Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching Wholesale Prices Deflate
Transcript
- Lucas: Luna, we got wholesale prices data yesterday that I think is actually more important for the Fed right now than the CPI print we saw on Tuesday. Luna: Because the Producer Price Index unexpectedly declined — down three-tenths of a percent in June. That's not something we see often. Lucas: Exactly. The headline PPI fell 0.3 percent month over month, and the big driver was a massive drop in gasoline. Wholesale energy prices fell almost 5 percent. But even core PPI, which strips out food and energy, was flat. That's a signal that pricing power is weakening at the producer level. Luna: And the Fed has been saying for months that they need to see more evidence that inflation is sustainably moving toward 2 percent. Wholesale deflation — even if it's just for one month — is pretty strong evidence. Lucas: Right. The CPI came in at 3.5 percent annualized in June, which was a tick below expectations. But the PPI tells us what's coming down the pipeline. If producers can't pass along price increases, that eventually shows up in consumer prices. Luna: So the question is whether this is a one-off driven by energy, or the beginning of a broader trend. Lucas: And that's exactly what the Fed is trying to figure out. The 10-year breakeven inflation rate — which is the market's expectation for average inflation over the next decade — has fallen to 2.23 percent. That's down from 2.25 just a day earlier. The market is starting to price in lower inflation risk. Luna: But the Fed has been burned before by calling the end of inflation too early. Remember last year when they thought the disinflation was solid, and then services inflation reaccelerated? Lucas: Absolutely. That's why Chair Powell has been so careful lately. He keeps saying they need 'greater confidence' before cutting rates. But the data is moving in the right direction. Core PCE, which is the Fed's preferred measure, came in at 130.1 in May — that's up only slightly from 129.67 in April. The trend is flattening. Luna: So if PPI keeps falling, and CPI stays around 3.5 percent, what does that mean for the rate path? Lucas: It means the Fed can afford to hold steady at the current effective fed funds rate of 3.63 percent, which is where it's been since June. The market is already pricing in a cut in September, but I think the Fed will wait for at least two more months of data before they move. They don't want to repeat the mistake of 2023, when they paused and then had to hike again. Luna: You know, walking through the economy like this, month after month, it really helps make sense of the data. If listeners find that useful — and I hope they do — there's a simple way to support the show and keep it ad-free. Lucas: Yeah, it's a small gesture that goes a long way. You can head to buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. No pressure, but if you get value from these conversations, it helps us keep going. Luna: And we're back to the data. One thing I want to dig into is the regional detail. The Fed's Beige Book came out yesterday and mentioned that the World Cup gave bars and restaurants a boost, but consumers are showing warning signs. Lucas: That's a great point. The Beige Book noted that discretionary spending is softening outside of event-driven boosts. So you have this weird mix: wholesale prices falling, consumer inflation still elevated, and the consumer showing signs of strain. That's a tricky environment for the Fed. Luna: And then there's the geopolitical side. Renewed hostilities in the Strait of Hormuz are pushing oil prices up globally, which could reverse the wholesale deflation we just saw. The ECB is already rethinking its rate path because of it. Lucas: Right. The Fed has to watch that closely. If energy prices spike again, that PPI decline could be a one-hit wonder. But for now, the trend is encouraging. The bond market is starting to believe it — the 2-year yield is at 3.70, which is basically flat week over week. The yield curve is still inverted, but less deeply than before. Luna: So the bottom line for listeners: the Fed is getting the disinflation data they've been waiting for, but they're not ready to declare victory. They want to see the pipeline effect play out in consumer prices. Lucas: Exactly. And the next big data point is the July CPI and PPI reports, which we'll get in August. If those show a continued decline, the September FOMC meeting becomes very interesting. But for now, the Fed is in a wait and see mode, and the wholesale deflation is the most important signal they've received in months.