Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Wholesale Prices Are Breaking The Inflation Narrative
Transcript
- Lucas: If walking through the economy with us has made something click, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that is literally what funds making this many of these shows possible. Luna: It really keeps the lights on without needing ads cluttering up the feed. Lucas: Exactly. So let's get back to where we left off last week, because the numbers coming out this morning are giving me pause. We spent a lot of time talking about the consumer side of inflation, the CPI prints, the way households feel at the grocery store. But if you look at the other end of the pipeline, the wholesale prices for September jumped 6.3 percent annually, which is the biggest gain we have seen since 2022. Luna: That feels like a massive outlier compared to the softer consumer data we've been tracking. Is this just a one-off blip in the reporting cycle? Lucas: I don't think it is. The thing people miss when they only look at the CPI is that wholesale prices capture the cost of goods before they hit the retail shelf. When those costs spike like this, it usually means businesses are either facing sudden input shocks or they are rebuilding inventory after running too lean. And right now, with the S&P 500 down nearly two percent over the last five days, the market seems nervous about exactly this kind of margin compression. Luna: So you are saying the pressure hasn't disappeared, it has just moved upstream? Lucas: Precisely. And here is the twist that makes this interesting for the Fed. While wholesale prices are screaming, the core PCE price index, which is the Federal Reserve's preferred gauge, only ticked up from 130.13 to 130.5 in August. That is still stubbornly above target, but it is not accelerating. You have this divergence where the producers are feeling the heat, but consumers haven't fully absorbed those costs yet. Luna: That creates a weird lag effect. Businesses might hold off on raising prices until their margins actually squeeze them, right? Lucas: Right. And that lag is dangerous because it means inflation could pop up later even if the data looks calm today. Look at the job market context. Unemployment ticked up to 4.2 percent in September, and initial jobless claims are creeping toward 200,000. If wages stay sticky while wholesale costs jump, companies are caught in a vice. They can't raise prices easily because demand is softening, but their costs are rising faster than they anticipated. Luna: It sounds like a classic stagflation risk, even if it is mild. Why aren't bond yields reflecting this worry more aggressively? Lucas: They are reacting, but maybe not in the way you would expect. The ten-year Treasury yield dropped 2.7 percent over the last week to sit around 5.10 percent. Investors are pricing in a scenario where the Fed holds rates steady in October, maybe even cuts later in the year, to help stabilize the economy. They see the weak jobs data and the cooling consumer prices, so they are betting on easier monetary policy to offset these wholesale spikes. Luna: But does that bet ignore the structural reality of those 6.3 percent wholesale jumps? Lucas: It ignores it partially. The market is focusing on the headline unemployment number and the slight dip in real GDP growth to 2.2 percent annualized. Those are the triggers for rate cut expectations. But if wholesale prices keep climbing quarter-over-quarter, that 2.2 percent growth rate could turn negative much faster than anyone thinks. It is not just about the Fed cutting rates; it is about whether the underlying machinery of production is becoming more expensive to run. Luna: I wonder if this is tied to the budget deficit swells we saw reported recently. Does government spending fuel these input costs? Lucas: That is a fair connection. The U.S. budget deficit swelled to almost 2 trillion dollars for fiscal 2026, up 12 percent in a single year. Massive liquidity injection into the system can absolutely drive up commodity prices and logistics costs. When you have that much capital chasing limited physical goods, wholesale prices naturally rise. It is less about productivity and more about pure monetary volume. Luna: So the Fed is fighting a war on two fronts. They have to cool the deficit-fueled demand without crushing the labor market that is already showing cracks. Lucas: Exactly. And that is why Kevin Warsh's comments earlier this week were so relevant. He suggested the Fed might surprise us, perhaps by holding firm longer than expected. If wholesale prices continue to accelerate, the Fed cannot afford to cut rates prematurely. Doing so would inject more fuel into an engine that is already overheating at the producer level. Luna: Do you think the current 3.75 percent effective Fed Funds rate is actually restrictive enough given these new cost pressures? Lucas: I think it is restrictive for the consumer sector, but maybe not for the business sector. Small and mid-cap companies, represented by the Russell 2000 which is down 2.6 percent this week, are more exposed to raw material costs. They do not have the pricing power of big tech or large retailers. So while the S&P 500 takes a hit, the smaller players are feeling the pinch immediately. That fragmentation in the market is a direct reflection of this wholesale inflation split. Luna: It feels like we are moving away from the broad-based inflation narrative into something more fragmented. Different sectors experiencing different realities. Lucas: We definitely are. And that makes forecasting harder. If you look at the JOLTS data, job openings dropped to 7,079,000 in August. Labor demand is clearly slowing. But average hourly earnings for private workers rose slightly to 37.80 dollars in September. Wages are still growing, which supports consumer spending, but it also adds to the cost base for employers who are already struggling with wholesale inputs. Luna: So the wage-price spiral isn't dead, it is just dormant? Waiting for the wholesale costs to force their hand? Lucas: That is a good way to put it. A dormant spiral. The danger is that when those wholesale costs finally pass through to consumers, the CPI will jump abruptly. We saw a preview of this with the PPI data economists flagged earlier. Hot PPI suggests the Fed's work is not done. If we see a similar spike in the upcoming CPI print, the market's current optimism about rate cuts will evaporate overnight. Luna: What happens to the dollar then? If inflation reignites, the USD should strengthen, right? Lucas: It usually does. But look at the ten-year breakeven inflation rate. It actually ticked up from 2.32 to 2.35 percent recently. That is a subtle signal that investors are starting to hedge against higher long-term inflation. If the dollar strengthens too much, it hurts exporters, but it helps importers. Given that global debt saturation is a recurring theme, a strong dollar makes servicing international debt harder for emerging markets, which could create spillover effects back into the U.S. economy. Luna: So the ripple effects go far beyond just domestic pricing. This connects back to those global debt warnings the Treasury dismissed recently. Lucas: Yes. The Treasury dismissed the IMF's debt warning, calling the forecasting messy. But when wholesale costs rise globally due to energy or logistics constraints, it affects everyone. The U.S. is not immune to global supply chain frictions. If China or Europe face their own inflationary pressures, their demand for U.S. exports could drop, further stressing the American manufacturing sector that is already dealing with high input costs. Luna: It seems like the isolationist view of the economy doesn't hold water anymore. Everything is linked through these cost channels. Lucas: Absolutely. You cannot separate domestic policy from global supply chains. And that is why I am watching the nonfarm payrolls closely. We added only 29,000 jobs in September, barely above zero. That stagnation, combined with rising wholesale costs, suggests we are entering a period of low-growth, high-cost instability. It is not a crash, but it is not a recovery either. It is a grind. Luna: A grind sounds exhausting for businesses trying to plan ahead. How are CFOs reacting to this uncertainty? Lucas: They are likely pulling back on capital expenditure. When you do not know if your raw materials will cost 6 percent more next month, you delay expansion. That hesitation feeds back into the GDP number, keeping that growth rate capped at 2.2 percent. It is a self-fulfilling prophecy of caution. The data tells us to wait, so we wait, and the economy stays flat. Luna: Do you think the Fed will acknowledge this wholesale spike in their next statement, or will they stick to the core PCE narrative? Lucas: I think they will acknowledge it, but they will frame it as transitory if they want to maintain their dovish bias. However, if the trend continues for two or three quarters, the language will have to shift. The Fed is data-dependent, and this data is getting noisy. The disconnect between the calm consumer surface and the turbulent wholesale depths is unsustainable. Luna: Unstable undercurrents. I like that imagery. It captures the hidden risk perfectly. Lucas: It does. And for listeners, the takeaway is simple: watch the producer prices, not just the consumer prices. The consumer data is the rearview mirror. The wholesale data is the windshield. If the windshield is clouded by rising costs, the car is going to slow down, regardless of how fast it was going yesterday. Luna: So we need to be looking upstream to understand where the economy is actually heading next quarter. Lucas: Exactly. And if the Fed misreads that signal, they could tighten when they should ease, or ease when they should hold. Either mistake could trigger the volatility we saw in the tech sector this week. The NASDAQ dropped 4.1 percent, leading all major indices. Tech stocks are sensitive to discount rates, which are sensitive to inflation expectations. If wholesale prices stay high, discount rates stay high, and valuations compress. Luna: It is a delicate balancing act. One wrong move and the whole structure wobbles. Lucas: Wobbles is putting it lightly. It could shatter confidence. But for now, we remain in this gray zone. The numbers are there, they are contradictory, and they demand attention. I will be watching the October PPI release with extreme care. If that number comes in hot, everything we discussed today becomes the immediate focus of every trader and policymaker in New York. Luna: And if it stays cool, we might have been worrying too early about the wholesale spike. Lucas: Then we have a false alarm. But in economics, false alarms are often just delayed truths. Let's see what the rest of October brings.