Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Climate Shocks Are Rewiring Central Bank Policy
Transcript
- Lucas: If you look at the headlines from Paris this week, you see a story that feels distant from Wall Street but is actually sitting right inside our inflation calculations. France’s wine production has just hit a seventy-year low, and it isn’t just about fine dining or weekend brunches. Luna: Right, because when the base crop shrinks that dramatically, the price elasticity kicks in hard across the entire food sector. Lucas: Exactly. And while we spend a lot of time debating whether the Fed should cut rates based on labor friction, the reality is that supply-side shocks from climate events are becoming structurally permanent. The Fed is staring at a CPI number where food and energy components are refusing to stabilize, not because of wage demands, but because the physical goods simply aren't there in expected volumes. Luna: So the pressure isn't coming from workers asking for more money, but from farmers losing their yield? Lucas: Precisely. Let’s look at the numbers as of late September 2026. The Core PCE price index is sitting at one hundred thirty point seven, up from one hundred thirty point three four last quarter. That might sound like a modest tick, but if you drill down into the sub-components, you see agricultural commodities and processed foods pulling the average up. This is what economists call greenflation, and it is fundamentally different from demand-pull inflation. Luna: And the Fed can’t lower interest rates to fix a drought. Lucas: They absolutely cannot. When you raise rates to kill inflation caused by excess demand, you’re trying to cool down consumer spending. But when inflation is caused by a shortage of wheat due to heatwaves, raising rates doesn’t make the crops grow faster. It just makes borrowing more expensive for everyone else, including the logistics companies trying to move what little grain is left. Luna: Which brings us back to those transport alarm bells I saw yesterday. Why are trucking and shipping companies so worried about fuel prices right now? Lucas: Because they are caught in the middle. The headline from Wednesday was blunt: transport companies, the backbone of the economy, are sounding alarms on fuel. With global supply chains already strained by these climate disruptions, any spike in diesel or aviation fuel gets passed directly to the consumer. You have higher freight costs meeting higher raw material costs, creating a perfect storm for the twelve-month CPI, which currently sits at three hundred thirty-four point one. Luna: It feels like the Fed is fighting a rear-view mirror war while the road ahead keeps changing. Lucas: That is the crux of the issue. The Federal Funds effective rate is holding steady at three point six three percent, but the daily rate has crept up to three point eight eight percent as of mid-September. That divergence tells me the market is pricing in risk that the official policy rate hasn’t fully captured yet. The Fed is waiting for data to confirm that these climate shocks are temporary blips rather than a new normal. Luna: But with wine yields down seventy percent, is this really temporary? Lucas: No, and that’s why the models are breaking. Traditional Phillips Curve analysis assumes a trade-off between unemployment and inflation. But here, you can have stable unemployment and rising inflation simultaneously because the shock is external. The labor market isn’t driving prices up; the weather is. And until the Fed incorporates a climate risk premium into their forecasts, they will keep misreading the signals. Luna: Does this mean we should expect higher volatility in the bond market? Lucas: Look at the ten-year Treasury yield. It’s at four point nine six percent, down slightly over the last five days, but the breakeven inflation rate is stuck at two point three three percent. Investors are demanding compensation for uncertainty. They know that next year’s harvest could be worse than this year’s, and they want insurance against that possibility baked into long-term yields. Luna: So the cost of capital is rising even if the Fed holds steady. Lucas: Exactly. And this puts businesses in a bind. If I’m a grocery chain, I can’t choose to source cheaper wine from a region that had a good harvest without disrupting my supply chain entirely. I have to pay the premium. Those costs flow through to the shelf price, and then the Fed looks at the Consumer Price Index and sees sticky inflation, forcing them to keep rates higher for longer. Luna: It creates a feedback loop where tight monetary policy doesn’t solve the root cause. Lucas: It exacerbates the pain elsewhere. High rates hurt small farms who need loans to invest in irrigation or drought-resistant seeds. So you get less adaptation capacity exactly when you need it most. It’s a policy mismatch. Fiscal policy—government spending on infrastructure and agriculture—is better suited to handle these shocks, but monetary policy is being asked to do fiscal work. Luna: And the markets are starting to realize that distinction. Lucas: The Nasdaq is up four point four percent over the last week, while the Dow is flat. Tech stocks might benefit from efficiency gains, but industrial and consumer staples are feeling the pinch of these input costs. The S&P 500 is at seven thousand seven hundred seventy-two, but that aggregate mask the divergence in sectors. Agriculture and transportation are bleeding margins. Luna: What about consumer sentiment? Are people just accepting higher prices? Lucas: Not at all. Goldman Sachs reported yesterday that consumer sentiment is in the dumps despite a solid economy. They blame a 'lower happiness' metric. People feel poorer not because they lost their jobs, but because their purchasing power is eroding due to invisible supply constraints. They can’t understand why milk or bread costs more, so they lose trust in the system. Luna: That loss of trust is dangerous for the Fed’s credibility. Lucas: It is. If the public believes the Fed is blind to the real drivers of inflation, they stop anchoring their expectations. Inflation expectations become unmoored. We see the ten-year breakeven at two point three three percent, which is above the two percent target. That gap represents the market’s belief that the Fed will eventually fail to tame these structural pressures. Luna: So the solution isn’t just tighter money, but better adaptation? Lucas: Yes. We need investment in resilient supply chains. We need technology that reduces waste in agriculture. We need logistics networks that are less sensitive to fuel spikes. But none of that happens overnight. The Fed is stuck managing the symptoms while the disease progresses. Luna: Do you think the Bank of England’s recent decision to hold rates reflects this same anxiety? Lucas: Very likely. The BoE defied the Fed’s potential hike lead and kept rates unchanged on Thursday. They are seeing similar supply-side pressures in Europe, particularly in energy and food. If major central banks are all hesitating, it suggests they are waiting for clarity on whether these shocks are transitory. But with climate change accelerating, transitory is becoming a risky bet. Luna: It seems like we need a new framework for central banking altogether. Lucas: We do. A framework that explicitly prices in climate risk. Imagine if the Fed had a separate metric for supply-side volatility, distinct from demand-side overheating. Then they could adjust policy more surgically. Instead of blunt interest rate hikes, they could coordinate with fiscal authorities to ease bottlenecks. Luna: Until then, investors are just guessing which way the wind blows. Lucas: And that is why the VIX remains elevated. Uncertainty is the enemy of valuation. When you don’t know if next quarter’s earnings will be crushed by a bad harvest or boosted by strong consumption, you demand a higher risk premium. That pushes equity valuations lower across the board. Luna: So the thirty-year low in wine isn’t just a tragedy for Bordeaux, it’s a macro indicator. Lucas: It is. Every drop of water that evaporates, every acre that burns, adds to the cost curve. The question for the rest of 2026 is whether the Fed will finally acknowledge that they are fighting a war on two fronts: inflation and adaptation. Because right now, they seem focused only on the first. Luna: And if they ignore the second, the first will never truly go away. Lucas: Well said. Before we wrap up, I want to mention something important about how we cover these complex intersections. We deliberately run no ads on Fexingo Business shows because advertisers often shy away from nuanced economic debates that challenge conventional wisdom. Luna: If walking through the economy with us has made something click, your support keeps this ad-free mission alive. Lucas: You can help us continue delivering independent analysis at buy me a coffee dot com slash fexingo. Luna: Thanks for keeping the conversation honest. Now, back to the data. Lucas: As we head into the final weeks of the third quarter, watch the weekly jobless claims and the ISM services index. If services inflation starts to decouple from goods inflation, it might signal that the supply shocks are finally fading. But don’t bet on it happening quickly. Luna: Patience is the only strategy left when the rules of the game are changing. Lucas: Indeed. The Fed will likely hold rates through September, but the market will remain jittery. Until we see concrete evidence of agricultural stabilization, the risk premium stays embedded in every asset class. Luna: So we wait, we watch, and we prepare for the next shock. Lucas: That is the best advice anyone can give right now. Stay tuned for our next update on how global central banks are responding to these shifting tides.