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Why this week’s positive inflation reports won’t look as good to the Fed

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Watermelons from Mexico are displayed on a shelf at a Target store on March 5, 2025 in Novato, California.

Justin Sullivan | Getty Images

On the surface, February’s inflation data released this week brought some encouraging news. But underneath, there were signs likely to keep the Federal Reserve on hold when it comes to interest rates.

While the consumer and producer price indexes both were lower than anticipated, that won’t necessarily be reflected in the main measure the Fed uses to gauge inflation.

Because of some byzantine math and trends in a few key areas beneath the headline readings, policymakers are unlikely to take a lot of comfort in these numbers, according to multiple Wall Street economists.

“In short, progress on inflation has started off 2025 on the wrong foot,” Bank of America economist Stephen Juneau said in a note. “Our forecast for PCE inflation reinforces our view that inflation is unlikely to fall enough for the Fed to cut this year, especially given policy changes that boost inflation. We maintain our view that policy rates will stay on hold through year-end unless activity data really weakens.”

Markets agree, at least for now. Traders are assigning virtually no probability to a cut at next week’s Federal Open Market Committee meeting and only about a 1-in-4 chance of a reduction in May, according to CME Group calculations.

Treasury Sec. Bessent: We're focused on ‘real economy,' not concerned about ‘a little’ volatility

While the Fed pays attention to the two Bureau of Labor Statistics gauges, it considers the last word on inflation to be the Commerce Department’s personal consumption expenditures price index.

Central bank officials believe the PCE reading — in particular the core that excludes food and energy prices — to be a broader look at price trends. The index also more closely reflects what consumers are buying rather than just the prices of individual goods and services. If consumers are, say, substituting chicken for beef, that would be more indicated in PCE rather than CPI or PPI.

Most economists think the latest PCE reading, scheduled for release later this month, will show the year-over-year inflation rate at best holding steady at 2.6% or perhaps even ticking up a notch — further away from the Fed’s 2% goal.

Specifically, Thursday’s PPI report, which measures wholesale costs and is thus considered an indicator for pipeline inflation, “confirms our fears that the benign February inflation print would map across to a hotter than expected inflation print on the Fed’s preferred PCE inflation gauge,” wrote Krishna Guha, head of global policy and central bank strategy at Evercore ISI.

“Rather than decline steadily through early [second quarter], PCE inflation looks instead set to be bumpy and choppy,” he added.

Some of the areas that will feed through from PPI and elevate PCE include higher prices for hospital care as well as insurance prices and air transportation, according to Sam Tombs, chief U.S. economist at Pantheon Macroeconomics.

“The outturn almost certainly will make the Fed wince,” Combs wrote.

Combs predicts the core PCE reading for February will show an inflation rate of 2.8%, a 0.2 percentage point increase from January. That’s about in line with others on the Street, as Bank of America and Citigroup see the core inflation rate at 2.7%. Either way, it’s moving in the wrong direction. The consumer price index showed a core inflation rate of 3.1%, the lowest since April 2021.

However, there could be some good news yet.

As much as the expectation is for a bounce from February, many forecasters see inflation pulling back beyond that, even with the impact from tariffs.

Citi thinks March will see a “much more favorable” reading, with the firm predicting an out-of-consensus call of the Fed resuming its rate cuts in May. Market pricing currently indicates a much greater likelihood of a June cut.

Economics

Credit default swaps are in demand again amid U.S. fiscal worries

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Traders work on the floor of the New York Stock Exchange (NYSE) at the opening bell on May 27, 2025, in New York City.

Timothy A. Clary | Afp | Getty Images

Investors are getting nervous the U.S. government might struggle to pay its debt — and they are snapping up insurance in case it defaults.

The cost of insuring exposure to U.S. government debt has been rising steadily and is hovering near its highest level in two years, according to LSEG data.

Spreads or premiums on U.S. 1-year credit default swaps were up at 52 basis points as of Wednesday from 16 basis points at the start of this year, LSEG data showed.

Credit default swaps are like insurance for investors. Buyers pay a fee to protect themselves in case the borrower — in this case the U.S. government — can’t repay their debt. When the cost of insuring the U.S. debt goes up, it’s a sign that investors are getting nervous.

Spreads on the CDS with 5-year tenor were at nearly 50 basis points compared with about 30 basis points at the start of the year. In a CDS contract, the buyer pays a recurring premium known as the spread to the seller. If a borrower, in this case, the U.S. government defaults on its debt, the seller must compensate the buyer.

chart visualization

CDS prices reflect how risky a borrower seems and are used to guard against signs of financial trouble, not just a full-blown default, said Rong Ren Goh, portfolio manager in Eastspring Investments’ fixed income team.

The recent surge in demand for CDS contracts is a “hedge against political risk, not insolvency,” said Goh, underscoring the broader anxiety about U.S. fiscal policy and “political dysfunction,” rather than a market view that the government is verging on failing to meet its obligation.

Investors are pricing in the increased concerns around the unresolved debt ceiling, several industry watchers said.

“The credit default swaps have become popular again as the debt ceiling remains unresolved,” said Freddy Wong, head of Asia Pacific at Invesco fixed income, pointing out that the U.S. Treasury has reached the statutory debt limit in January 2025.

The Congressional Budget Office said in a March notice that the Treasury had already reached the current debt limit of $36.1 trillion and had no room to borrow, “other than to replace maturing debt.”

Treasury Secretary Scott Bessent said earlier this month that his department was tallying the federal tax receipts collected around April 15 filing deadline to come up with a more precise forecast for the so-called “X-date,” referring to when the U.S. government will exhaust its borrowing capacity.

Data from Morningstar shows that spikes in CDS spreads on U.S. government debt have typically aligned with periods of heightened worries around U.S. government’s debt limit, particularly in 2011, 2013 and in 2023.

Wong pointed out that there are still several months before the U.S. reaches the X-date.

The U.S. House of Representatives has passed a major tax cut package which could reportedly see the debt ceiling raised by $4 trillion, pending approval from the Senate.

In a May 9 letter, Bessent urged congressional leaders to extend the debt ceiling by July, before Congress leaves for its annual August recess, in order to avert economic calamity, but warned “significant uncertainty” in the exact date.

“There is still enough time for the Senate to pass its version of the bill by late July to avoid a technical default in U.S. Treasury,” added Wong.

During the debt ceiling crisis in 2023, the U.S. Congress passed a bill suspending the debt ceiling just days before the U.S. government entered into a technical default.

In the past, the U.S. has come dangerously close to a default but in each case, Congress acted last minute to raise or suspend the ceiling.

Fiscal reckoning

The surge in CDS prices is likely a “short-lived” reaction while investors wait for a new budget deal to raise the debt limit. It is unlikely a sign of an impending financial crisis, according to industry watchers.

During the 2008 financial meltdown, institutions and investors actively traded CDS linked to mortgage-backed securities, many of which were filled with high-risk subprime loans. When mortgage defaults soared, these securities plummeted in value, resulting in enormous CDS payout obligations.

However, the implications for soaring demand for sovereign CDS are very different compared to demand for corporate CDS which was the case in 2008, where investors were making an actual call about growing default risk at corporations, said Spencer Hakimian, founder of Tolou Capital Management.

“Traders seem to believe that CDS provides a speculative instrument for betting on a government debt crisis, which I view as extremely unlikely,” said Ed Yardeni, president of Yardeni Research, who added that the the U.S. will “always prioritize” paying interest on its debt.

“The U.S. government won’t default on its debt. The fear that it might do so is not justified,” he told CNBC.

Moody’s earlier this month downgraded the U.S. sovereign credit rating to Aa1 from Aaa, citing the government’s deteriorating fiscal health. 

Should the Senate pass the bill in time, the massive ceiling increase will push up the Treasury supply, putting the U.S. fiscal deficit condition back in the spotlight, Wong warned.

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Economics

Elon Musk says Trump’s spending bill undermines the work DOGE has been doing

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Tesla CEO Elon Musk attends the Saudi-U.S. Investment Forum, in Riyadh, Saudi Arabia, May 13, 2025.

Hamad I Mohammed | Reuters

Elon Musk criticized the Republican spending bill that recently made it through a House vote, saying it counters the work he’s been doing to reduce wasteful government spending.

In an interview to be aired June 1 on “CBS Sunday Morning,” the richest man in the world and the head of the Department of Government Efficiency advisory board said the “big, beautiful bill” will not help the nation’s finances.

“I was, like, disappointed to see the massive spending bill, frankly, which increases the budget deficit, not just decrease it, and undermines the work that the DOGE team is doing,” Musk said in a clip the program shared on social media platform X.

DOGE says it has saved $170 billion in taxpayer money since it began in January, targeting areas of government waste and redundancy in sometimes-controversial ways.

For instance, it has gutted the U.S. Agency for International Development and reduced staff elsewhere. DOGE-related moves have been responsible for some 275,000 government layoffs, according to Challenger, Gray & Christmas, a consultancy firm.

The sweeping One Big Beautiful Bill Act by contrast, is projected to raise the federal budget deficit by $3.8 trillion over the next 10 years, according to the Congressional Budget Office. The deficit is on track in 2025 to run close to $2 trillion, with the national debt now at $36.2 trillion.

“I think a bill can be big or it could be beautiful, but I don’t know if it could be both,” Musk said in the clip.

Trump and congressional Republicans counter that the bill reduces spending in key areas and will generate enough growth to compensate for the tax reductions. The legislation, though, is expected to face strong resistance in the Senate.

For his part, Musk has pulled back his DOGE work, saying he plans to focus on running his companies, which include X, Tesla and SpaceX. Musk had been a frequent presence in the White House since Trump’s election.

In an interview with The Washington Post published Tuesday, Musk said the federal bureaucracy is “much worse than I realized” and that DOGE became “the whipping boy for everything.”

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Economics

How young voters helped to put Trump in the White House

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THE 2024 election unfolded like a political thriller, replete with a last-minute candidate change, backroom deals, a cover-up, assassination attempts and ultimately the triumphant return of a convicted felon. But amidst the spectacle, a quieter transformation unfolded. For the first time, millennials and Gen Z, people born between 1981 and 2006, comprised a plurality of the electorate, and their drift towards Donald Trump shaped the outcome.

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