In July, the US Producer Price Index (PPI) showed a year-on-year increase of 3.3%, exceeding the expected 2.5%. The month-on-month PPI rose by 0.9%, compared to an estimated 0.2%. PPI excluding food and energy also increased by 0.9% month-on-month, against a forecast of 0.2%. Year-on-year PPI excluding these categories reached 3.7%, higher than the 2.9% estimate. PPI excluding food, energy, and trade rose 0.6% month-on-month, and 2.8% year-on-year.
Final demand services increased by 1.1% compared to a 0.1% decline in June. Final demand goods rose by 0.7%, while trade services saw a 2.0% rise, following a 0.3% fall previously.
Federal Reserve Interest Rate Expectations
The Federal Reserve’s interest rate expectations have shifted, with 58 basis points of cuts projected before the end of the year. There is a 93% likelihood of a 25 basis point cut in September.
In financial markets, the 2-year debt yield increased to 3.713%, the 10-year to 4.248%, and the 30-year yield decreased slightly to 4.827%. US stocks fell, with the Dow down 167 points, S&P dropping 30.08 points, and Nasdaq decreasing by 129 points.
Today’s producer price inflation numbers were a surprise, coming in much hotter than anyone expected. This sharp increase in costs for businesses creates uncertainty about what the Federal Reserve will do next. We believe this uncertainty will lead to higher market volatility in the coming weeks.
Traders should consider buying protection against a market downturn. With producer costs rising so quickly, corporate profits could get squeezed, and we are already seeing some companies issue cautious guidance for the future. Buying put options on stock indices like the S&P 500 (SPY) or the Nasdaq 100 (QQQ) could be a prudent move.
Rate Cut and Dollar Strength
The chances of a rate cut in September have fallen, though they remain high. We can use interest rate derivatives, such as SOFR futures, to bet that the Fed will not cut rates as aggressively as the market currently prices in for the rest of 2025. The CME FedWatch Tool reflects this shift, showing a noticeable drop from the near-certainty of a cut that we saw just last week.
This situation is also a bet on a stronger U.S. dollar. If the Fed is less likely to cut rates due to stubborn inflation, the dollar becomes more attractive. The U.S. Dollar Index (DXY) has already climbed to a multi-week high above 104.5, and trading options on currency ETFs can capitalize on this trend.
We should also watch the bond market’s reaction, especially the yield curve. The two-year yield has risen more than the ten-year yield, suggesting near-term policy worries. Historically, when we’ve seen similar unexpected inflation reports back in 2022, the Cboe Volatility Index (VIX) consistently jumped above 25, signaling heightened fear.
