Is There a New Problem with Core PPI?

by: James Picerno

This morning's update on wholesale prices brings news that inflation may not be going quietly into the sunset just yet.

Producer prices rose 0.6% last month, up sharply from the 0.2% decline in June, the Bureau of Labor Statistics reported today. But that's a straw man. Energy was the culprit, courtesy of July's sharp rise in crude oil- a rise that's since pulled back.

It'll be tougher explaining away the rising trend in core PPI, however. As our chart below illustrates, PPI excluding food and energy continues bubbling higher on a rolling 12-month basis. For the year through July, core PPI jumped 2.4%, the highest pace in nearly two years.

PPI Chart

The trend has apparently caught the attention of traders in Fed funds futures. A number of contracts have dropped sharply in price this morning, suggesting that the prospects for a rate cut have dimmed, at least for the moment.

That's not surprising, given the news on PPI today, at least when viewed through the prism of rolling 12-month changes. Still, one metric alone doesn't tell us much, which is why all eyes now turn to tomorrow's July consumer price report. The consensus forecast calls for a slower pace in headline CPI and about the same for core. We'll see.

Given the initial reaction in Fed funds futures, however, it's clear that Bernanke and company will have to tread carefully. The least jitter about inflation is enough to bring bond bears out from hiding.

Indeed, the notion that a rate cut's needed strikes this reporter as more of a gift to Wall Street than Main Street at this juncture. That, of course, could change if the subprime ills start spilling over into the broader economy in a larger way. Until, and if that happens, today's PPI gives the Fed a notch less credibility on cutting rates. But in these volatile times, today's logic can easily become tomorrow's statistical garbage.

Allot depends on the CPI. So, stay tuned....