Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / What Wholesale Deflation Means for the Fed Rate Path
Transcript
- Lucas: So wholesale prices fell 0.3 percent in June — that's the headline from Wednesday's Producer Price Index report, and it's the first monthly decline we've seen since the energy-driven drop last October. Luna: And the market kind of shrugged. S&P futures barely budged. But I think there's more here than just 'gasoline went down again.' Lucas: Exactly. The energy component did account for most of the drop — gasoline prices fell sharply. But even stripping out food and energy, core PPI was flat. And that's interesting because we've been hearing so much about services inflation being sticky. Luna: Yeah, and I think that's where the listener might be confused. CPI came in at 3.5 percent annualized on Tuesday, which is still above the Fed's target. So how do we square a hot consumer inflation number with falling wholesale prices? Lucas: A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: It's a small thing that makes a real difference. Keeps the show ad-free, lets us dig into numbers like this. Lucas: Right. So back to the wholesale picture — the key is that PPI measures what producers pay, and that doesn't always pass through to consumers immediately or completely. But when producer prices are falling, it usually means less pricing pressure down the line, especially in goods. Luna: And goods inflation has been the easier part of the puzzle. The Fed's problem has always been services — rent, insurance, healthcare. That stuff doesn't show up in PPI the same way. Lucas: True, but here's why this matters for the rate path. The Fed has been watching real rates — the difference between nominal rates and inflation expectations. The ten-year breakeven rate is now at 2.22 percent, down a basis point from yesterday. If wholesale deflation pulls headline inflation lower over the next few months, real rates could rise even if the Fed holds steady. Luna: Which would effectively tighten conditions without the Fed doing anything. That's the kind of argument that could sway the doves on the FOMC. Lucas: Exactly. And we already saw core PCE tick up slightly in the May data — from 129.67 to 130.1 — so the Fed's preferred gauge isn't cooperating yet. But if PPI continues to soften, it's a leading indicator that PCE might follow. Luna: Let me push back on that a little. The drop in PPI was mostly gasoline. Gasoline prices are volatile. One month doesn't make a trend. The Fed has been burned before by calling victory too early. Lucas: You're right. And Chair Powell has been very clear that they need sustained evidence. But look at the broader context. China's growth just slowed to its weakest since 2022 — that's putting downward pressure on global commodity prices. The World Cup gave bars and restaurants a temporary boost, but the Fed's own Beige Book noted consumer warning signs. The demand side is cooling. Luna: So you're saying the deflation in wholesale might be more structural than just a gas station anomaly. Lucas: I'm saying it's worth watching. The Fed is data-dependent, and this data point tilts in the direction of easing. If we get another month of soft PPI, the conversation at the September meeting shifts noticeably. Luna: And what about the other side — the risks? Renewed Hormuz hostilities are driving an ECB rates rethink. If energy prices spike, that whole narrative flips. Lucas: Absolutely. Geopolitical risk is the wildcard. The Fed has to balance the softening domestic data with external shocks. That's why they're in a holding pattern right now — the fed funds rate is at 3.63 percent, unchanged since June. They're waiting for clarity. Luna: So for the listener trying to make sense of all this: the wholesale deflation is a bullish sign for rate cuts eventually, but it's not enough by itself. We need to see it in consumer prices, and we need to see it sustained. Lucas: Right. And the next big checkpoint is the July PCE data, due out in late August. If that shows core PCE dipping, the odds of a September cut go up. If it stays sticky, the Fed stays patient. Luna: One more thing — the ten-year yield is at 4.57 percent, essentially flat on the week. The market is not pricing in a panic. But the yield curve is still inverted, which historically has been a recession signal. Lucas: Yeah, the two-year is at 3.70, the ten-year at 4.57 — that's about 87 basis points of inversion. The Fed has been watching that closely, as we've discussed before. But the fact that it's persisted for so long without a recession has made some economists question its predictive power. Luna: Or maybe it's just that the recession is delayed, not canceled. Soft landing is still the base case, but wholesale deflation adds a new layer. Lucas: It does. And I think the key takeaway for today is: don't ignore the PPI report just because it's not the Fed's primary gauge. When producers start cutting prices, it eventually reaches consumers. The question is timing — and whether external shocks interrupt the process. Luna: So we'll be watching the August data closely. And maybe the September FOMC meeting gets interesting after all. Lucas: Always interesting. But yes — this is a thread worth pulling. We'll keep tracking it.