Expecting a PPI Shock

If you look at PPI (producer price index) inflation in the United States, you can see that the latest reading for the past 12 months is 6.9%. This number is bad enough, but the six months to the end of March were even worse, with inflation running at an annualized rate of 11%. The next two or three readings are likely to show an acceleration of this number because crude oil has risen 20% since the end of March.

PPI also includes weightings from agricultural commodities which have been on a tear in recent months but have somewhat retreated in April. A good measure of global food prices is an index produced by the Food and Agriculture Organization of the United Nations. The FAO food price index peaked in March and shows a very modest decline of less than 1% in April. Although some food commodities have seen bigger price declines in April, for example rice down 20%, overall food prices are unlikely to offset the surge in energy prices for April and May PPI figures.

The Fed is dancing around reality by conveniently ignoring food and energy inflation but a rising PPI will have one of two consequences. It will either force the Fed to raise rates again, or it will result in a margin squeeze for a large number of companies. Either outcome is negative for the equity market.

Comments

[buyitcheap:]

A rate increase or substantially increased jawboning at the very least is a lock if the above described scenario does play out. That will take a good 10% off the oil/energy indexes as well as the Commodity index.

2008 May 19 02:23 PM

[billb:]

One of the things I don't understand is that energy and food are left out because they are "volatile". Why not take a moving average of the PPI with food and energy to establish a trend. I understand that this is lagging, but to me, the only people that benefit from the PPI reading sans food and energy are those that don't eat or buy fuel.

2008 May 19 02:52 PM

[Jason Rines...:]

Or the ones bill b that don't notice when the families monthly energy bill doubles in three years from $600 a month to $1,200 or the monthly food bill also doubles about the same amount. A lot of consumers can choose different food items to eat, coupon and bargain shop, but energy is a different matter.

2008 May 19 05:26 PM

[bearfund:]

The PPI is the number to watch. Many government costs depend on the CPI. Almost nothing depends on the PPI. Therefore it's much less likely to be manipulated and tends to better reflect reality. If you tell me prices have risen 7% YoY, I'm likely to say, yeah I can believe that. If you tell me it's 2% I'll call you a liar to your face, because you deserve it. How long until they start monkeying with this, too, just because the market starts watching it?

2008 May 20 12:45 AM