Producer Price Pop Complicates the Outlook

We always knew the next few quarters were not going to be easy for businesses, consumers, or markets. You can probably throw economic forecasters into the mix too. Economists have been sounding the warning for months that a tariff shock was coming and likely to be stagflationary. Yet, months passed, and people started asking, “Where’s the beef?”

Trade policy uncertainty eased, small business confidence jumped, and attention shifted to the OBBBA (Chart 1). Markets largely ignored the latest machinations on trade policy, choosing the glass half-full view that tariffs could have been worse and the pass-through to consumers wouldn’t be so bad. The July CPI report, despite an uptick in services, saw an encouraging drop in energy prices and much better-behaved goods inflation that appeared to support that view (Chart 2). Core goods inflation rose just 0.2% or 2.5% a.r. in July, not far above its long-term trend. In short, July CPI gave the Fed room to look past possible tariff-induced inflation and start focusing on labor market support. Then the July producer price and import price reports landed with a thud. The shockingly ‘hot’ figures cloud the outlook for consumer inflation and interest rates.

Investors received a sobering dose of reality with the 0.9% pop in producer prices for July—far larger than forecast and the biggest monthly increase since March 2022. For those that need a refresher on what consumer inflation was like back in March 2022, CPI inflation was running at a torrid 13% annualized pace and was 8.5% y/y with the pandemic price shock near its peak. Let’s pray history doesn’t repeat itself. So, what were the top takeaways from the July U.S. inflation reports? First: not much tariff-driven goods inflation evident at the consumer level yet, though the inflation talk could be giving cover to services businesses to further raise prices. The problem is the service sector is a much bigger share of the economy. At the same time, wholesalers are shoulder-deep in broad inflation pressures that could soon reach consumers.

Nearly all categories of producer prices saw sizable monthly increases in July. Volatile trade services prices jumped 2.0% last month, responsible for around half the increase in final demand services prices (Chart 3). Trade services are basically the mark-up wholesalers earn from re-selling goods. The implication is that distributors are already passing on tariff-induced cost increases upstream and perhaps benefiting from inventory or pricing adjustments downstream. PPI final demand food prices jumped 1.4%, the biggest monthly increase since February. PPI finished goods prices increased a hot 0.47% last month, its largest monthly increase since January and second consecutive month above 0.4%. Unfortunately, the widespread jump in producer prices across all categories last month suggest much of the tariff impact on consumer prices still lies ahead of us. And so, we revised our forecast for Q3 CPI and core CPI inflation to a respective 3.4% and 4.0% annualized. This puts headline Q4/Q4 CPI and core CPI inflation at a broiling 3.1% and 3.4%, respectively, by the end of the year.

While a September rate cut is still our baseline forecast, it is no longer a sure thing. Some FOMC voters will clearly argue for another cautious hold, given the uncertain outlook and near-term risks to both sides of the dual mandate. From a risk management standpoint, Jay Powell may still lean toward higher inflation being the bigger threat, given the unemployment rate is still near full-employment levels. July’s inflation reports remind us that the tariff-driven inflation threat is real and imminent.

How Will the Fed Mark the Inaugural Rate Cut Anniversary?

On September 18, 2024, the FOMC surprised with a 50-bp inaugural rate cut, which was followed by two consecutive quarter-point moves for a total of 100 bps by year-end. It has been crickets since on the rate reduction front. The OIS market is currently pricing in more than 80% odds of a 25-bp move on September 17, with some buzz about marking the one-year anniversary of the first action with a matching 50-bp rate cut. To get some insight here, let’s do a quick comparison of the critical data.

The unemployment rate was 4.2% in August 2024 and a 4.2% average over three months, which is exactly where it stands currently (July). In terms of labor market slack, conditions have moved sideways. But 11 months ago, conditions were deteriorating noticeably. Indeed, the Sahm Rule was being triggered. The three-month average (using unemployment and labor force figures directly) was at least 0.5 ppts above its low over the preceding 12 months during the July-September 2024 interval. This was not interpreted as a recession signal (breaking the Sahm Rule’s perfect record as a recession predictor), but it was taken as an indication of the degree to which the labor market had weakened.

And by August 2024, the deceleration in household employment growth (on a year-over-year basis) had dipped its toe in negative territory. Negative yearly job growth rates had historically only occurred during, or in the aftermath of, recessions. Again, this wasn’t taken as a recession signal, just a weakness indicator, particularly since payroll employment growth was still 1.2% y/y. Interestingly, since January’s change to the household survey’s methodology, this job metric has contracted on net over the six latest months. As for the monthly changes in payroll employment, they had slipped below the 100k mark in each of the three months before the September 2024 Fed confab, which is what has happened during the latest three months.

On the inflation front, the core CPI was up 3.2% y/y in August 2024 with the three- and six-month metrics running at 1.9% and 2.6% annualized rates respectively, a clear cooling trend. In July 2025, the core index was 3.1% y/y (clearly sticky) with the three- and six-month trends at 2.8% and 2.4% annualized, suggesting a bit of warming.

The core PCEPI rose 2.7% y/y in July 2024 (the latest data for the September meeting) with the three- and six-month measures running at 2.3% and 2.5% annualized rates respectively (again, a clear cooling trend). In June 2025, this core index was 2.8% y/y (again, clearly sticky), with the three- and six-month metrics at 2.6% and 3.2% annualized, which is a more mixed pattern.

Meanwhile, the upside risks surrounding inflation prospects have mounted owing to tariffs. We are already seeing a smattering of pressures in select consumer items and further up the production pipeline (via producer prices).

Bottom Line: The recent slowdown in job growth and elevated labor market slack make the case for a rate cut next month. But the hefty upside risks surrounding an already-sticky inflation profile advise against celebrating the one-year anniversary of rate cuts in more than a restrained fashion.

The 411 on 232s

The Administration has ramped up its use of Section 232 ‘national security’ tariffs with many new investigations underway. Amid the legal uncertainty surrounding IEEPA tariffs, ‘232s’ appear destined to endure and expand.

After hearing oral arguments on July 31, the U.S. Court of Appeals is deliberating its ruling on whether tariffs imposed under the International Emergency Economic Powers Act (IEEPA) are legal. The decision will likely be appealed to the Supreme Court. One of the arguments against IEEPA tariffs is that Congress has constitutional authority over taxes and duties, and it delegates some of this authority to the President only under specific legislation (Table 1). And IEEPA is not one of them.

Indeed, the original ruling by the U.S. Court of International Trade (which was appealed) indicated that Section 122 of the Trade Act of 1974, and not IEEPA, was the suitable remedy for large persistent trade deficits. Section 122 gives authority to impose tariffs of up to 15% for up to 150 days (and Congress could extend them). In the August 1 re-introduction of country-specific, IEEPA-justified reciprocal tariffs, note that 43 of the 69 affected jurisdictions faced a duty of 15% or less, with the ‘baseline’ global tariff still at 10%. These are all potentially justifiable under Section 122. Meanwhile, the other tariff workhorse for the Administration has been the ‘232s’.

Section 232 of the Trade Expansion Act of 1962 gives authority to impose tariffs once it’s determined that imports of certain goods are occurring “in such quantities” or “under such circumstances” that they “threaten to impair the national security”. This determination is made via an investigation by the Bureau of Industry and Security (BIS), which is part of the U.S. Department of Commerce. Once an investigation has been started, the BIS has up to 270 days to prepare a report with recommendations for the President. Given the national security concerns, the reports are not immediately made public, but they are eventually published (often redacted). Once a report is delivered, and there’s a positive determination (that imports threaten national security), the President has 90 days to decide whether to concur and whether to take action. And then 15 days to implement the action, within a 30-day window to inform Congress.

Note that national security extends beyond national defense. The BIS’ Section 232 Investigation Program Guide states that “the term ‘national security’ can be interpreted more broadly to include the general security and welfare of certain industries, beyond those necessary to satisfy national defense requirements, which are critical to the minimum operations of the economy and government.” The criteria are:

• “requirements of the defense and essential civilian sectors;

• “growth requirements of domestic industries to meet national defense requirements;

• “quantity, quality, and availability of imports;

• “impact of foreign competition on the economic welfare of the essential domestic industry;

• “the displacement of any domestic products causing substantial unemployment, decrease in revenues of government, loss of investment or specialized skills and productive capacity; and

• “other factors relevant to the unique circumstances of the specific case.”

Before 2017, there had been 26 individual investigations initiated since the legislation was enacted (Chart 1). Since the first report in 1963, nine had positive determinations, 16 had negative determinations, and one investigation was terminated. Among the positive determinations, petroleum imports generally, or from specific countries (Iran, Libya), were the subject of eight separate investigations over the 54-year interval. These resulted in either license and other fees being imposed (3), embargoes (2), or no action being taken (3). Imports of machine tools were the subject of the other investigation which resulted in voluntary export restraints. Note that before 2017, only non-tariff barriers were employed as remedies when action was taken. And investigations on the same subject were repeated over time, even those with negative determinations, such as the case for manganese and chromium. This was the inaugural investigation in 1963 and it subsequently went 0-for-3.

Beginning in 2017 in the first Trump Administration, Section 232 investigations started to emphasize the broader definition of national security (and all the above criteria). For the interval ending in 2020, eight investigations were started: seven resulted in a positive determination and one was terminated (Table 2). Tariffs were imposed for the first time as an outcome of a 232 investigation, on steel and aluminum. (These were eventually removed for many countries/regions during both the Trump and Biden Administrations.) For the rest, the actions were administrative (no tariff or non-tariff barriers) e.g., working groups to monitor the situation. No actions on transformers and components along with vanadium occurred before President Trump’s first term ended.

President Biden’s actions in the case of the two ‘leftover’ investigations were also administrative. From 2021 to 2024, only one new Section 232 investigation was initiated. This resulted in a positive determination in the case of neodymium-iron-boron permanent magnets. Again, the action was administrative.

On his second Inauguration Day, this year, President Trump signed the America First Trade Policy Memorandum. It ordered that “the Secretary of Commerce, in consultation with the Secretary of Defense and the heads of any other relevant agencies, shall conduct a full economic and security review of the United States’ industrial and manufacturing base to assess whether it is necessary to initiate investigations to adjust imports that threaten the national security of the United States”.

On February 10, the President announced that tariffs on steel and aluminum would be re-imposed effective March 12. On March 26, he announced new tariffs on automobiles effective April 3 (parts followed within a month). In both cases, the original investigations from the first Trump Administration were dusted off. Based on 2017 data, the following tariff levels were recommended (among other measures): steel 24%, aluminum 7.7%, and autos and parts 25%. At the time, steel and aluminum were rounded up to 25% and 10%, respectively. The Administration opted not to tariff autos and parts ahead of the USMCA’s new higher (and rising) regional value content requirement. In the USMCA, future Section 232 tariffs on autos and parts would exclude Canada and Mexico under certain conditions, and both countries would get time to negotiate tariff-rate quotas for future 232s. The current Administration has not honored these parts of the USMCA.

One wonders whether the conclusions drawn from 2017 data would be confirmed by fresher figures. Pre-2017, multiple investigations occurred on the same subject. This time, aluminum was set at 25%, the same as steel, and both were later boosted to 50%. Autos and parts were set at the original 25%, excluding USMCA-compliant parts and the U.S. content in USMCA-compliant vehicles.

And the BIS has been busy as nine new Section 232 investigations have been initiated (Table 2 again). The first of them, on copper, resulted in a report to the President on June 30. The investigation looked at copper imports in all forms (ores, concentrates, refined copper, alloys, scrap copper, and derivatives). According to the July 30 proclamation, the report concluded that “copper is being imported into the United States in such quantities and under such circumstances to threaten to impair the national security”. It recommended a universal 30% tariff on semi-finished copper products and copper-intensive derivative products, among other measures (tariff recommendations for other copper forms are unknown). The President opted for 50%.

We await announcements on the other ongoing investigations. The President has talked about a 100% tariff on semiconductors and a potential ‘eventual’ duty on pharmaceuticals as high as 250%.

Meanwhile, the trade deals with Japan and the EU rolled back the 25% Section 232 tariffs on automobiles and parts to the deal’s universal 15% levy. The 50% tariffs on steel and aluminum remained. The U.K.’s deal reduced duties on autos to 10% (up to a quota) and kept the metals’ tariff at 25% instead of 50%, with the prospect of being reduced to the 0%-to-10% range.

The fact that Section 232 tariffs are being set both well above and below their prescribed rates show that they are being employed as trade negotiation levers as much as national security levies. Regardless of the legal fate of IEEPA-justified duties, the tariff parade appears poised to persist, partly paced by 232s.