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Real Deflation Coming Soon?

I have been a long and continuous opponent of the Fed's Zero Interest Rate Policy - it is ok for short periods of time but the consequences of long term interest rate reduction is not well understood. Japan tried it and it got deflation.

Now we are beginning to evidence deflation setting in - partly accelerated by the strength of the dollar (isn't that what happened to Japan and the Yen?). Coincidence? - maybe but maybe not.

Next week we will see the Consumer Price Index for February - but we have already seen both the Producer Price Index and Import / Export Price Index which are deflating at a very high rate.

The Producer Price Index inflation continued its growth deceleration - and overall the PPI is in deflation year-over-year. In all events, the intermediate processing continues to show a very large deflation in the supply chain.

The PPI represents inflation pressure (or lack thereof) that migrates into consumer price.

  • The BLS reported that the headline Producer Price Index (PPI) finished goods prices (now called final demand prices) year-over-year inflation rate fell from 0.0% to 0.6%.
  • The market had been expecting:
month over month change Consensus Range Consensus Actual
PPI-Final Demand Goods (PPI-FD) 0.1 % to 0.7 % +0.3% -0.5%
PPI-FD less food & energy (core PPI) 0.0 % to 0.2 % +0.1% -0.1%
PPI-FD less food, energy & trade services 0.0 % to 0.2 % +0.1% +0.0%

The producer price inflation breakdown:

category month-over-month change year-over-year change
final demand goods -0.4%  
final demand services -0.5%  
total final demand -0.5% -0.6%
processed goods for intermediate demand -0.6% -6.4%
unprocessed goods for intermediate demand -3.9% -25.0%
services for intermediate demand +0.1% +1.2%

In the following graph, one can see the relationship between the year-over-year change in crude good index and the finish goods index. When the crude goods growth falls under finish goods - it usually drags finished goods lower.

Percent Change Year-over-Year - Comparing PPI Finished Goods (blue line) to PPI Crude Materials (red line)

Global trade prices are continuing to deflate. Import prices are down 9.4% from a year ago, while export prices are down 5.9% from a year ago. Of course oil prices were up 6.5% this month, but agricultural prices fell 2%.

  • with import prices up 0.4% month-over-month, down 9.4% year-over-year;
  • and export prices down 0.1% month-over-month,down 5.9% year-over-year..
  • the markets were expecting:
  Consensus Range Consensus Actual
Export Prices - M/M change -0.8 % to 0.5 % -0.1% -0.1%
Import Prices - M/M change -1.0 % to 0.9 % +0.2% +0.4%

There is only marginal correlation between economic activity, recessions and export / import prices. Prices can be rising or falling going into a recession or entering a period of expansion. Econintersect follows this data series to adjust economic activity for the effects of inflation where there are clear relationships.

Econintersect follows this series to adjust data for inflation.

Year-over-Year Change - Import Prices (blue line) and Export Prices (red line)

The question remains - can the Fed EVER move away from zero interest? If it does, the dollar will continue to strengthen.

Other Economic News this Week:

The Econintersect Economic Index for March 2015 continues to show a growing economy, but the rate of growth is decelerating. All tracked sectors of the economy are expanding - but most sectors are showing some slowing in their rate of growth. The negative effects of the recently solved West Coast Port slowdown (a labor dispute which had been going on for months) can be seen be seen in much of the raw data - and it will be an economic drag on 1Q2015 GDP. Although beyond our forecast view, we expect a slight economic bounce in the coming months as a trillion dollars annually of cargo begins to traverse the West Coast Ports again in a normal flow.

The ECRI WLI growth index value crossed slightly into negative territory which implies the economy will not have grown six months from today.

Current ECRI WLI Growth Index

The market was expecting the weekly initial unemployment claims at 292,000 to 320,000 (consensus 309,000) vs the 289,000 reported. The more important (because of the volatility in the weekly reported claims and seasonality errors in adjusting the data) 4 week moving average moved from 306,000 (reported last week as 304,750) to 302,250. The rolling averages have been equal to or under 300,000 for most of the last 6 months, but this week again exceeded this number.

Weekly Initial Unemployment Claims - 4 Week Average - Seasonally Adjusted - 2011 (red line), 2012 (green line), 2013 (blue line), 2014 (orange line), 2015 (violet line)

Bankruptcies this Week: England-based Towergate Financial filed for Chapter 15 protection, BPZ Resources, Dune Energy, Allied Nevada Gold, Doral Financial (dba Doral Financial Puerto Rico), Standard Register Company, Chassix Holdings

To read all of our analysis and news for the past week [click here].

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.