Stocks have rallied significantly, partly on the argument that the impact of the Trump administration’s tariffs on inflation will be smaller than was feared earlier this year.
However, the July Producer Price Index, which measures wholesale goods prices, has called that thinking into question.
While consumer-level inflation, as measured by the Consumer Price Index and Personal Consumption Expenditures Index, has ticked only marginally higher, PPI inflation soared in July far more than economists expected.
Pricing pressure at factory gates is often viewed as a precursor to consumer inflation, suggesting that CPI and PCE data could worsen in the next month or two.
If so, it wouldn’t be great news for stocks, which perform best when households and businesses feel flush rather than cash-strapped.
Wholesale inflation surged more than expected in July, denting hopes for aggressive Fed interest rate cuts later this year.Shutterstock
The Federal Reserve doesn’t directly control how much your bank will charge you for a credit card, mortgage or auto loans, or whether stocks go up or down.
However, the Federal Funds Rate determines how much banks charge each other when they lend reserves overnight. So, changes (and expected changes) to Fed interest rates, and the resulting impact on the prime rate and Treasury yields, influence how much shoppers and businesses pay in interest and have left over to spend.
That affects economic activity, which in turn affects corporate revenue and earnings growth, which are the lifeblood of higher stock prices.
As a result, investors closely watch the Fed’s monetary policy.
The central bank decides its monetary policy based on economic data, specifically data on jobs and prices, which enable it to balance its dual mandate to foster low unemployment and inflation.
So far, the data have led the Fed to sit on its hands in 2025, leaving rates unchanged because of concern that the tariffs would cause inflation to spike.
But investors have increasingly modeled for eventual rate cuts, hoping trade negotiations would lower effective tariffs by more than expected this spring, thus supporting stock prices and, eventually, lower rates.
Those hopes strengthened following recent weak jobs data, leading most to predict that the Fed will lower rates in September, driving higher GDP, sales and earnings.
Unfortunately, the July PPI report may have tossed a monkey wrench into that optimism.
According to the Bureau of Labor Statistics, which produces the inflation report, PPI increased 0.9% in July, the most significant jump since June 2022. Economists expected a 0.2% increase.
Overall, headline PPI inflation rose 3.3% in July year-over-year. The index for final demand minus volatile foods, energy, and trade services was up 2.8% in the past year, “increasing 0.6% in July, the largest increase since rising 0.9% in March 2022,” according to the BLS’s statement.
More Economic Analysis:
“July PPI explodes to the upside leaving Powell in a bind and expected rate cuts in question,” wrote longtime Wall Street analyst Stephen Guilfoyle in a TheStreet Pro post.
“In what can only be termed as a kick in the pants for anyone hoping for (or betting on) a series of aggressive rate cuts to kick off with the Sept. 17 Federal Open Market Committee policy decision, this was a rude awakening.”
The average annual return for the S&P 500 since the 1950s is about 10%, yet the benchmark index has rallied 28% since April 9’s reciprocal tariff pause.
The gains have been unrelenting, locking many investors out of the market. As a result, the S&P 500’s valuation has arguably become stretched and may be pricing stocks for perfection.
The S&P 500’s price-to-earnings multiple, a key valuation measure investors use to determine whether stocks are cheap or pricey, has climbed above 22. That’s flirting with levels last seen near the highs in February before stocks fell sharply on tariff announcements.
Historically, high p/e multiples haven’t translated into significant gains one year later, suggesting that earnings will have to grow faster than prices if stocks are to continue moving up.
Any delay to rate cuts that could fuel GDP and profit growth would be unwelcome.
“July producer prices simply exploded to the upside. There’s no way to sugarcoat this,” said Guilfoyle. “Unless this is reversed or revised in a more frigid direction with the early September release of the August data, the Fed has all the ammo it needs to be more cautious, and Fed Chair Jerome Powell looks a lot less foolish than I thought he had.”
Currently, the CME’s FedWatch tool, which tracks rate-cut probabilities based on the futures markets, still shows a likely cut in September and October. However, the chances for a third cut in 2025 fell dramatically.
“That third rate cut of a quarter point that had been priced in for December ahead of this release has now been pushed out to April. That’s a big deal,” said Guilfoyle.
Related: Treasury secretary sends blunt message to Pelosi, Congress
