Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / The Fed Is Watching Wholesale Prices Deflate
Transcript
- Lucas: So wholesale prices unexpectedly dropped 0.3 percent in June, and the big driver was a sharp decline in gasoline costs. The headline number came out this morning, and it's got the bond market leaning a little further into rate-cut expectations. Luna: But isn't this just one month of data? The Fed's been pretty clear they want to see a sustained trend before they move. Lucas: Right, it's one month. But the context matters. Consumer inflation already came in softer than expected yesterday—3.5 percent annual, down from 3.8 percent in May. So you've got both the CPI and the PPI now pointing in the same direction: price pressures are easing. And the wholesale number is particularly interesting because it tends to lead consumer prices. Luna: Lead in what sense? If producers are charging less, does that eventually show up at the checkout counter? Lucas: Exactly. A drop in producer prices often feeds through to consumer prices within a couple of months, especially for goods. The PPI captures input costs for things like food, energy, and raw materials. When those fall, retailers have room to cut prices or at least stop raising them. So this June PPI print could be an early signal that the July and August CPI reports will also come in soft. Luna: But the core PPI—excluding food and energy—what did that do? Because the headline decline was all gasoline. Lucas: Core PPI was flat month over month. So you're right to flag that. The headline move was entirely energy. But here's the thing: the Fed's preferred inflation gauge, the core PCE, actually puts a lower weight on energy than the CPI does. So if energy keeps falling, the PCE could decelerate even faster than the CPI. And the PCE already ticked up slightly in May, but that was largely due to a bounce in services. The goods deflation trend is intact. Luna: Alright, so the data is moving in the Fed's favor. But the fed funds rate is still at 3.63 percent. What's the market pricing for a cut in September? Lucas: As of this afternoon, fed funds futures are pricing about a 70 percent chance of a quarter-point cut at the September FOMC meeting. That's up from around 55 percent a week ago. The two-year Treasury yield is down to 3.70 percent—that's basically at the fed funds rate, which tells you the market thinks the Fed is done hiking and will start cutting soon. The ten-year is at 4.55, so the curve is still inverted, but less deeply than earlier this year. Luna: And the breakeven inflation rate—the market's expectation for average inflation over the next decade—is at 2.25 percent. That's pretty much right on the Fed's target. Lucas: Exactly. The 10-year breakeven has been hovering around 2.25 for a few weeks now. That suggests the bond market believes the Fed has inflation under control. The question is whether the Fed agrees. Chair Powell has been saying they need more confidence before cutting. But if the next few CPI and PCE prints confirm this disinflation trend, that confidence could build quickly. Luna: So is the risk now that the Fed might be too slow to cut? If they wait too long, could they tip the economy into recession? Lucas: That's the debate. Some economists argue that with inflation falling and the labor market still solid but cooling, the Fed should start normalizing rates soon. Others say they should hold steady until they see clear evidence that services inflation is also coming down. The core services ex-housing—what the Fed calls 'supercore'—is still running around 4 percent. So there's a split. Luna: Speaking of the labor market, the headlines today also mentioned renewed geopolitical tensions in the Gulf. Does that complicate the inflation picture? Lucas: It could, if oil prices spike. But so far, the response has been muted. Brent crude is actually down a bit this week, partly because of demand concerns out of China. China's GDP just came in at its slowest pace since 2022, and that's putting a lid on energy prices. So for now, the geopolitical risk is more of a tail risk than an immediate threat. The bigger story is the deflationary pull from weak global demand. Luna: So if I'm a business owner listening, what should I take away from this? Lower input costs are good, but does it also signal weaker demand ahead? Lucas: That's the nuance. Falling producer prices can be a double-edged sword. On one hand, your costs are going down, which can boost margins if you hold your selling prices steady. On the other hand, if the decline is driven by weak demand, your volumes might suffer. The key is to watch your own customers' behavior. Are they still buying at the same pace? If yes, lower input costs are a tailwind. If no, you might need to cut prices to move inventory. Luna: The other thing I'm thinking about: the dollar. If the Fed cuts rates while other central banks hold or hike, the dollar could weaken. That would make imports more expensive and could reignite inflation. Lucas: That's a real risk. The ECB is dealing with its own inflation challenges, especially with the Hormuz situation you mentioned. If the ECB has to keep rates higher for longer, the euro could strengthen against the dollar. But if the Fed cuts and the ECB holds, the dollar weakens, and that pushes up import prices. The Fed has to weigh that against the domestic inflation data. It's a delicate balance. Luna: Honestly, if walking through the economy with us has made something click, that's the link: buy me a coffee dot com slash fexingo. It's the smallest way to keep the show ad-free. Lucas: Yeah, it genuinely helps. No pressure, but if you find value in these conversations, that's where you can support. Luna: So back to the PPI: the wholesale deflation story is new. It's not just about falling gasoline. We saw declines in some core goods categories too—like lumber and metals—which suggests the disinflation is broadening. Lucas: Right. The details matter. In the June PPI, the index for processed goods for intermediate demand fell 0.5 percent. That's stuff like steel, chemicals, and plastic resins. That's a leading indicator for finished goods prices down the line. So the pipeline is disinflationary. If that persists, the Fed will have a strong case for cutting rates sooner rather than later. Luna: And yet, the Fed's own projections from June showed only one cut this year. Do you think they'll revise that in September? Lucas: I think they'll have to, if the data keeps coming in this soft. The dot plot is a lagging indicator. By September, we'll have two more CPI prints, two more PPI reports, and the July jobs number. If all those show continued cooling, the FOMC will likely pencil in at least two cuts for 2026. The market is already ahead of them, but the Fed tends to move cautiously. Luna: So the bottom line: wholesale deflation is real, it's broadening, and it's giving the Fed cover to cut. But the timing depends on whether the next few data points confirm the trend. Lucas: Exactly. This episode is about one data point, but it's a data point that might mark a turning point. The PPI is often overlooked compared to the CPI, but it's arguably more important for forecasting. If you're watching the Fed, watching producer prices is a good way to anticipate their next move. Luna: And we'll keep watching it with you. Thanks for listening.