Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Is Tracking Chinese Import Prices Again
Transcript
- Lucas: Luna, I want to start with a number that might have flown under the radar last week. Import prices posted a surprise gain in June, and the cost of goods coming in from China hit its highest level since 2008. Luna: That's a big deal, especially after years of Chinese export prices actually dragging global inflation down. Lucas: Exactly. For the better part of two years, cheap Chinese exports were a major disinflationary force. It helped bring down headline inflation even when domestic services inflation was sticky. But that's clearly shifting. Luna: So what's driving the reversal? Is it just tariffs, or is there something structural happening inside China? Lucas: It's a mix. We know China just reported its slowest quarterly growth since 2022, and investment is slumping. That's actually part of the story — when domestic demand is weak, Chinese producers usually cut prices to stay competitive globally. But we're not seeing that this time. Luna: Right, because input costs are rising. Energy, raw materials, maybe even labor. Lucas: Yes. And there's also the geopolitical layer. Renewed tensions in the Strait of Hormuz are pushing up shipping and insurance costs. Plus, some Chinese factories are relocating supply chains to avoid tariffs, which adds cost. So even if the headline tariff rate doesn't change, the effective cost of importing from China is going up. Luna: And this comes at a delicate moment for the Fed. They've been encouraged by core CPI finally ticking down — it went from 336.12 to 336.1 in June, a small but real move. Lucas: Right. That's the kind of data that gives the FOMC confidence to start thinking about rate cuts — especially with the unemployment rate dropping to 4.2 percent and jobless claims falling. But if import prices keep rising, that disinflation narrative gets complicated. Luna: Because the Fed's preferred measure, core PCE, includes imported goods. And if Chinese goods are getting more expensive, that could keep core PCE sticky even as domestic demand softens. Lucas: Exactly. The ten-year breakeven inflation rate is at 2.25 percent, basically unchanged. But markets are pricing in a slightly higher inflation risk premium, which is why the ten-year Treasury yield is still above 4.6 percent. Luna: So the yield curve is un-inverting, but not because growth is roaring — it's because the term premium is rising on inflation uncertainty. Lucas: That's the right framing. The two-year yield is at 3.73, the ten-year at 4.63, so the curve is positively sloped again. Historically that's a signal that the economy is healing, but this time it feels more like a risk premium story. Luna: And the consumer data adds another wrinkle. The World Cup gave bars and restaurants a temporary boost, but the Fed's own Beige Book noted that consumers are flashing warning signs. Lucas: Right. Spending on services held up because of the World Cup, but underlying retail sales — especially for goods — are soft. And credit card balances are creeping up again. So you have this tension: sticky inflation from imported goods, a consumer that's resilient but increasingly reliant on credit, and a Fed that wants to cut rates. Luna: It feels like the Fed is stuck again, but for different reasons than last year. Lucas: Last year it was domestic services inflation that wouldn't budge. Now it's goods prices coming back from an unexpected direction. If Chinese import prices keep rising, it could delay the first rate cut well into 2027. Luna: And one more thing — wholesale prices actually fell 0.3 percent in June, driven by a drop in gasoline. So the pipeline from producer to consumer is mixed. Gasoline down, Chinese goods up. Lucas: That's the kind of cross-current that makes the Fed's job so hard. But it's also why we do this show — to make sense of these conflicting signals. Luna: And speaking of that — it's worth mentioning that this show is ad-free, and that's entirely thanks to a small group of listeners who chip in each month. Lucas: Yeah, it's really simple: if walking through the economy with us has made something click, you can support the show at buy me a coffee dot com slash fexingo. No pressure, just a way to keep it going. Luna: We don't have ads, we don't have sponsors, and that's how we want it. So thank you to everyone who already helps make that possible. Lucas: Alright — back to the data. So the key question for the next few months is whether this Chinese price surge is a one-off or the start of a trend. Luna: What would make it a one-off? Lucas: If global energy prices cool down and shipping costs normalize, Chinese exporters could regain some pricing power and possibly even lower prices again to win market share. But if the geopolitical situation stays hot and China's domestic demand remains weak, they might actually need to keep prices higher to maintain margins. Luna: So the Fed is really watching two things: the path of Chinese import prices and the strength of the consumer. Lucas: Right. And on the consumer side, the World Cup bump is already fading. July and August data will be crucial. If retail sales soften and import prices stay elevated, the Fed will have to choose between fighting inflation and supporting growth. Luna: That's the classic stagflationary setup, but with a twist — the labor market is still pretty tight. Lucas: Exactly. Unemployment at 4.2 percent, job openings still above 7.5 million. So it's not stagflation in the classic sense, but it's a policy dilemma. Do you cut rates to help the consumer, or hold to make sure inflation doesn't re-accelerate? Luna: And the market is already pricing in a slower pace of cuts. The Fed funds rate is at 3.63 percent, and futures suggest maybe one cut by year-end. Lucas: That feels about right to me. The Fed will want to see at least another month of core PCE easing before they commit. And if Chinese import prices keep rising, they might wait even longer. Luna: So the bottom line: the disinflation tailwind from China is turning into a headwind, and that changes the calculus for everyone. Lucas: It really does. And it's a reminder that in a globally connected economy, no inflation story is purely domestic. We'll keep tracking this closely. Luna: For sure. And if you want to help us keep doing that, you know where to find us. Lucas: Thanks for listening, and we'll be back tomorrow.