Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Import Prices from China Are Distorting the Feds Inflation Data
Transcript
- Lucas: So, import prices from China just hit their highest level since 2008. That is not a headline you would expect to see when overall inflation is cooling. It is the kind of crosscurrent that makes the Fed's job genuinely hard right now. Luna: Right — because the general narrative is that inflation is coming down, wholesale prices actually deflated last month, but then you look at this one channel and it is pointing the other way. Lucas: Exactly. The wholesale price index fell 0.3 percent in June, driven by a big drop in gasoline. That is deflation in the producer pipeline. Meanwhile, the cost of goods coming in from China is rising. So the Fed has to ask: which signal is the real one? Luna: And the answer probably is that both are real, but they just affect different parts of the economy. Lucas: That is exactly how I see it. The wholesale deflation is mostly in energy and commodities — things the U.S. either produces domestically or sources from multiple places. The China import price increase is specific to goods where China is still the dominant supplier, and where tariffs and geopolitical friction are adding cost. Luna: So the Fed cannot just look at the headline CPI or PCE and say 'job done'? Lucas: No, they cannot. And they know it. Look at the core PCE — it edged up to 130.1 in May from 129.67. That is not a big move, but it is moving in the wrong direction if you want to declare victory. The ten-year breakeven inflation rate also ticked up to 2.24 percent. The market is pricing in slightly higher inflation expectations. Luna: And the breakeven is kind of the market's summary judgment on where inflation is headed over the next decade. Lucas: Exactly. So when you put it together — falling wholesale prices, rising import costs from China, a sticky core PCE, and a slightly higher breakeven — the picture is messy. The Fed's preferred measure, the core PCE, is still above their 2 percent target. They cannot cut rates aggressively, but they also do not want to tighten further because the economy is sending conflicting signals. Luna: And this is where the China factor becomes a real headache for policymakers. Because it is not a demand-driven inflation. It is a supply-side shock from trade policy and geopolitics. Lucas: Right. If it were demand-pull inflation, raising rates would be the obvious answer. But when the cost of imported goods goes up because of tariffs or shipping disruptions, monetary policy is a blunt instrument. You can raise rates to cool demand, but that does not fix a broken supply chain. Luna: So the Fed is stuck. They are watching data that is partly driven by trade policy, not by consumer spending or wage growth. Lucas: And they have been explicit about that. Several Fed speakers this year have said they are looking through one-time price shocks from tariffs. But the question is: when does a one-time shock become persistent? If import prices stay elevated for another six months, it starts to feed into expectations and then into core inflation. Luna: That is the risk. And we have seen that play out before — during the 2018-2019 trade war, tariffs led to a modest bump in consumer prices, but it was transitory because companies absorbed some of the cost. This time, it might be different. Lucas: Why do you think it is different? Luna: Because the supply chain is more fragmented now. After COVID, companies diversified away from China, but not completely. For many products, there is still no real alternative at the same scale. So when China's costs go up, it is harder to absorb. Lucas: And the data backs that up. The import price index for goods from China is at levels we haven't seen since 2008. That is before the global financial crisis. So it is not just a small blip. Luna: And what does that mean for the Fed's rate path going into the second half of 2026? Lucas: Well, the effective federal funds rate has been flat at 3.63 percent since June. The Fed is clearly in a wait and see mode. The market is pricing in a cut maybe later this year, but that depends on whether inflation continues to ease. If the China import price pressure starts showing up in core PCE, they will hold. Luna: So we are basically in a data-dependent stalemate. Lucas: Exactly. And one of the most important data points to watch is the next CPI release, which will show whether the China import cost is passing through to consumers. Because so far, the wholesale deflation has offset some of that pressure. But if wholesale prices stabilize and import prices keep rising, the pass-through becomes inevitable. Luna: And the Fed is watching that spread very closely. Lucas: They are. And this is actually a good moment to mention — if you find this kind of granular analysis useful, we do this because we believe in making economics accessible. We deliberately do not run ads on these episodes. If you want to support that approach, the link is buy me a coffee dot com slash fexingo. It is a small way to keep this completely listener-supported. Luna: Yeah, and it makes a real difference. We hear from listeners who say it helps them understand what the Fed is actually doing, and that is what we want. Lucas: Alright, back to the China import story. One thing I want to highlight is how this connects to the broader disinflation narrative. The reason wholesale prices fell was largely gasoline. That is a volatile component. So if energy prices rebound, the deflation signal disappears, and you are left with the China import pressure and sticky services inflation. Luna: And that is exactly the scenario the Fed fears — the so-called 'last mile' of inflation being the hardest. Lucas: Yes. The easy gains from falling energy and goods prices are behind us. What remains is services inflation, which is driven by wages and housing, and now potential goods inflation from China. That is a tougher nut to crack. Luna: And monetary policy works with long and variable lags, so the Fed has to be careful not to overreact to one month of data. Lucas: Right. That is why they are focused on the trend in core PCE and breakeven rates. The breakeven at 2.24 is still close to their target, but it is up from 2.22 the week before. Not a big move, but if it continues to rise, it signals that the market expects inflation to stay above target. Luna: And that would make it harder for the Fed to cut rates even if the economy slows. Lucas: Exactly. So the bottom line is: the Fed is navigating a narrow path. They have to balance the risk of easing too soon and reigniting inflation against the risk of staying tight too long and causing a recession. The China import price data adds a layer of complexity because it is not driven by domestic demand. Luna: It is almost like an external tax on consumption. Lucas: That is a good way to put it. And the Fed cannot cut that tax. Only trade policy can. So the central bank is essentially waiting to see if the fiscal and trade authorities adjust course. Luna: But they cannot count on that happening. Lucas: No, they cannot. And that is why the range of outcomes for the second half of 2026 is so wide. If China import prices moderate, the Fed can cut. If they keep rising, we could see rates on hold for the rest of the year. Luna: And if they start to pass through to core inflation, we might even be talking about a hike. Lucas: That is the tail risk, yes. It is not the base case, but it is on the radar. The Fed wants to avoid that at all costs, because hiking now would be very unpopular and could trigger a recession. Luna: So the data over the next two months is critical. Lucas: Absolutely. Especially the July and August CPI and PCE reports. If they show that the China import price increase is contained to a few categories, the Fed can look through it. But if it broadens, that changes everything. Luna: And that is what we will be watching closely. Lucas: For now, the takeaway is that the inflation picture is more layered than the headline numbers suggest. The Fed is dealing with a disinflation that is real but uneven, and the China factor is the wildcard that could either fade or become the next big story. Luna: And it is a reminder that in a globalized economy, the Fed cannot control everything. Lucas: That is the key insight. Monetary policy is powerful, but it is not a cure-all. Sometimes the most interesting questions are the ones the Fed cannot answer by adjusting rates.