Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Tariffs And The Inflation Shock
Transcript
- Lucas: The New York Fed just dropped a note that is going to make central bankers very nervous. They are saying outright that inflation on many everyday items was entirely due to tariffs right now. Luna: So we are looking at a direct policy cost being passed down to consumers, rather than some organic demand surge or labor shortage? Lucas: Exactly. It is a mechanical shift in the price level. If you look at the broader market environment today, October eighth two thousand twenty-six, the S&P five hundred is up slightly, but that masks the underlying friction. The real story is in the details of what people are actually buying. Luna: It feels like we are trading one set of economic problems for another. We spent years fighting post-pandemic supply chain breaks, and now we are fighting political ones. Lucas: Right. And the tricky part is that tariffs are not a temporary shock. They are a structural tax on imports. When you see a headline like this, it changes how you model the next six months of inflation. You cannot just wait for the bottleneck to clear because the bottleneck is now a law. Luna: Does this mean the Federal Reserve has less room to maneuver? If prices are rising because of policy, cutting rates might just fuel more demand on top of those higher costs. Lucas: That is the classic stagflation trap. You have slow growth and rising prices simultaneously. Let’s look at the actual numbers to see how deep this hole is. Core CPI, which excludes food and energy, is sitting at three hundred thirty-seven point eight as of August first. That is up from three hundred thirty-six point seven nine the prior month. Luna: Three hundred thirty-seven point eight. So it is still ticking up, not cooling off as much as the markets hoped. Lucas: Precisely. And if you look at the PCE price index, the Federal Reserve’s preferred gauge, core PCE is at one hundred thirty point five. It moved from one hundred thirty point one three. These are small percentage moves, but they are persistent. They do not go away. Luna: I remember when we talked about productivity traps last week. Is this different? Because tariffs should theoretically force companies to become more efficient to absorb the cost. Lucas: That is the theory, but the reality is lagging. Productivity takes time to adjust. In the short term, businesses just pass the cost through. We saw real GDP growth slow to two point two percent annualized in the second quarter. That is down from two point five percent. Growth is decelerating while prices are sticking. Luna: Two point two percent growth with sticky inflation. That is textbook stagnation territory. Are consumers starting to feel this pinch yet, or are they still absorbing it? Lucas: They are feeling it. Unemployment ticked up to four point two percent in September. It was four point one percent before. It is a small move, but combined with job openings falling to seven thousand seventy-nine from seven thousand three hundred thirty-five, the labor market is softening. Luna: So you have fewer jobs available, slightly higher unemployment, and prices that are rigid because of these tariff policies. What happens to the average worker? Lucas: Their purchasing power erodes. Even if wages rise, if prices rise faster due to tariffs, they are worse off. Average hourly earnings for private workers were at thirty-seven point eight dollars in September, up slightly from thirty-seven point seven six. That increase is not enough to offset the cumulative effect of these import taxes over several quarters. Luna: It feels like a wealth transfer from consumers to the government and protected industries. But who benefits from this specific dynamic? Lucas: Domestic producers who face less foreign competition, certainly. But the net effect is negative for the overall economy. The ten-year breakeven inflation rate is at two point three six percent. It is flat, which means the market isn't pricing in a massive runaway inflation event, but it is also not pricing in deflation. It is pricing in a muddle-through scenario. Luna: A muddle-through sounds exhausting for investors. How are the equity markets reacting to this news? The Russell two thousand is down one point four percent over the last five days. Lucas: Small caps are getting hit hard. They rely more on domestic supply chains and domestic labor, but they also borrow more. Higher rates to fight inflation hurt them disproportionately. Meanwhile, the S&P five hundred is holding up at seven thousand seven hundred sixty-five, but that is driven by large tech and multinational firms that can hedge currency risk. Luna: So the divergence between large caps and small caps is widening. This isn't just an inflation story; it is a size story. Companies with global reach can survive the tariff shock better than purely local ones. Lucas: Exactly. And that creates a weird incentive structure. It pushes capital toward larger, more consolidated players. You see less innovation from the middle class of businesses because the barrier to entry just got higher with these added costs. Luna: If I am running a mid-sized manufacturing firm, I am staring at a bill I didn't expect and a customer base that is tightening its belt. Do you think these tariffs will lead to consolidation? Lucas: I think they will accelerate it. Mergers and acquisitions activity often picks up when uncertainty rises, as smaller players get bought out by larger ones to survive. We are seeing that pattern emerge in other sectors too. Luna: Before we go deeper into the consolidation angle, I want to pause for a second. If walking through the economy with us has made something click, or if you find value in our deep dives into these complex dynamics, a couple of dollars a month is genuinely what keeps these shows ad-free and independent. You can support us at buy me a coffee dot com slash fexingo. It makes a real difference in keeping this research rigorous. Lucas: Thanks for that. It really does help us dig into the data without needing corporate sponsors dictating the topics. Now, back to the consolidation idea. You mentioned the mid-sized manufacturer. Luna: Yes. If I am that manufacturer, and I know my margins are squeezed by tariffs, do I raise prices further and risk losing customers, or do I absorb the cost and hope for a policy reversal? Lucas: You do neither. You try to restructure your supply chain, which takes time and money you don't have. Or you lobby harder. But realistically, most firms just absorb a portion of the cost and cut back on hiring or investment. That feeds back into the GDP slowdown we saw earlier. Luna: So the tariff is acting like a drag on future growth potential, not just current prices. It is a double hit. That explains why the IMF chief Georgieva is talking about AI as both a hope and a hazard. Maybe efficiency gains from technology are the only thing keeping the economy afloat against these policy headwinds. Lucas: That is a brilliant connection. We discussed AI masking stagnation in episode two hundred seven, but here it is even more critical. If tariffs reduce trade volumes, productivity must come from doing more with less. AI and automation are the only levers left for many firms. Luna: But automation requires capital investment. And if interest rates stay high to combat this tariff-induced inflation, who can afford to invest in AI? It becomes a catch twenty-two. Lucas: Only the largest firms. Again, we circle back to concentration. The big tech giants with cash reserves can invest in AI despite high rates. Small and medium enterprises cannot. This widens the gap between winners and losers in the economy. Luna: It feels like we are moving toward a bifurcated economy. One part that is high-tech and globally integrated, and another part that is stagnant and locally trapped. Is there any historical parallel for this? Lucas: The nineteen seventies had elements of this, but the nineteen nineties had a different dynamic with globalization. Today, we are seeing a retreat from globalization coupled with rapid technological change. It is a unique combination. The policy response is usually to protect domestic industry, but that protectionism often stifles the very innovation needed to compete globally. Luna: So the cure might be making the disease worse. If we keep raising barriers, we lose the competitive edge that drives productivity. How long can this tension hold before something breaks? Lucas: Until the political pressure becomes too great. Consumers feel the pinch at the register. If inflation stays above target for too long, the central bank may be forced to act aggressively, potentially triggering a recession. Or, the political backlash forces a policy pivot, lowering tariffs, which could suddenly deflate prices but hurt the domestic industries that relied on that protection. Luna: Either way, there is pain. A recession or an industrial shakeout. Which path do you think is more likely given the current data points? Lucas: Given that real GDP is already slowing to two point two percent and unemployment is ticking up, we are close to the edge. A minor shock could tip us into contraction. But the Federal Reserve is watching closely. The fact that the ten-year breakeven is stable suggests they believe they can manage this without a hard landing, provided inflation doesn't spike further. Luna: Stable breakevens are comforting, but they are backward-looking. They reflect expectations, not necessarily reality. If those tariffs persist, expectations might shift quickly. Lucas: True. Markets are good at pricing in known risks, but bad at pricing in policy shifts. This is why the New York Fed's note is so important. It signals that the authorities recognize the distortion. Once they acknowledge it, the question becomes: what will they do about it? Luna: Acknowledgment is the first step. But action is another matter. It seems like we are waiting for a signal from Washington or the Fed on whether this is a temporary blip or a new normal. Lucas: Waiting is the hardest part for investors. You are navigating a fog where the map is changing every day. The key is to focus on resilience. Companies with strong balance sheets and diversified supply chains will weather this. Those reliant on cheap imports or single-source suppliers are vulnerable. Luna: Resilience is the keyword. Not growth, not expansion, just survival. It is a sobering outlook for the rest of the year. Lucas: It is. But understanding the mechanics—how tariffs feed into CPI, how that affects Fed policy, and how that filters down to corporate strategy—gives you a clearer picture than just watching the headlines. We are tracking these threads carefully. Luna: And for you, the listeners, it means paying attention to the details behind the broad indices. The story is in the margins, in the small caps, and in the supply chain reports. Lucas: Exactly. Keep an eye on those job openings numbers and the core CPI releases. They will tell you whether the tariff shock is fading or taking root. Luna: We will see you next time with another deep dive into the forces shaping our financial world.