Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why The Fed Is Watching Wholesale Prices
Transcript
- Lucas: The headline from Friday was loud, but it’s the wrong one. Yes, the U.S. added 165,000 jobs and the unemployment rate slipped to 4.1 percent. It looks like a textbook soft landing on the surface. But if you look at the wholesale inflation data coming out of China right now, you see a different story brewing underneath. Luna: That’s the part nobody is talking about in the mainstream press. They’re still stuck on the nonfarm payrolls number. What exactly is happening with Chinese wholesale prices? Lucas: It just hit its highest level in more than four years. We are seeing a sharp uptick in producer prices there, which means the cost of raw materials, energy, and intermediate goods is rising fast. When those costs go up globally, they eventually bleed into the U.S. supply chain, even if consumer demand looks stable. Luna: So the Fed might be watching the wrong gauge. They have been so focused on core CPI excluding food and energy, but wholesale spikes usually precede consumer price hikes by several months. Lucas: Exactly. And here is the tricky part: the U.S. core PCE price index only moved from 130.49 to 130.9 in September. That feels tame. But if input costs are surging in manufacturing hubs like China, that pressure hasn't fully passed through to the checkout counter yet. It’s lagging. Luna: But does that matter if wages aren't growing fast enough to pass those costs on? Average hourly earnings were up to thirty-eight dollars in October. That’s barely above the previous month. Lucas: Right, and that’s where the disconnect happens. Companies are hoarding labor, as we’ve discussed, but they aren’t raising prices aggressively because consumers are resisting. However, when wholesale inflation hits 4.86 percent on the ten-year Treasury yield expectations, markets get nervous. Investors start pricing in a future where margins get crushed. Luna: Wait, hold on. You said the ten-year Treasury yield is around 4.86 percent. That’s actually down 1.8 percent over the last five days. So bonds are rallying, not selling off. Why would investors care about Chinese wholesale prices if they are betting on lower rates? Lucas: Because the bond rally isn’t about ignoring inflation; it’s about expecting weaker growth. The market is essentially saying, 'We don’t think the Fed will hike again, and we don’t think inflation will stick.' But that assumes the shock is contained. If Chinese wholesale prices keep climbing, it becomes a stagflationary risk—slower growth but higher costs. Luna: That’s a dangerous mix. Especially with the Fed Funds effective rate sitting at 3.88 percent. If costs rise while growth slows, the real interest rate could become restrictive very quickly without the Fed doing anything. Lucas: Precisely. Let’s look at the nominal GDP. It’s sitting at 33 trillion dollars, with real growth at 3.4 percent annualized. That sounds healthy, but it’s driven by inventory buildup and government spending, not necessarily organic consumer strength. When input costs rise, that margin of error disappears. Luna: So you’re saying the strong jobs report is masking a vulnerability in the production side of the economy. The labor market is tight, but the supply side is getting expensive. Lucas: I’m saying the two are colliding. China’s wholesale inflation is a leading indicator for global trade costs. Since the U.S. imports a massive amount of intermediate goods, those prices will eventually show up in our Producer Price Index, or PPI. And once PPI moves, Core CPI follows. Luna: But the CPI data from September shows a modest increase from 334.13 to 336.3. That’s not a spike. Are we really predicting a crisis based on overseas data? Lucas: Not a crisis, but a recalibration. Look at the JOLTS job openings. They ticked up to 7,523 thousand in September. Employers are still hiring, which keeps wages sticky. If wages stay high and input costs rise, you get profit compression. That’s what hurts equities more than outright inflation. Luna: Profit compression is a silent killer for the S&P 500. The index is at 7,550, but if margins shrink, the multiple expansion stops. Are you suggesting the tech-heavy NASDAQ might feel this pain first? Lucas: Definitely. Tech companies rely on efficient global supply chains for hardware and components. If those costs jump, their gross margins take a hit before the revenue side adjusts. The VIX is quiet now, but it’s waiting for the earnings season confirmation of those margin pressures. Luna: It’s interesting that the Dow is up 1.2 percent over the last five days while the Nasdaq is down 0.5 percent. Maybe the market is rotating away from growth stocks that are sensitive to input costs. Lucas: That rotation makes sense. Value stocks in sectors less dependent on complex global supply chains might be holding up better. But the broader issue is the Fed’s dilemma. They can’t cut rates if wholesale inflation starts pushing up domestic prices, but they can’t hold rates steady if growth stalls due to high borrowing costs. Luna: So the 2.23 percent breakeven inflation rate is misleading because it doesn’t capture the upstream shock. It’s backward-looking, based on current consumer prices, not future producer prices. Lucas: Correct. Breakevens are a measure of expected long-term inflation, but they are slow to react to sudden shifts in commodity or wholesale markets. We need to watch the actual PPI releases closely over the next month to see if that Chinese shock is transmitting. Luna: And what about the dollar? A stronger dollar usually helps import prices, but if the global trade environment is tightening, maybe that hedge isn’t working anymore. Lucas: The dollar is relatively strong, but if the U.S. economy slows down due to margin compression, the dollar could weaken. Then imported inflation becomes even worse. It’s a feedback loop. The key data point to watch this Tuesday is the upcoming CPI report, but I’ll be looking at the PPI print instead. Luna: So the lesson here is to ignore the headline jobs number and focus on the cost of production. It’s a subtle shift, but it changes the entire outlook for the next quarter. Lucas: Exactly. Strong employment is good, but only if the companies creating those jobs can afford to pay them without raising consumer prices excessively. If wholesale inflation is already running hot, the buffer is gone. Luna: It’s a reminder that the global economy is more interconnected than we give it credit for. A price spike in China isn’t just an overseas statistic; it’s a direct line item on your local retailer’s balance sheet. Lucas: Right. And until that cost passes through to the consumer, the Fed might feel comfortable keeping policy steady. But that comfort is fragile. One bad PPI report could change the narrative entirely. Luna: So for listeners trying to navigate this, should they be worried about their portfolios or just keeping an eye on the news? Lucas: Keep an eye on the news, but also check your own exposure to companies with thin margins. Those are the ones that will get squeezed if input costs rise faster than revenues. Diversification is key, but understanding the source of inflation matters more than ever. Luna: Good advice. It’s easy to get distracted by the daily noise, but focusing on the underlying mechanics gives you a clearer picture. Lucas: Absolutely. If walking through the economy with us has made something click, consider supporting the show. 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. That's F. E. X. I. N. G. O. Luna: Thanks for the support, it really helps us dig deeper into these topics every day. Lucas: Back to the macro picture. As we head into November, the question isn’t whether the jobs report was strong, but whether the cost of producing those jobs is sustainable. Watch the wholesale numbers. Luna: It’s a subtle signal, but in economics, the small ripples often predict the big waves. Lucas: Let’s see if the PPI data confirms that theory next week. Until then, stay curious and keep watching the inputs.