Upstream Pressure, Downstream Reality: What the CPI vs. PPI Gap Means for Corporate Profits and the Economy

This past week we read about the headline Consumer Price Index (CPI) and how it compares to the Median CPI (read my post here). Here in this note, I will explain what the CPI says with respect to the Producers Price Index (PPI). The PPI tracks the wholesale selling prices received by domestic businesses.

Comparing the CPI and PPI provides a view into corporate profit margins, business pricing power, and the inflation pipeline. The latest economic data reveals a significant divergence: wholesale costs are rising much faster than retail prices (PPI at 6.3% vs. CPI at 3.7%). This gap points to an upstream supply shock that is currently squeezing corporate profit margins rather than fueling an economy-wide boom.

The Mechanics: What the CPI vs. PPI Relationship Tells Us

To understand how inflation moves through the economy, economists monitor the “spread” between what consumers pay and what producers receive as a rough proxy for the pressure on corporate margins:

Profit Margin Proxy Spread = CPI – PPI

When the CPI is greater than the PPI (Positive Spread):

• Consumer prices rise faster than wholesale input costs.
• Businesses have high pricing power and can easily pass on costs.
• Result: Corporate profit margins expand.

When the PPI is greater than the CPI (Negative Spread):

• Wholesale input costs rise faster than consumer prices.
• Businesses face resistance when attempting to pass higher costs on to consumers.
• Result: Corporate profit margins are squeezed.

While the CPI-PPI spread can provide insight into pricing power and margin pressure, it should not be viewed as a direct measure of corporate profitability. Labor costs, financing costs, productivity trends, and industry-specific factors also influence profit margins.

In addition to serving as a profit margin proxy, the PPI acts as an early-stage inflation pipeline: changes in wholesale costs often influence consumer prices with a lag, although the timing and magnitude vary considerably (some believe it often takes 3 to 6 months for them to filter into consumer prices). Although the CPI and PPI do not measure the same basket of products, the important observation is that they are directionally related.

What the Latest BLS PPI Report Shows

The latest release from the U.S. Bureau of Labor Statistics highlights a dramatic surge in upstream costs:

• Annual Surge: Over the last 12 months, the PPI for final demand jumped 6.3%, the fastest 12-month advance since December 2022.
• Monthly Acceleration: In September alone, the final demand prices increased 1.3%, the fastest 12-month advance since March 2022.
• The Energy Driver: Over 80% of the goods increase was driven by energy costs, which jumped 10.8% in a single month (led by a 20.3% spike in gasoline).
• Underlying Core Wholesale: Even after stripping out food, energy, and trade, core PPI rose 5% over the last year, indicating that wholesale cost pressures are broad across the industrial supply chain.

Interpreting the CPI vs. PPI Spread Chart

Courtesy of ZeroHedge, we obtained the following graph:

Let’s analyze the big picture of where we are in the economic cycle. When the CPI is greater than the PPI, you see a positive spread (green bars). When the PPI is greater than the CPI, you see a negative spread (red bars).

• 2015 – 2016: Strong corporate profit margin expansion (green bars, CPI > PPI)
• 2021 – 2022: Massive supply shock / corporate profit margin squeeze (deep red bars, CPI < PPI)
• 2023 – 2024: Corporate profit margin recovery (green bars, CPI > PPI)
• 2025 – Present: Sharp negative plunge to -2.6% (red bars, CPI < PPI)

Key Takeaway: The current deep red bars demonstrate that this is a classic supply/cost shock. Businesses are currently absorbing a substantial portion of higher wholesale energy and logistics costs rather than passing 100% of them immediately onto consumer price tags.

Conclusion

Federal Reserve monetary policy has a delicate balancing act to perform, because it cannot pump more oil or clear transport bottlenecks. Aggressive interest rate hikes to curb inflation could have the knock-on effect of choking off business investment and hiring, which will heighten recession risks. The risk is a type of self-fulfilling prophecy: in attempting to prevent inflation from becoming entrenched, the Federal Reserve may tighten financial conditions enough to contribute to the very recession it hopes to avoid. My view is that the Federal Reserve is likely to continue following its stated guidance and respond to persistent inflation pressures with additional gradual interest rate hikes.

If wholesale costs remain near 6.3% for multiple quarters, businesses will be tempted to eventually pass these higher costs through to consumers to protect corporate profit margins, which could push the CPI higher in 2027. 

Why an October Rate Hike Appears Increasingly Unlikely

According to the Financial Times reporting,

“Federal Reserve chair Kevin Warsh has signalled that hotter-than-anticipated inflation has not swayed his views on the US economy, prompting traders to further scale back bets on a rate rise this month…Bets on a rate increase climbed to as high as 55 per cent following stronger than expected US inflation figures on Wednesday before edging back. They fell further after Warsh’s comments, declining from around 27 per cent to around 15 per cent on Friday [October 16], according to Fed funds futures.”

In other words, it is highly unlikely that the Federal Reserve is going to hike rates at their next meeting on October 28. Although we are told that the Federal Reserve is independent, the fact is that, like all human beings, members of the Federal Reserve committee responsible for monetary policy are subject to influence. Barring a major economic surprise, I suspect that the proximity of the U.S. Congressional elections on November 4 reduces the likelihood of a rate increase at the October meeting. The last thing the Federal Reserve likely wants to do is draw attention to itself just days before an election, as its actions could be interpreted by some as favoring one group over another.

Having said that, I fully agree with Goldman Sachs’ economists that:

“’[a]longside other recent comments from FOMC participants, Warsh’s comments indicate that the FOMC is set to pause in October,’ economists at Goldman Sachs noted, adding they expect officials to raise rates at the Fed’s final meeting of the year in early December.”

In my view, the question is not whether rates will rise, but whether the Federal Reserve chooses to wait until after the election before taking further action. I think they will wait.

Decoding U.S. Inflation: What Headline CPI vs. Median CPI Tells Us About the Economy

The U.S. Bureau of Labor Statistics published the September 2026 Consumer Price Index for All Urban Consumers (CPI) on October 14, 2026, showing that the index “increased 0.6 percent on a seasonally adjusted basis…after rising 0.4 percent in August…Over the last 12 months, the all items index increased 3.7 percent before seasonal adjustment.”

That increase is modest, yet it could lead some observers to conclude that inflation pressures are once again broadening across the economy. However, to better understand whether inflation is truly broad-based, it is helpful to examine the Median Consumer Price Index, which is calculated by the Federal Reserve of Cleveland. By comparing the 12-month headline CPI rate against the 12-month median rate, we can clearly determine whether price pressures are widening across ordinary household purchases or confined to a few outlier categories.

We accessed the St. Louis Fed FRED database to construct our graphs.

 

We show the headline CPI (solid blue lines) by cumulative price change over the preceding 12 months, landing at 3.7% in September. With respect to the Median CPI, it measures the middle (50th percentile) price change across all consumer categories. The Median CPI (green dash lines) currently stands at 2.8%. This data transformation allowed us to establish a like-for-like comparison. 

Historical Context at a Glance

Three periods stand out:

1. Jan-2021 to Mid-2022: Both Headline CPI and Median increased in tandem. This meant that inflation was pervasive and widespread across every sector of the economy, and that prompted aggressive rate hikes by the Federal Reserve.

2. Mid-2022 to Late 2024: CPI dropped rapidly, as the supply disruptions during COVID subsided; but Median CPI remained elevated, consistently running above Headline CPI. That dynamic meant that core domestic expenses took longer to cool, creating inflation “stickiness” that kept the FRB on hold.

3. Mid-2025 to Early 2026: Median CPI steadily broke lower, with both metrics converging on average around the 2% - 3% range.

Conclusion:

As shown by the latest data, Headline CPI has ticked up to 3.7%, which gives the impression that inflation is heating up again. However, the Median CPI remains anchored at 2.8%, which suggests inflation is not presently exhibiting the type of broad-based acceleration characteristic of a new inflationary cycle. The latest data does not yet support the conclusion that the economy has entered a renewed inflationary cycle. Of course, things can change rather quickly, but when it comes to an inflationary phase, we are not there right now.

Locking In Treasury Yields: Opportunity or Premature Optimism?

According to a recent Financial Times article, investors are increasingly buying US Treasuries as yields climb toward levels not seen in decades. The rationale is straightforward: many investors believe rates may not rise much further, making current yields an attractive opportunity to lock in income. With inflation expectations remaining relatively stable, real Treasury yields have risen to around 3%, a level that many portfolio managers view as compelling.

One aspect of the article that caught my attention was the graph showing the sharp rise in US real yields since 2021:

While many investors appear to interpret current yield levels as attractive, the chart itself does not clearly indicate that real yields have reached a ceiling. In fact, the trend over the past several years has been upward. If real yields continue to rise, it would suggest that nominal interest rates are increasing faster than inflation expectations. Such a development could indicate the presence of structural forces supporting higher interest rates. However, the chart itself does not identify the source of those forces.

A second observation concerns the argument that financial stress, particularly in Europe, could lead to capital flows into US Treasuries. This logic is understandable. During periods of uncertainty, investors often seek the perceived safety and liquidity of the Treasury market. Increased demand would tend to push Treasury prices higher and yields lower. However, it is also worth considering whether a future economic slowdown or sovereign debt concern could simultaneously increase government borrowing needs, adding more Treasury supply to the market. The eventual direction of yields may depend on which force proves stronger.

For that reason, the most interesting question raised by the article may not be whether current Treasury yields are attractive. Rather, it is whether investors are correctly assessing the longer-term forces influencing interest rates.

Conclusion:

If inflation moderates and risk aversion rises, today's buyers may be locking in attractive returns. If structural forces continue pushing real yields higher, however, today's yields may prove less attractive than they currently appear. On balance, I believe the risks are tilted toward higher yields. Time will ultimately determine which view is correct, but the debate itself highlights just how important the Treasury market has become to the broader investment landscape. 

What Does It Mean When Private Equity Sees Global Financial Crisis-Level Opportunities While Markets Appear Calm?

According to the Financial Times, 

"Dipan Patel, co-chief executive of UK-headquartered buyout group Permira, told the FT Private Capital Summit in London this week that deals cut after the dotcom crash and global financial crisis were ‘among the best’ ever. ‘We're right back there today,’ he said."

Patel's comments caught my attention because they suggest that private market valuations have become unusually attractive, comparable in some respects to opportunities seen after the dotcom crash and the Global Financial Crisis.

While this does not necessarily imply that another crisis is imminent, it does raise an important question: Why are experienced dealmakers finding opportunities today that remind them of periods following major market dislocations?

If private market opportunities are indeed becoming comparable in some respects to those seen after prior market dislocations, while the broader financial markets continue to function with relatively little visible stress, we should consider whether underlying economic and financial risks are greater than generally perceived. At a minimum, Patel's observations may suggest that pockets of stress are developing beneath the surface, even if a broader crisis has yet to emerge.

Why Higher Treasury Yields Do Not Necessarily Mean Economic Disaster

Dan Ivascyn, chief investment officer at Pimco, argues that a 6% yield on the 10-year US Treasury bond is a realistic possibility. He warns that such a scenario could trigger selling pressure in the bond market as leveraged investors unwind positions and other market participants seek to reduce risk. Higher yields could also place pressure on equity and credit markets. At the same time, however, he believes that further increases in yields may ultimately be constrained by investors seeking to lock in relatively attractive bond returns, particularly when compared with riskier assets. Ivascyn also highlighted sovereign debt markets outside the United States that appear attractive from a risk-reward perspective, including Australia and the United Kingdom.

In theory, higher interest rates are not necessarily bad. What matters is not only the level of rates themselves, but also the expectations surrounding them. Economies tend to struggle most when expectations become unanchored and conditions change abruptly. If markets broadly expect higher rates and those expectations develop gradually, businesses, consumers, and investors can adapt their behavior over time. Problems tend to arise when rates rise sharply or unexpectedly, creating imbalances that force participants to adjust all at once.

Think about a rush of water. The initial surge can create havoc, but over time the water settles and the disturbance gradually subsides. The same analogy applies to economic shocks. The initial disruption often triggers a rush for the exits, so to speak, as markets rapidly reprice risk and participants scramble to adjust. Eventually, however, markets establish a new equilibrium and adapt to the new reality.

My poster-child example is Turkey. Consider the following two charts showing consumer price inflation and real GDP in Turkey:

The purpose of this example is not to compare Turkey with other nations, nor to suggest that high inflation is desirable. Rather, it illustrates that economies are often capable of functioning even under extremely difficult conditions. Since 2021, Turkey has experienced annual consumer price inflation exceeding 20%, creating significant economic challenges for households and businesses. Yet economic activity continued, businesses remained open, transactions continued to occur, and the economy adapted, albeit painfully. In short, difficult economic conditions do not necessarily imply economic paralysis.

Conclusion:

The takeaway from all this is that while higher Treasury yields would almost certainly create economic and financial market disruptions, disruption is not the same thing as collapse. In my view, one major factor that can increase the probability that a disruption turns into a collapse is ineffective government intervention, but that is a story for another day. Suffice to say for now that adjustment can be painful, and some sectors may experience greater stress than others, but economies generally adapt to changing conditions over time. A 6% 10-year Treasury yield would likely present meaningful challenges for markets, businesses, and consumers, but it does not automatically mean that an economic catastrophe is inevitable.

Higher Rates, Higher Risks: The Growing Pressure on Corporate Borrowers

According to the Financial Times,

“A sharp sell-off in US government bonds is starting to reverberate across corporate America, forcing companies to overhaul their borrowing plans and even raising the spectre of defaults among the most lowly rate businesses.

Borrowing costs for companies with the lowest credit ratings hit their highest levels since May 202 this month at 17 per cent, driven by the rise in Treasury yields to multiyear highs and by investors demanding more compensation for lending to such businesses. The risk premium for groups rated triple C or lower has risen to 12 percentage points, the biggest since 2022.”

This prompted me to examine the data myself and assess whether the evidence supports the Financial Times' conclusions.

My Analysis:

When companies borrow money in the bond market, the interest rate (or “effective yield”) they must pay depends on their financial strength. I analyzed three distinct corporate tiers:

• US Corporate (Investment Grade): Consisting of solid, blue-chip corporations with strong balance sheets.
• BB High Yield: Consisting of mid-tier companies with higher debt but stable businesses.
• CCC & Lower High Yield: Consisting of higher-risk or financially strained companies with the highest borrowing costs. These were the ones that were of special focus in the Financial Times reporting.

To easily compare how fast borrowing rates have grown across these different tiers in 2026, I indexed all yields to a baseline score of 100 on January 1, 2026. The way to read this index is to think of 100 as the starting point. If the index rises to 120, it means that tier’s interest rate increased by 20% from where it started in the year. This helps us see which companies saw their borrowing costs rise fastest in percentage terms and whether all rates moved up and down at the same time.

Take a look at the graph, courtesy of the data obtained from the St. Louis FED FRED database:

What the Numbers Show:
Early 2026 (January – May): During the first five months of the year, all three credit tiers move together in a tight band between 100 and 112.

Mid-to-Late 2026 (June – October): Starting in June 2026, the lowest-rated debt (CCC & Lower) broke away and shot upward. Given the dynamics of the chart I’ve included (i.e., it is not a live chart with values that can be observed when hovering the mouse), I’m mindful that the exact values are difficult to see. However, roughly-observing:

• CCC & Lower reached ~136 by October (a +36% proportional increase in its yield rate).
• BB High Yield rose to ~128 (+28% increase).
• US Corporate (Investment Grade) rose to ~124 (+24% increase).

How 2026 Differs from 2025:

In 2025 we saw High-risk companies enjoy a relatively lower rate pressure for much of the year (which you can see that their index spent long stretches down around 88), while mid-tier BB bonds saw the biggest spike in the spring of 2025.

In 2026 that dynamic completely flipped. In the second half of 2026, consistent with what the Financial Times reported, the most vulnerable companies faced the steepest rate hikes, seeing their borrowing cost surge much faster than those of safer corporations. Why? As Treasury yields have increased, so has the baseline cost of capital for all borrowers. Lower-rated companies often experience an additional widening of credit spreads as investors demand greater compensation for default risk. As a result, CCC borrowing costs can rise much faster than those of investment-grade issuers.   

Conclusion:

Refinancing Squeeze on Vulnerable Businesses: A +36% jump in borrowing rate levels means heavily indebted, lower-tier corporates face a severe increase in annual interest expenses when rolling over or issuing new debt. The open question becomes how many of these firms will be able to obtain financing.

Growing Caution in the Market: When investors demand much higher proportional yields from CCC-rated issuers compared to solid blue-chip companies, it signals heightened market concern about credit stress, debt serviceability, and default risks among financially vulnerable firms.

Should the upward trend in yields persist, I would expect default risk to rise across the corporate sector, particularly among lower-rated issuers that depend heavily on refinancing. At the same time, Investment Grade corporations may become increasingly selective in their debt issuance, acquisition strategies, and capital allocation decisions as financing costs rise. In that environment, higher borrowing costs would act as a drag on both corporate activity and broader economic growth.