Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Watching Wholesale Prices More Than CPI
Transcript
- Lucas: Wholesale prices unexpectedly declined 0.3 percent in June, driven by a big drop in gasoline. That headline came out yesterday, and I think it might be more important than the CPI number we got on Tuesday. Luna: Because the Producer Price Index tends to lead consumer prices, right? If producers are paying less, that should eventually flow through to the stuff we buy. Lucas: Exactly. The CPI came in at 3.5 percent annualized, which was a tick below expectations. Energy eased, but core inflation — excluding food and energy — was essentially flat. The PPI drop, though, is a fresher signal. It suggests pipeline pressure is easing faster than what we see at the retail level. Luna: So the Fed might be looking at PPI more closely now? I mean, they always look at a basket of data, but this seems like a leading indicator. Lucas: I think so. The Fed funds rate is at 3.63 percent, and the market has been pricing in a cut later this year. If wholesale prices keep falling, it gives the Fed cover to ease without worrying about reigniting inflation. But the core PCE — which is the Fed's preferred gauge — is still running a bit hot. The May reading was 130.1, up from 129.67. Luna: Right, so they're stuck between a softening PPI and sticky core services. That's the classic dilemma. Lucas: And then there's the labor market. Unemployment ticked down to 4.2 percent in June, and jobless claims just fell to 215,000. That's a tight labor market. So the Fed has to balance falling goods prices against still-solid wage growth and services inflation. Luna: Average hourly earnings are up to 37.6 dollars, which is about 4 percent year-over-year. That's above the inflation rate, so real wages are positive. That's good for consumers, but it keeps pressure on services prices. Lucas: Right. And the 10-year breakeven inflation rate is at 2.23 percent, which is exactly where the Fed wants it. So the market is pricing in that inflation is under control. The question is whether the Fed agrees enough to cut. Luna: Let's dig into the PPI number. What drove the drop? Lucas: Energy was the big factor. Gasoline prices fell sharply in June. We saw that at the pump, and it showed up in the wholesale data. But it's not just energy. The core PPI, excluding food and energy, was also soft. That suggests broader disinflation in the goods sector. Luna: And that's consistent with what we're hearing from China. Their export prices are low, and that's pushing down global goods prices. The headline yesterday said China posted its slowest quarterly growth since 2022, and investment slumped. So they're exporting deflation in a way. Lucas: Exactly. We talked about that in a previous episode. The China export price effect is real. But the PPI data is a more direct read for the U.S. economy. It captures what domestic producers are paying for inputs, and it's falling. Luna: If you're a manufacturer, lower input costs are great. But if you're the Fed, you want to make sure this isn't just a temporary blip from gasoline. Lucas: Right. And that's why they'll watch the next few months of data. The June CPI was encouraging, but core services inflation — things like rent and healthcare — remain stubborn. The Fed's preferred measure, the core PCE, was at 2.6 percent annualized in May. That's still above the 2 percent target. Luna: So the PPI drop is a good sign, but it's not the whole story. Lucas: And if walking through the economy with us has made some of this click, I'll just say: the show stays ad-free because of listener support. If today was useful to you, you can help keep it that way at buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small way to say this kind of deep dive is worth backing. We appreciate it. Lucas: So back to the PPI — one thing that stood out to me is that the drop was broad-based. It wasn't just gasoline. There were declines in food, in chemicals, in transportation. That's a sign that disinflation is becoming more entrenched. Luna: But the bond market doesn't seem fully convinced. The 10-year Treasury yield is at 4.55 percent, up a bit from last week. That's still elevated. Lucas: Right. The yield curve is still inverted in some maturities, but the long end is staying high. That could be because of term premium — investors demanding more compensation for holding long-term bonds given the uncertainty around fiscal policy and inflation. Luna: Or it could be that the market is pricing in that the Fed won't cut as aggressively as previously thought. Lucas: Exactly. Fed funds futures still imply a cut by September, but the probability has come down a bit. The strong labor market and sticky core inflation are giving the Fed reason to hold steady. Luna: And then there's the geopolitical factor. The headlines about renewed Hormuz hostilities are driving oil price uncertainty. That could reverse the gasoline price drop we just saw. Lucas: That's the wildcard. If energy prices spike again, the PPI drop might be short-lived. The Fed would have to factor that in. So the next few weeks of data are critical. Luna: Let's zoom out. What does this mean for investors? Lucas: If disinflation continues and the Fed cuts, that's generally positive for equities, especially interest rate sensitive sectors like real estate and utilities. But if inflation reaccelerates, we could see a sell-off. The S&P 500 is at 7,572, up slightly this week. The Russell 2000, though, is at 2,976, down 0.5 percent in the last five days. Small caps are still struggling. Luna: Because they're more sensitive to borrowing costs. If rates stay high, they get squeezed. Lucas: Exactly. So the PPI data is a ray of hope for small caps, but they need to see actual rate cuts to rally. Luna: And for the consumer, lower wholesale prices should eventually mean lower prices at the store. But we haven't seen that fully yet. Lucas: That's the transmission mechanism. It takes time. But if the PPI trend holds, we should see CPI moderate further in the coming months. The July CPI report will be key. Luna: So to sum up: PPI dropped unexpectedly, driven by energy and broader goods disinflation. The Fed has a dilemma between falling goods prices and sticky services. The labor market is still tight, giving them cover to wait. But if the trend continues, a rate cut becomes more likely. Lucas: That's the picture. And we'll be watching the data closely. Thanks for joining us on The Macro Memo.