Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching Import Prices From China
Transcript
- Lucas: So import prices posted a surprise gain in June, and the cost of goods from China hit their highest level since 2008. That is a number that should probably get more attention than it did. Luna: I saw that headline from CNBC. It felt like it got buried under the wholesale deflation story and the China GDP miss. But if you're the Fed, this is a pretty direct channel into core goods inflation. Lucas: Exactly. For the last several episodes we've been talking about how the Fed is watching services inflation, wholesale deflation, the breakeven rate. And those are all important. But import prices from China are the old-school inflation bogeyman that had mostly gone quiet for two years. Now they're back. Luna: Let's put a number on it. The import price index for June — what did it actually show? Lucas: Overall import prices rose 0.2 percent month over month, which doesn't sound like much, but it was a surprise because the consensus was for a decline. And within that, prices for goods from China rose 0.4 percent and are now up about 3.8 percent year-over-year. That's the highest since October 2008, right before the global financial crisis really cratered trade. Luna: And this is happening while wholesale prices actually fell 0.3 percent in June, driven by a big drop in gasoline. So you've got dueling signals: upstream deflation in energy, but upstream inflation in Chinese manufactured goods. Lucas: That's the tension the Fed has to sit with. The producer price index showing deflation is good for the headline inflation narrative, but the import price data is a warning that the goods disinflation we've been counting on might be stalling. And the China piece is especially tricky because it's partly a tariff story. Luna: Right, because tariffs act like a supply-side tax. They raise the cost of imported goods directly, and that's not something monetary policy is well-suited to counteract. Lucas: Exactly. If higher Chinese import prices are driven by tariffs or by supply chain reshoring that's inherently costlier, the Fed can't really hike rates to fix that. All they can do is look through it, but the risk is that it feeds into expectations. And the 10-year breakeven inflation rate, which is basically the bond market's inflation expectation over the next decade, is sitting at 2.22 percent. That's down slightly from 2.23, but it's still above where the Fed wants it. Luna: So you're saying the breakeven might be giving false comfort? Because it's not moving much, but the composition of inflation is shifting in a way that could persist. Lucas: That's exactly what I'm saying. The breakeven is a summary statistic. It doesn't tell you whether the inflation is coming from domestic services or imported goods. And if the imported goods channel is reawakening, that's a different kind of problem. It's less responsive to rate policy. Luna: We should also tie in the China GDP number that came out the same day. China's economy grew at its slowest pace since 2022, with investment slumping. So you have weaker domestic demand in China, which normally would mean lower export prices to the rest of the world. But instead we're seeing higher prices. That's counterintuitive. Lucas: It is counterintuitive, and it suggests that the price increases are not demand-driven. They're structural. Chinese factories are facing higher input costs themselves — energy, raw materials, labor — and they're passing those through. Plus, the tariff environment hasn't eased. So even as Chinese domestic demand softens, the cost of making stuff and shipping it to the US is going up. Luna: And that's exactly the kind of inflation that the Fed's favorite measure, core PCE, is picking up. Core PCE for May was 130.1, up from 129.67 in April. It's creeping higher, not lower. Lucas: Right. And core PCE is the one the Fed really watches. CPI for June actually fell a bit — the all-urban index went from 333.98 to 332.6. But core CPI was essentially flat. So the headline improvement is mostly energy. Strip that out, and the underlying picture is sticky. Now throw in rising import prices from China, and you've got a reason for the FOMC to stay cautious. Luna: The Fed funds rate is at 3.63 percent, and the interest on reserve balances is 3.65. The market has been pricing in a cut later this year. Does this data change that? Lucas: It should give the hawks on the committee more ammunition to hold steady. If import prices keep rising, especially from China, then the disinflation narrative takes a hit. The Fed has been saying they need more confidence that inflation is sustainably moving toward 2 percent. A multi-year high in Chinese import costs does not build that confidence. Luna: So you're in the 'no cuts in 2026' camp? Lucas: I'm not ready to go that far, but I think the probability of a cut before the November meeting just dropped. The Fed will want to see at least two more months of data to determine whether this is a blip or a trend. And the China GDP slowdown complicates the global outlook too — weaker Chinese demand could mean lower commodity prices, which is disinflationary, but it also means less global growth, which is a different risk. Luna: Let's zoom out. The last time Chinese import prices were this high was 2008. Back then, the Fed was cutting rates aggressively because of the financial crisis. Now they're in a completely different position — inflation still above target, economy still growing, labor market still tight. Different era, different policy response. Lucas: That's a great point. In 2008, the deflationary shock from the financial crisis overwhelmed everything. Today, the economy is in much better shape. The S&P 500 is at 7,481, the Dow is above 52,000. Small caps are actually up over the past week, which suggests some confidence in domestic activity. So the Fed has room to be patient. They don't have to panic about a single import price report. Luna: But they also can't ignore it. Because if import prices feed into core goods inflation, and that starts to show up in PCE, then the narrative shifts from 'we're making progress on inflation' to 'inflation is reaccelerating in certain sectors.' Lucas: And that's exactly what the Fed is paid to monitor. They parse every subcomponent. The question is whether the FOMC will start talking about this more explicitly in their post-meeting statements. We've got the next meeting at the end of July. The language could shift from 'inflation remains elevated' to 'inflation remains elevated and recent data suggests some persistence in imported goods prices.' Luna: I think if you're a listener trying to make sense of the rate path, the key takeaway is that the easy disinflation — the stuff from falling energy prices and easing supply chains — may be over. The next phase is harder, and it involves global trade dynamics that the Fed can't control. Lucas: Exactly. And if walking through the economy with us has made something click, I'll just say — the way these episodes stay ad-free and independent is listener support. If today was useful, you can find us at buy me a coffee dot com slash fexingo. No pressure, just a way to keep this going. Luna: Yeah, it's a small gesture that makes a big difference for us. And we really appreciate everyone who's chipped in. Lucas: Alright, back to the data. One more thing on China — the import price increase is not uniform across all categories. Capital goods are up, consumer goods are up, but raw materials are actually down. So it's really about processed manufactured goods. That's the stuff that goes into your electronics, your appliances, your auto parts. Luna: Which means it hits consumer pockets directly. If you're buying a new laptop or a car repair part, those prices are going up. Lucas: And that's the kind of inflation that people feel. It's not abstract. So even if the Fed looks through it on a policy level, the political pressure to address it will grow. Especially with midterms coming. Luna: Do you think the Fed is factoring in political pressure? They've been pretty adamant that they're data-dependent. Lucas: They say that, and I believe they mean it. But they're not in a vacuum. The minutes of the June meeting, which we'll get later this month, might show more discussion of global trade risks. I'll be watching for any mention of import prices specifically. Luna: One last thing — the breakeven rate at 2.22. You said it might be giving false comfort. But historically, a 2.22 percent breakeven is within the range the Fed has tolerated. Lucas: It is, but the trend matters. It had been falling. Now it's flat to slightly up. And if import prices continue to rise, that breakeven could start moving higher. The Fed wants it below 2 percent, ideally around 2. But they've been above that for years. The question is whether the import price channel pushes it further away. Luna: So we're watching import prices, breakevens, and core PCE. That's the trifecta for the next few months. Lucas: Add in the wholesale deflation story too, because that creates the confusion. If you only look at PPI, you'd think inflation is vanquished. But the import data says, not so fast. The Fed has to reconcile both. Luna: And the bond market is already signaling something. The 2-year yield is at 3.70 percent, the 10-year at 4.55. The spread is still inverted, which is a recession warning, but not as deeply inverted as it was. Lucas: Right, the inversion has been unwinding slowly. That's consistent with a soft landing scenario. But if import prices push inflation higher, the Fed might have to keep rates higher for longer, which could re-invert the curve. It's a delicate balance. Luna: What would you say is the one thing a listener should remember from this episode? Lucas: That Chinese import prices are at a 17-year high, and that's a new variable in the Fed's inflation equation. It doesn't guarantee a rate hike, but it makes a cut less likely. And it means the next few CPI and PCE reports are even more important than usual. Luna: Good note to end on. We'll keep watching the data. Lucas: And we'll be back tomorrow with more.