slow and the labor market softens, the doves will push harder. Luna: And the two-year yield is already pricing in a cut. If the Fed doesn't deliver, that could cause a sharp repricing. Lucas: Yeah, that's the risk. The market is leaning into a cut, but the data isn't cooperating. The Fed has to manage expectations carefully. Luna: One more thing — the yield curve has been steepening. The ten-year yield at 4.66 is up, the two-year at 3.67 is down. That's a steepening bias. Lucas: Right. A steeper curve often signals that the market expects future growth and inflation, but in this case, the short end is falling on rate-cut bets while the long end is holding up because of inflation concerns. It's a confusing signal. Luna: So what should listeners watch for between now and September? Lucas: Two things. First, the July employment report — if payrolls come in weak, that bolsters the cut argument. Second, the next core PCE print. If it stays at 3.3 or higher, the hawks will dig in. The Jackson Hole symposium in late August will be key for Fed communication. Luna: And Singapore's move? Could that contagion affect other central banks? Lucas: The US is a different beast, but it's a reminder that global inflation isn't dead. If oil keeps rising, it could complicate the Fed's path. Luna: So a divided Fed, a slowing economy, sticky inflation, and global headwinds. That's a lot to balance. Lucas: It is. And the next few weeks will be critical in shaping the narrative. We'll be watching closely. Luna: And if you want to stay on top of these developments, subscribing to the podcast helps. Thanks as always for listening.