Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Import Prices From China Are Distorting the Feds Inflation Picture
Transcript
- Lucas: There's this assumption floating around that inflation is basically solved because CPI and PCE are trending down. But the Fed is staring at a data point that cuts against that narrative pretty sharply. Luna: You're talking about the import price data that came out yesterday. Lucas: Exactly. Import prices posted a surprise gain in June, and the really striking number is that the cost of goods coming in from China hit its highest level since 2008. That's not a small blip. Luna: So the very thing that helped cool inflation over the last couple of years — cheap Chinese goods — might be reversing. And that creates a problem for the Fed's narrative. Lucas: Right. For most of 2024 and 2025, core goods inflation was essentially flat to negative. A lot of that was because China was exporting deflation. Their factory-gate prices were falling, and that passed through to everything from electronics to furniture to apparel. But now that channel is closing. Luna: And the timing is awkward because wholesale prices here at home actually fell in June. The headline PPI dropped 0.3 percent, driven by a big decline in gasoline. Lucas: So you've got this split screen: domestic wholesale prices deflating on energy, but import prices rising on goods. The Fed has to figure out which signal matters more for the inflation outlook six months from now. Luna: And which one does? I mean, the PPI is the more direct read on domestic production. But import prices feed into producer costs too. Lucas: That's the thing. The PPI decline is mostly energy, which is volatile and can reverse. But the import price increase is structural — it reflects higher Chinese production costs, currency dynamics, and maybe some tariff pass-through. If that persists, it'll start showing up in core goods CPI later this year. Luna: So the Fed is basically stuck. They want to cut rates, the market is pricing in cuts, but this import price data gives them cover to wait. The fed funds rate has been at 3.63 percent since June. Lucas: And the 10-year breakeven inflation rate — which is the market's expectation for average inflation over the next decade — ticked up to 2.24 percent. That's still within the Fed's comfort zone, but it's creeping away from 2 percent. The last thing they want is to cut too early and then have to reverse course because import prices push headline inflation back up. Luna: Right, and you can see why the market is jittery. The S&P 500 is down 0.8 percent over the last five days, and the NASDAQ is off 1.4 percent. That's not a panic, but it's a repricing of rate expectations. Lucas: Meanwhile, the two-year yield has fallen to 3.71 percent, which suggests the bond market still thinks the Fed will cut this year. But the ten-year is at 4.54 percent. That's a steep curve, and it usually means the market sees higher growth and inflation ahead. Luna: So the bond market is pricing in cuts, but also higher long-term inflation. That's a tricky signal for the FOMC. Lucas: Yeah, and the Fed's own preferred measure — core PCE — actually edged up to 130.1 in the latest reading. That was May data, but it shows the disinflation momentum is stalling. Combine that with rising import prices, and the hawks on the committee have plenty of ammunition to argue for holding steady. Luna: Let's talk about why Chinese import prices are rising specifically. Is it mostly currency? Or is it domestic inflation in China? Lucas: It's a mix. The renminbi has been relatively stable against the dollar, so that's not the main driver. What's happening is that China's own producer price index has started to turn positive after a long deflationary period. Their factory costs are going up — for energy, for raw materials, for labor. And that gets exported to us. Luna: Plus there's the geopolitical layer. Renewed tensions in the Strait of Hormuz are driving up energy costs globally, which feeds into Chinese production costs. The ECB is already rethinking its rate path because of that. Lucas: Exactly. And then you have the tariff overhang. Even though there haven't been major new tariffs announced recently, the existing ones remain in place. Importers have learned to pass those costs through. So the structural floor for import prices is higher than it was three years ago. Luna: So what does this mean for the average listener who's just trying to figure out whether mortgage rates will come down this year? Lucas: I think the honest answer is that the path to lower rates just got a little longer. If import prices keep rising, the Fed will want to see convincing evidence that it's not spilling into core inflation before they pull the trigger. That probably pushes the first cut into late 2026, maybe even 2027. Luna: And that's a shift from even a few weeks ago, when the market was pricing in a September cut. Lucas: Yeah, the CME FedWatch tool has backed away from that. The probability of a cut at the September meeting dropped below 50 percent after the import price data. Not a dramatic repricing, but a meaningful one. Luna: So the Fed is data-dependent, and the data is giving them mixed signals. I think a lot of people hear 'inflation is coming down' and assume that means rates are coming down. But the last mile is always the hardest. Lucas: Absolutely. And on that note — if walking through the economy with us has made something click for you, we keep this show entirely listener-supported. No ads, no sponsors. If today was worth the price of a coffee to you, you can find us at buy me a coffee dot com slash fexingo. Luna: It really does help us keep digging into these angles. We don't take it for granted. Lucas: Okay, back to the data. One more number I want to highlight: China's GDP growth for the second quarter came in at the slowest pace since 2022. That's partly why their government is calling for stimulus. But slower growth in China also means less demand for commodities, which could actually put downward pressure on some import prices. Luna: So there's a countervailing force. If China slows enough, their export prices might fall again. It's not a one-way street. Lucas: Exactly. And that's why the Fed isn't panicking. They can afford to wait and see which force wins out: Chinese cost inflation or Chinese demand weakness. In the meantime, they stay put at 3.63 percent. Luna: It's a waiting game. And for the rest of us, it means higher rates for longer — at least until the data resolves the contradiction. Lucas: Right. And that's the real story: the easy disinflation is over. The next phase is going to be choppier, and import prices are going to be a key signal to watch.