Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / How Wholesale Inflation Is Reshaping the Fed's Next Move
Transcript
- Lucas: So yesterday's Producer Price Index number — 1.1 percent headline, double the whisper number — that's the kind of data point that makes you rethink the whole inflation narrative. Luna: And it was almost entirely energy, right? The core PPI ex food and energy was actually pretty muted. Lucas: Exactly. The energy component surged nearly 5 percent month-over-month. That's the highest monthly jump since early 2022. And you can draw a pretty straight line from that to the situation in Iran. Luna: Meanwhile, the ECB hiked rates for the first time since 2023 yesterday, explicitly citing energy costs. So this is a global pattern, not just a US one. Lucas: Right, and that's the interesting tension. The ten-year breakeven inflation rate — the market's implied expectation for average inflation over the next decade — actually fell to 2.29 percent. Down from 2.34 a week ago. So markets are looking at the same energy spike and saying 'this is transitory.' But the PPI says 'not so fast.' Luna: If walking through the economy with us has made something click, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: It really does help keep this show ad-free and focused on the numbers that matter. So, thank you if you've ever thrown a couple bucks our way. Luna: Yeah, truly. Anyway — back to the PPI. Lucas, you mentioned the Fed's current rate is 3.62 percent. Does this wholesale inflation pressure change the odds of a cut this year? Lucas: I think it makes a cut less likely in the near term, but not for the reason you'd expect. The Fed has been watching core PCE — that's their preferred gauge — and core PCE has been hovering around 2.8 percent. That's still above their 2 percent target, but trending down. The PPI spike is upstream — it takes time to feed through to consumer prices. So the Fed might look at this and say 'let's wait and see if this is a one-month blip, or the start of a new trend.' Luna: But the CPI also came in hot — 4.2 percent annualized in May. That's the highest in three years. So it's not just wholesale. Lucas: Yeah, the CPI number was ugly. But again, energy was the main driver there too. Core CPI, ex food and energy, was up 3.4 percent year-over-year — still elevated, but not accelerating. So the inflation story right now is really the energy story. Luna: And that energy story is geopolitical. The Iran situation isn't going away anytime soon. So how do you model that as a macro forecaster? Lucas: It's tricky. The traditional models don't handle war-related supply shocks well. You can look at scenarios — assume a certain percentage of global oil supply gets disrupted, and then model the pass-through to gasoline prices and then to core inflation. But the uncertainty band is huge. Luna: The market seems to be pricing in a relatively benign outcome. The VIX is still in the mid-teens, and the S&P is near all-time highs. Lucas: Right, and that's the disconnect. The bond market is pricing in lower long-term inflation, but the equity market is acting like the energy spike is a non-event. One of them is probably wrong. Luna: Which side do you lean on? Lucas: I think the bond market might be a bit too complacent. The ten-year breakeven at 2.29 percent implies that inflation will average below 2.3 percent for the next decade. That's a pretty aggressive bet given that we've been above 2 percent for most of the past five years. Luna: And the Fed's own projections — the dot plot — what do those show? Lucas: We don't have a new dot plot until the June meeting, which is in a couple of weeks. But as of the March projections, the median FOMC member expected two quarter-point cuts this year. That was before the CPI and PPI numbers came in. I would be surprised if that median shifts toward more cuts. Luna: So we might stay at 3.62 percent for a while. Lucas: Possibly through the summer. The Fed has been very data-dependent, and the data just got messier. The jobs market is still tight — 4.3 percent unemployment, but job openings jumped to 7.6 million in April, up from 6.9 million. That's a big swing. Luna: The JOLTS number was a surprise. I thought openings would continue to drift down. Lucas: Me too. But the labor market is still showing resilience. And that gives the Fed cover to hold rates steady even if inflation ticks up a bit. They don't want to cut into a strong labor market and risk reigniting demand-side inflation. Luna: What about the consumer? The Michigan sentiment number has been slipping. Lucas: Yeah, sentiment is low. But spending hasn't collapsed yet. The consumer is stressed but still spending, partly because wages are still growing — average hourly earnings are up about 4 percent year-over-year. That's above inflation on a nominal basis, but after adjusting for CPI, real wages are barely positive. Luna: So the squeeze is real, but it's not acute enough to force a recession. Lucas: Exactly. It's a slow bleed, not a heart attack. And that's the hardest environment for the Fed. They can't cut because inflation is sticky, but they can't keep rates high forever without risking something breaking. Luna: Something like the commercial real estate market? That's been a worry for a while. Lucas: Yes, that's the classic risk. But so far, it's been more of a slow motion problem than a crisis. Office vacancy rates are high, but banks have been provisioning for losses. It hasn't cascaded. Luna: What about the yield curve? It uninverted earlier this year, and that's usually a recession signal. But we haven't seen one yet. Lucas: The curve uninverted without a recession, which is rare. But the 'curve uninversion' signal is more about the timing — recessions tend to follow about six to eighteen months after the curve flattens or reinverts. The fact that we haven't had a recession yet doesn't mean we're out of the woods. Luna: So you're still cautious. Lucas: I'm cautious but not bearish. The economy is in a weird equilibrium — slow growth, sticky inflation, tight labor. It could tip either way. The wildcard is energy. If the Iran situation escalates, all bets are off. Luna: And if it de-escalates? Lucas: Then we could see inflation cool quickly, and the Fed might have room to cut by the end of the year. But that's a big if. Luna: Alright, so we're watching the PPI, the CPI, and the geopolitics. Anything else on your radar for next week? Lucas: Industrial production data comes out next week. That will give us a read on the manufacturing side. And the FOMC minutes from the last meeting are due — they might give us some color on how much the energy situation is worrying them. Luna: Good. We'll be watching. Thanks, Lucas. Lucas: Thanks, Luna. Talk to you next time.