Summary
Highlights
The June Producer Price Index (PPI) showed a 0.3% fall in wholesale prices, a pleasant surprise for economists expecting a flat reading. This was the first decline since the energy crisis, with May's alarming 1.1% reading revised to 0.6%. Annual wholesale inflation eased to 5.5% from 6.5%. The Consumer Price Index (CPI) also fell by 0.4% for the month, pulling annual consumer inflation down to 3.5%. This positive data led to a stock market rally, but the report captured a moment (June) when a ceasefire held, and war-risk premiums were deflating, a situation that no longer exists.
The decline in June's PPI was primarily driven by a 1.4% fall in prices for final demand goods, with energy plunging 6.4% and gasoline tumbling 12%. The BLS attributed nearly two-thirds of the goods decline to gasoline. This was due to a temporary ceasefire in the Strait of Hormuz, which reduced the 'war premium' on oil products. However, while wholesale gasoline fell, retail margins for fuels and lubricants jumped 13%, illustrating the 'rockets and feathers' phenomenon where price increases are passed on quickly, but decreases are not.
Excluding volatile components like food, energy, and trade services, producer prices still rose 0.1% in June, with a core measure up 5.1% over the past 12 months. Upstream, raw inputs for the American production pipeline (Stage One Intermediate Demand) are running at 11% year-over-year, with processed goods up 11.1% and unprocessed goods up 13%. This indicates that producer input costs are rising at triple the pace of consumer prices, which will either hurt corporate margins or be passed on to consumers. Furthermore, natural gas prices rose 16.6% in June, indicating persistent inflation outside of the oil complex, partly due to the increasing demand from the AI buildout.
The '321 crack spread', which represents the margins refiners earn from turning crude oil into gasoline and diesel, hit an all-time record of $64.58 a barrel on July 8th. This is higher than the peaks during the 2022 energy crisis. This is significant because the U.S. has permanently closed or converted 1.2 million barrels per day of refining capacity since 2019, and globally, refineries are processing 8.4 million fewer barrels per day than before the war. This permanent reduction in refining capacity means that even if crude prices fall, refined product prices are unlikely to follow suit due to insufficient supply. Inventories of transportation fuels are projected to reach their lowest levels since 2000 by 2026.
The ceasefire that contributed to June's low inflation numbers has already collapsed. U.S. forces struck Iranian targets, Washington reinstated the naval blockade near the Strait of Hormuz, and Iran has declared the Strait closed. Tanker transits have dropped by over 50% in a week, and WTI crude is back above $80, a one-month high. The cost increases that did not fully reflect in June due to the 'rockets and feathers' effect will now quickly reach consumers in July. This situation puts pressure on the Federal Reserve, which cannot address these supply-side issues. The Fed's June dot plot erased the 2026 rate cut, with nearly half the committee penciling in at least one hike this year.
Investors should watch for the July PPI report on August 13th, crack spreads, tanker war risk premiums as a real-time gauge of fear, and the Fed's upcoming meeting. Despite the grim outlook, there is potential good news: this is primarily a supply shock inflation problem, and supply shocks, while violent, tend to end. The rapid draining of the war premium in June when the ceasefire held demonstrates this. While some underlying issues like tariffs and services will persist, the immediate storm of oil-related inflation is expected to pass when the conflict resolves. However, the August 13th report is predicted to paint a very different, more challenging picture.