Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / How China Export Prices Are Reshaping Global Inflation
Transcript
- Lucas: So yesterday's CPI print came in at 3.5 percent year-over-year for June, a bit softer than the consensus expectation. And the knee-jerk reaction in markets was relief — bond yields dipped, equities ticked up. But I think the more interesting story is hiding in the composition of that number. Luna: You're talking about the goods versus services split again, right? Lucas: Exactly. Core goods prices actually fell month over month for the third straight month. And the biggest driver there isn't domestic demand — it's what's happening on the other side of the Pacific. China's producer price index just hit a near four-year high on the factory gate side, but their consumer price index is barely above zero. That gap is essentially exporting disinflation to the rest of the world. Luna: So weaker Chinese domestic demand means they're dumping cheap goods into global markets, and that's helping keep our goods inflation in check? Lucas: That's the mechanism. China's economy grew at its slowest pace since 2022 last quarter. Investment slumped, domestic consumption is tepid. So manufacturers push excess supply into export markets at lower prices. For the U.S., that means lower prices for furniture, clothing, electronics — all the stuff that goes into core goods. And that's a big reason why core PCE, which the Fed watches more closely, has been drifting down even as services inflation stays sticky. Luna: So how much of the recent CPI moderation can we actually attribute to this China effect? Lucas: If you look at the data, import prices from China have fallen about 2 percent year-over-year for the past six months. That directly feeds into the core goods component, which makes up roughly 20 percent of the CPI basket. A 2 percent drop there knocks about 0.4 percentage points off headline CPI. So in a world without that Chinese disinflation, CPI would be closer to 3.9 percent right now instead of 3.5. Luna: That's a pretty big swing. And it's not something the Fed can control either. They can't fix China's demand problem. Lucas: Right. This is a supply-side tailwind that the Fed is happy to take, but they can't count on it lasting. In fact, there are early signs that Chinese producer price inflation is starting to creep up — the near four-year high I mentioned. That's partly due to commodity cost pressures and partly due to capacity cuts in some heavy industries. If that filters through to export prices, the disinflation boost could start fading later this year. Luna: So you're saying the Fed might be looking at a window of opportunity here — inflation looks soft in the near term partly because of this China factor, but they can't let their guard down? Lucas: Exactly. The fed funds rate is at 3.63 percent effective, and the market is pricing in a cut in September. But if this China disinflation starts reversing, core inflation could re-accelerate just as the labor market is softening. The unemployment rate did tick down to 4.2 percent in June, but jobless claims are edging lower too. So the Fed is in a tough spot — they want to ease before the economy slows too much, but they don't want to ease into a rebound in inflation. Luna: This is why the 10-year yield is stuck above 4.5 percent. The bond market is skeptical that the Fed can cut aggressively without reigniting inflation. Lucas: The 10-year is at 4.59 percent as of this morning. That's up about 10 basis points from a month ago. And the breakeven inflation rate, which is the market's expectation for average CPI over the next decade, is at 2.25 percent. That's actually a little above the Fed's 2 percent target. So the bond market is basically saying 'we don't believe the disinflation is durable.' Luna: I want to zoom out for a second. China isn't the only big economy exporting disinflation. What about Europe? Japan? Are we seeing a broader global disinflation wave? Lucas: It's more fragmented than a wave. Europe is also struggling with weak demand, but their inflation is still above target because energy prices are less of a drag than last year. Japan is actually dealing with inflation that's too high for their taste — core CPI there is around 2.5 percent. And then you have India, where inflation just accelerated to 4.38 percent in June, above forecasts. So the disinflation is really concentrated in goods-producing economies with weak domestic demand, primarily China. Luna: That's helpful context. So we're not in a global deflationary spiral. It's a specific China story that's creating a temporary tailwind for U.S. inflation. Lucas: Temporary is the key word. If China's economy stabilizes later this year — and there are growing calls for stimulus — those export prices could rise. And that would remove one of the biggest cushions keeping core goods inflation low. The Fed will have to adjust its policy accordingly. Luna: You know, it's conversations like this that make me appreciate how much we get into the weeds here. And I know we deliberately keep the show ad-free because we think the analysis should speak for itself. Lucas: Yeah, we're not sponsored by anyone, and we want to keep it that way. If you find value in these daily deep dives and want to support the model, the simplest way is to buy me a coffee dot com slash fexingo. No pressure, but it helps us keep the lights on without any ad commitments. Luna: Exactly. So back to the China story — one thing I've been watching is the divergence between China's producer prices and consumer prices. The PPI is high, but CPI is low. That suggests margins for Chinese manufacturers are getting squeezed. How sustainable is that? Lucas: Not very. When margins get compressed, companies eventually either cut production or raise prices. We're already seeing some capacity cuts in Chinese steel and cement. If that continues, export volumes will fall and prices will rise. The question is timing. For now, the disinflation is still flowing, but the Fed has to be aware that the faucet could get turned off. Luna: And if it does, we could see core PCE start moving back toward 3 percent. That would make any rate cuts this year very unlikely. Lucas: Right. The market is pricing in about 75 basis points of cuts over the next 12 months. If China disinflation reverses, that could get cut in half. So this isn't just an academic debate — it has real implications for portfolio positioning. Bond bulls should be watching Chinese PPI data as closely as U.S. CPI. Luna: Good point. So what should our listeners be looking for in the coming weeks? Lucas: Two things. First, the July Chinese trade data due out next week — look at export prices specifically, not just volumes. Second, any signs of Chinese stimulus. If Beijing announces a big fiscal package, that could boost domestic demand and reduce the need to export cheap goods. That would be a signal that the disinflation wind is about to shift. Luna: And on the U.S. side, we have the Fed meeting next week. Any chance they acknowledge this China factor in their statement? Lucas: Probably not explicitly. The Fed tends to talk about global developments in general terms. But the Summary of Economic Projections, which comes out quarterly, might show a lower inflation forecast for this year. If it does, China disinflation is a big part of the reason why. The real test will be in September — if Chinese data starts turning, the Fed might have to revise its forecast back up. Luna: So it's a story that's still unfolding. Thanks for unpacking it, Lucas. Lucas: Always a pleasure. We'll keep tracking it.