Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / The Wholesale Price Shock And The Fed's Dilemma
Transcript
- Lucas: The numbers coming out of the Commerce Department on Thursday were stark enough to make anyone doing macro work sit up straight. Wholesale prices jumped 6.3 percent annually in September, which is the biggest gain we have seen since early 2022. Luna: That is a massive deviation from the soft landing narrative that has been circulating all summer. Are retailers actually absorbing those costs, or are they just passing them through? Lucas: It looks like they are trying to absorb some of it, but the margin compression is real. When you pair that with the fact that the U.S. budget deficit has swelled to almost two trillion dollars for fiscal 2026, up twelve percent in a single year, you start seeing a structural tension. The government is spending heavily while supply chains are showing signs of renewed strain. Luna: So the Fed is essentially staring down a dual threat: stubborn supply-side inflation and a fiscal environment that makes borrowing more expensive for everyone else. Lucas: Exactly. And here is the thing about the current market setup as of mid-October twenty twenty-six. Everyone expects the Fed to hold rates steady in October. The consensus is solid. But Kevin Warsh recently pointed out that if the data shifts even slightly, someone on the committee could surprise us. With the ten-year yield sitting around five point one percent, the pressure is already visible in the bond market. Luna: I remember when five percent was considered the ceiling. Now it feels like the new floor for many investors. Does the market believe the Fed can tame these wholesale spikes without breaking something? Lucas: The market is betting on patience, not aggression. Look at the PCE price index. It came in at one hundred thirty-one point six for August, up from one hundred thirty-one point seventeen. Core PCE is at one hundred thirty point five. These are still rising, just slowly. The Fed isn't panicking because the headline CPI is forty-four hundredths of a percent higher than last month, bringing the annual rate to roughly three percent. Luna: Three percent sounds manageable until you realize it’s still above their two percent target. Why is the Fed so calm about a number that hasn't moved much in months? Lucas: Because they are watching the labor market with far more scrutiny than the price tags in the grocery store. The effective Fed Funds rate is currently at three point seven five percent. That is up from three point six three back in September. They have been tightening incrementally, testing the waters to see if the economy can handle higher borrowing costs without collapsing. Luna: But if wholesale prices keep climbing at that six point three percent pace, won't that eventually feed into wages? Workers will demand more to cover their living expenses. Lucas: That is the classic wage-price spiral fear. But right now, the data doesn't show a broad-based wage explosion. What we are seeing is a specific shock in intermediate goods. The Treasury has even dismissed recent IMF debt warnings as messy forecasting, which suggests they think the long-term fiscal picture is manageable despite the short-term noise. Luna: Dismissal is easy when you aren't the ones holding the bag. If the IMF thinks the debt trajectory is dangerous, shouldn't the Fed be concerned about market confidence? Lucas: They should be, and they are. The VIX is hovering near levels that suggest underlying anxiety. But the Fed's mandate is price stability and maximum employment, not balancing the federal ledger. They have to ignore the political pressure to fix the deficit and focus on the interest rate lever they control. Luna: It feels like they are walking a tightrope. Tighten too much and you trigger a recession. Not tighten enough and inflation becomes entrenched again. Lucas: Precisely. And notice how the S&P five hundred has dropped nearly two percent over the last five days while the Dow has barely moved. The tech-heavy Nasdaq is down four percent. Investors are worried about the valuation multiples of high-growth companies in an environment where capital is becoming permanently more expensive. Luna: So the small caps in the Russell two thousand are getting hit too, down two point six percent. This isn't just a tech problem. It's a cost of capital problem across the board. Lucas: Right. When your cost of borrowing rises, your future cash flows are worth less today. That is basic finance. But let's go back to that wholesale price jump. Six point three percent is an outlier. Usually, these shocks are transient. Shipping disruptions happen, then they clear up. Luna: Unless the shipping disruptions are caused by geopolitical issues or labor strikes that don't resolve quickly. Is there any evidence that this is a temporary blip or a new normal? Lucas: The data points to a mix. There are supply chain bottlenecks in certain sectors, but the broader trend in services inflation is cooling. The key is whether this wholesale spike bleeds into final consumer prices. So far, retailers are eating the cost to keep customers happy. But they can't eat it forever. Luna: So we are waiting for the quarterly earnings reports to see whose margins get crushed. That will tell us if the Fed needs to act sooner rather than later. Lucas: Exactly. And if the Fed does act, they likely won't do it in October. The meeting minutes will probably emphasize caution. They want to see at least another month of data to confirm whether this is a flash in the pan or a trend. Luna: Given the budget deficit size, I wonder if the Fed is also worried about losing credibility if they signal weakness. Can they afford to look hesitant? Lucas: Credibility is everything for a central bank. If markets think the Fed is behind the curve, they will front-run the expected rate hikes, pushing yields up further. That would make the Fed's job harder. So they walk very carefully. Luna: It reminds me of the early eighties, but on a much smaller scale. Volcker had to break the back of inflation. Powell just wants to keep it gentle. Lucas: Powell knows he doesn't need to be Volcker. He just needs to be consistent. The challenge is that consistency is hard when the external environment is changing so fast. The wholesale price data is a reminder that the global economy is fragile. Luna: If you've gotten value from us unpacking these complex economic signals, consider supporting the show directly. A couple of dollars a month helps keep these deep dives ad-free and available. You can find us at buy me a coffee dot com slash fexingo. It really makes a difference for independent production. Lucas: We appreciate every listener who helps sustain this kind of detailed analysis. Back to the economics, though. Let's look at the breakeven inflation rate. It sits at two point three five percent on the ten-year note. Luna: That implies the market expects inflation to average two point three five percent over the next decade. Which is higher than the Fed's target, but lower than the current monthly print. Lucas: Right. So the long-term view is somewhat optimistic. They think the current shock will fade. But if that wholesale price growth continues into Q4, those breakevens will rise, and the Fed will be forced to react. Luna: So we watch the next few jobs reports and CPI prints closely. Any sign of acceleration, and the 'hold' strategy falls apart. Lucas: Correct. The path of least resistance right now is stability, but stability is expensive. For now, the Fed stays put, watches the deficit spenders, and hopes the supply chains heal themselves. Luna: A risky bet, but one that seems to be playing out. We'll see if the numbers cooperate next month.