Inventory Inflation Stories and the Fed’s Perspective
The Federal Reserve has been asserting for months that tariffs directly contribute to inflation. This isn’t just a casual observation; it’s presented as a firm belief that seems firmly rooted in their framework. Yet, the data tells a different story. Consumer prices haven’t soared in line with increased tariffs. Thus, the Fed has introduced a new idea: inflation is merely lagging. According to them, businesses are still working through older stock and only hike prices once those items are sold out.
At face value, that may make sense. But, like many of the Fed’s narratives, this one crumbles under closer examination. The recent S&P Global Flash PMI Report reveals just how flawed the Fed’s inventory theory actually is.
Manufacturing Resilience
The August PMI provided the most promising manufacturing data since 2022, with the index rising from 49.8 to 53.3. There was a notable increase in output and new orders, backlogs grew, and factory employment surged at an impressive rate. The overall private sector composite output index climbed to 55.4, indicating the most vigorous growth of the year. If you’re in search of proof that American manufacturing is thriving despite the new tariff policies, look no further.
But it wasn’t just growth that stood out. The PMI’s sales price metrics also saw a significant uptick. Companies across both manufacturing and service sectors indicated they’re raising prices at the fastest rate in three years, directly citing tariffs as a contributing factor. Specifically, service prices have experienced a marked increase.
This serves as concrete evidence that contradicts the Fed’s theory positing that high inventory keeps prices low, especially when inventory levels are on the rise. Many firms are accumulating finished goods due to uncertainty around tariffs, indicating that they are simultaneously building stock and raising prices.
Challenges to Fed Logic
This situation undermines the Fed’s rationale. If we accept their viewpoint, businesses should hold off on price increases until they deplete old stock. Yet, companies need to factor in the cost of replacing inventory, rather than relying solely on new prices based on last quarter’s costs. The increasing costs of replacement, compounded by the expenses of holding excess inventory, actually drive prices upward, not downward.
So, why maintain this delayed narrative? If not, the Fed must confront the possibility that tariff impacts aren’t just automatic. Maybe foreign exporters will absorb these costs, or perhaps currency changes will offset them. The margins might tighten. Instead of exploring these possibilities, the Fed sticks with its delayed “pass-through” narrative.
The risk here is significant: If there’s a belief that tariff-driven inflation is on the horizon, it might lead to over-preparation. You could end up waiting for inflation that never materializes. This mirrors what the Fed experienced during the “temporary” inflation narrative. Everything seems tethered to supply chain issues, labor shortages, all to uphold the existing model.
Evaluating the Divergence
The S&P Flash PMI provides real-time insights. The Fed claims that tariff-related inflation hasn’t yet materialized due to inventory buffers. In contrast, PMI indicates that stock levels are at a record high, with price increases now accelerating. Which narrative do you find more credible?
If inflation remains subdued despite tariffs and stockpiling, it would appear that the Fed has been waiting for something that may never arrive. Conversely, if prices stabilize amid sustained growth, it suggests a scenario that deviates from the Fed’s predictions of unchecked inflation, aligning more closely with domestic production and moderate inflation.
This isn’t just an academic concern. By insisting that tariff-driven inflation is “on the way,” the Fed has overlooked the risk of waiting indefinitely and failed to respond adequately until a mirage appears. Consequently, even if growth is sluggish, monetary policy could be overly stringent, inadvertently affecting other areas.
The PMI paints a different picture. American factories are active, demand remains robust, and prices are climbing alongside precautions. The Fed’s lag theory doesn’t account for this reality. It simply shows that the Fed seems unwilling to re-evaluate its own assumptions.
