Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why China Export Prices Are Driving a Global Disinflation Wave
Transcript
- Lucas: So China's producer price index hit a near-four-year high in June — the data came out last week. But here's the twist: consumer price growth actually weakened. That divergence is sending a pretty clear signal through global supply chains, and it ties directly into the inflation puzzle the Fed is staring at right now. Luna: Right — higher factory-gate prices in China but lower consumer prices there. How does that ripple out to us? Lucas: Think of it this way: China is still the world's factory for a huge range of manufactured goods. When Chinese producer prices rise, it usually means input costs are going up — energy, commodities, that kind of thing. But if consumer demand in China is weak, those factories can't pass the costs through to domestic shoppers. So what do they do? They export the disinflation. They keep prices low on goods sold abroad to hold onto market share. Luna: Which means the rest of the world gets cheaper TVs, furniture, electronics — putting downward pressure on goods inflation. That's exactly what we've been seeing in US core goods prices. Lucas: Exactly. The US core CPI reading for May showed goods prices falling month over month — again. Meanwhile, services inflation remains sticky. That's the 'two-speed' inflation story the Fed keeps talking about. And China's factory-gate dynamic is a big reason goods disinflation has persisted longer than most forecasters expected. Luna: So China's domestic weakness is actually helping the Fed's fight against inflation, at least on the goods side. But that creates a weird dependency — if China's economy picks up and domestic demand strengthens, those producer cost increases could start flowing through to export prices. Lucas: Right. And we're already seeing some early signs of that. China's consumer price index came in at 4.38 percent in June — that's above expectations. But the core reading, excluding food and energy, is still quite low. The bigger story is that producer price inflation accelerated while consumer price growth moderated. That wedge suggests margins are getting squeezed. Luna: Which brings us back to the Fed. If goods prices keep falling but services inflation is stubborn — and the labor market is still adding jobs at a decent clip — then the Fed is stuck. The fed funds rate is at 3.63 percent effective, and the market is pricing in a cut sometime this fall, but the data hasn't really lined up for it yet. Lucas: Exactly. The jobs report for June showed nonfarm payrolls up by about 57,000 — that's a solid number, not booming but not recessionary either. Average hourly earnings ticked up to $37.60, so wage growth is still running above the level consistent with 2 percent inflation. And the unemployment rate actually dipped to 4.2 percent from 4.3. Luna: So the labor market is still tight enough that the Fed can't declare victory on inflation. But goods deflation from China is doing some of the work for them. It's an unusual dynamic. Lucas: Yeah. And it's not just China. We're seeing similar patterns across emerging Asia. Vietnam, Taiwan, South Korea — all of them are seeing producer price increases that aren't fully passing through to consumer prices because global demand for manufactured goods is still relatively soft. The IMF recently noted that global goods trade volumes are barely growing. Luna: That's part of the 'funflation' phenomenon too, right? People are spending more on experiences and services — dining out, travel, concerts — and cutting back on buying stuff. That shift depresses demand for goods, which forces factories to compete on price. Lucas: Exactly. And that's why you see headlines about 'funflation' — the idea that staying in isn't the cost-saver it used to be, because even groceries and home supplies have gotten more expensive. But the stuff you buy at Best Buy or IKEA? That's actually getting cheaper in real terms, partly because of this global disinflation wave. Luna: It's a strange world where your new TV costs less but your dinner out costs more. And the Fed has to weigh both. Lucas: Which is exactly why the breakeven inflation rate — the market's expectation for average inflation over the next ten years — is stuck at 2.24 percent. That's right around where it's been for months. The bond market is basically saying: 'We see the disinflation in goods, but we also see the stickiness in services, and we're not convinced the Fed can get all the way to 2 percent without a recession.' Luna: And if you look at the yield curve, the ten-year Treasury is at 4.61 percent, the two-year is at 4.36. That's a pretty flat curve — not inverted anymore, but not steep either. The market is pricing in some cuts, but not a lot. Lucas: Right. The fed funds rate is 3.63, the ten-year is a full percentage point above that. That normally signals that bond investors expect inflation or growth to pick up. But given the global backdrop, I think it's more about term premium — investors demanding extra compensation for uncertainty around fiscal policy and the inflation path. Luna: So where does that leave us for the rest of 2026? If China's producer price inflation keeps rising but consumer demand stays weak, we could see even more disinflationary pressure on goods. That might let the Fed cut rates once or twice without reigniting inflation. Lucas: That's the bull case. The risk is that China's domestic demand picks up — maybe from stimulus — and suddenly those producer cost increases start showing up in export prices. Then the Fed would have to hold steady for longer. And if services inflation doesn't moderate, we could be stuck with a 3.6 percent fed funds rate well into 2027. Luna: It really feels like the next few months of data will be decisive. The July CPI report, the August jobs numbers, and the next Fed meeting in September — those will tell us a lot. Lucas: Absolutely. And one thing I'm watching closely is the JOLTS data. Job openings ticked up slightly in May to 7.59 million, but that's still well below the peak of over 12 million. The labor market is cooling, just slowly. If openings start falling faster, that could be the signal the Fed needs to cut. Luna: Especially if wage growth starts to moderate. Average hourly earnings are still rising at about 4 percent annualized. If that comes down to 3.5 or below, the Fed might feel more comfortable. Lucas: Exactly. And that's where the China factor comes in again. If cheap imports keep goods prices low, that gives workers more purchasing power even with slower wage growth. So the Fed might be willing to tolerate a slightly higher wage number if goods deflation is offsetting it. Luna: It's a complicated puzzle. But I think the key takeaway for listeners is: don't look at inflation as one number. Look at goods versus services, and look at what's happening in China and other exporting economies. That's where the real story is. Lucas: Well said. And if walking through the economy with us has made something click, we'd love it if you considered supporting the show. It keeps us ad-free and lets us keep diving into these global dynamics. You can find us at buy me a coffee dot com slash fexingo. Luna: Yeah, even a small contribution goes a long way in helping us maintain the independence and depth that we aim for. We really appreciate everyone who listens. Lucas: Alright, back to the data. One more thing I want to flag: real GDP growth for the first quarter of 2026 was revised up to 2.1 percent annualized. That's a solid number, especially after the near-stall in the previous quarter. The US economy is still growing, but the composition matters. Consumer spending was strong, but business investment was a bit soft. Luna: And that softness in business investment ties back to the uncertainty we were talking about — tariffs, trade policy, the election cycle. Companies are hesitant to commit to big capital expenditures when they don't know what the regulatory landscape will look like next year. Lucas: Exactly. And if that uncertainty persists, it could weigh on productivity growth, which is the real driver of long-run living standards. So the China disinflation story is interesting, but it's not the whole picture. We've got a lot to watch in the second half of the year. Luna: We'll be tracking it all. Thanks for joining us on The Macro Memo. Lucas: See you next time.