The Inventory Inflation Lag Story Slouches Toward Oblivion
The Federal Reserve has been telling us for months that tariffs are inflationary. This isn’t a tentative hypothesis—it’s treated as revealed wisdom, etched into the Eccles Building’s granite. But the problem is the data keep failing to comply. Consumer prices have not surged in proportion to the tariff hikes. So, the Fed has invented a new theory: inflation is simply delayed. Firms, they argue, are still working through old inventories and will only raise prices once those shelves empty.
At first glance, that sounds plausible. But like so much of the Fed’s “make-it-up-as-you-go” storytelling, it falls apart under scrutiny. And the latest S&P Global Flash PMI report shows just how wrong the Fed’s inventory theory really is.
Factories Roar Back, Prices Follow
The August PMI delivered the best manufacturing reading since 2022, with the index jumping to 53.3 from 49.8. Output and new orders surged, backlogs piled up, and factory hiring accelerated at the fastest pace in years. The broader composite output index for the private sector rose to 55.4, signaling the strongest growth this year. If you’re looking for evidence that American industry is alive and well under the new tariff regime, here it is.
But growth wasn’t the only story. The PMI’s selling-price gauges surged too. Companies across manufacturing and services reported raising prices at the fastest pace in three years. Tariffs were explicitly cited as a factor. Services prices, in particular, jumped.
This is precisely the kind of real-world evidence that contradicts the Fed’s theory that inventories are holding prices down — because inventories themselves are also surging. Finished-goods stockpiles hit the highest level on record, with many firms explaining that they were deliberately stockpiling because of tariff uncertainty. In other words: precautionary inventory builds and price hikes are happening simultaneously.
The Fed’s Inventory Illusion
This undercuts the Fed’s logic. If you believe their minutes, firms should be holding back on price hikes until they burn off old stock. But in practice, businesses price forward to what it will cost to replace inventory, not backward to what they paid last quarter. Rising replacement costs, coupled with the expense of carrying extra stock, push prices higher, not lower.
So, why cling to the lag story? Because otherwise the Fed would have to face the possibility that tariffs are not mechanically inflationary. Perhaps foreign exporters absorb costs. Perhaps currency moves offset them. Perhaps margins compress. But rather than consider these alternatives, the Fed doubles down on its priors and invents a “delayed pass-through” narrative.
The danger is obvious: if you’re convinced tariff inflation is just around the corner, you’ll keep policy tighter than warranted. You’ll wait to see the phantom inflation that never arrives. This is what the Fed did during the “transitory” saga—blaming supply chains, labor shortages, anything to preserve the models. Now it’s inventories.
A Testable Divergence
The S&P Flash PMI gives us a real-time test. The Fed says inflation from tariffs hasn’t arrived yet because of inventory buffers. The PMI shows inventories at record highs and price increases already accelerating. Which story looks more credible?
If inflation continues to undershoot despite tariffs and stockpiles, the Fed will have been waiting for Godot—tightening against a ghost. If, on the other hand, the price gauges remain firm while growth holds up, it suggests tariffs may be compatible with stronger domestic output and moderate inflation, not the runaway spiral Fed models predict.
The risk is not just academic. By convincing itself that tariff inflation is “still to come,” the Fed risks waiting forever, refusing to cut until the phantom shows up. That means monetary policy could stay too tight even as growth softens and disinflationary forces strengthen elsewhere.
The PMI is telling us a different story: America’s factories are humming, demand is solid, and prices are rising alongside precautionary inventories. The Fed’s lag theory doesn’t explain this. It only explains the Fed’s refusal to question its own assumptions.
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