The Fed has been grappling with inflation for two years now.

And while inflation was more stubborn than anticipated, early signs show that Fed chair Powell may finally be on the verge of victory.

For one, headline inflation hit a two-year low of 3% last month. But it’s not just that. Alternative inflation “barometers” that track costs across supply chains are all hinting at subsiding prices.

The catch: it may take time for the effect to reach grocery shelves.

PPI is moderating

When we talk about inflation, we usually refer to price changes for everyday things such as groceries or rent.

CPI, or the Consumer Price Index, is the most popular measure of consumer inflation. But consumers are not the only group who face rising prices. Inflation is also measured through the PPI, or the Producer Price Index, which tracks the costs incurred by producers.

Think of it this way: When a car factory sells a completed car to a dealership, the transaction is captured in PPI. When that car is sold to a consumer, the transaction is captured in CPI.

In other words, CPI is the cost of buying stuff, while PPI is the cost of making stuff.

The good news is that the cost of making stuff is beginning to stabilize. According to UBS’s July report, PPI is not only falling, it is just short of deflation.

PPI inflation peaking

PPI and CPI are closely linked. When it’s more expensive for a business to make something, they have to charge more to make a profit. That’s why it's such a big deal that PPI has subsided.

And this isn’t just short-term noise; Core PPI is falling too.

Core PPI is a version of PPI that removes some of the prices that fluctuate a lot. It's designed to get a more accurate reading of underlying inflation trends.

After all, if the price of a product is randomly changing all the time, it’s not going to be very helpful when it comes to measuring inflation.

Both PPI and Core PPI falling so decisively is good news for the Fed.

Declining construction inflation

We can get even more insight by looking at the PPI inflation of some “bellwether” industries—such as construction.

People need construction for housing. Businesses need it for operating spaces. So when construction costs rise, they typically feed through to the rest of the economy.

For example, when building costs increase, it can lead to higher mortgage or rent payments for individuals and businesses. This results in a direct increase in living expenses or overhead for businesses.

The good news, again, is that construction inflation has fallen.

Construction inflation fall

On the initial inflation breakout, construction inflation shot up much higher than other sectors. This led to so-called “knock-on” inflation effects in other sectors.

But now that construction inflation fell, we may see inflation backing down elsewhere as well.

Declining transportation inflation

Transportation costs also have a major pricing impact on the rest of the economy because they directly influence what consumers pay.

For example, if trucking goods across the country suddenly becomes more expensive, most firms will often pass that cost along. In the end, those costs end up plumping up the price of final goods.

When inflation began to rise, transportation costs jumped a bit higher than average. But now prices are moderating:

Transportation costs chart

That said, the evidence of falling inflation is not just seen in consumer prices or PPI.

Unemployment is rising

People losing their jobs certainly isn’t something to celebrate. But in terms of inflation, a weaker labor market is actually a good sign.

The two charts below show that the situation is getting tougher for employees. As shown by the increased first-time filings for unemployment (“initial claims”), layoffs are on the rise:

Initial claims in chart

According to UBS economist Jonathan Pingle, unemployment claims already exceed pre-pandemic levels.

“Smoothing through the recent ups and downs in initial claims, the 4-week moving average sits at 247K; compared to pre-pandemic, that level is higher than in all but one week of 2018 and 2019,“ Pingle says.

Those who lost their jobs also have a harder time finding another job, as seen by the increased filings for unemployment (“continuing claims”). If adjusted for seasonality, actual numbers may be even worse:

Continuing claims raising in chart

A weak labor market is important cooling inflation is cooling because there is more competition for jobs—which, in turn, slows down wage growth.

So, while workers aren’t celebrating losing their jobs, the Fed might be.

An impending victory

Inflation is a function of thousands of variables and its direction can change anytime. But for now, it seems that the Fed has gained the upper hand in this battle.

As shown by PPI data, especially in bellwether sectors like transportation and construction, producer prices are falling significantly.

Meanwhile, the labor market is weakening.

This data helps drive home one conclusion: After a turbulent two years, the Fed’s most aggressive monetary move in almost 40 years is beginning to bear fruit.