The August Producer Price Index Summary held no surprises. Energy price inflation went up, headline inflation went up, core inflation not so much.
The Producer Price Index for final demand moved up 0.4 percent in August, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. Final demand prices rose 0.1 percent in July and decreased 0.1 percent in June. (See table A.) On an unadjusted basis, the index for final demand increased 5.4 percent for the 12 months ended in August.
In August, the index for final demand goods advanced 1.1 percent, and prices for final demand services increased 0.1 percent.
The index for final demand less foods, energy, and trade services rose 0.3 percent in August after moving up 0.4 percent in July. For the 12 months ended in August, prices for final demand less foods, energy, and trade services advanced 4.7 percent.
At 5.4% year on year, headline factory gate inflation was just above Wall Street’s consensus estimate, as was core inflation at 4.7%.
The predictability extended even to the narratives in the financial media. Because the headline inflation metric rose, the Producer Price Index Summary is another reason for the Fed to raise the federal funds rate, because inflation and reasons and whatever.
Just as predictably, the data does not support a rate hike. If anything, the August PPI print is a reason for the Fed to stand pat on the federal funds rate.
Media All Reach Same Conclusion: Fed Will Hike
The lack of surprises in the PPI data meant that both corporate and alternative media outlets ended up reporting largely the same thing: energy price inflation was up, making goods prices higher, and therefore the Fed is more likely to raise the federal funds rate.
That was the explicit conclusion of CNN, for example:
Thursday’s report could strengthen the case for the Federal Reserve to raise interest rates at its policy meeting next week.
ZeroHedge’s analysis reached the same conclusion.
As CNBC noted, Wall Street, despite anticipating the PPI print, still reacted badly.
Excluding food and energy, core PPI accelerated by 0.2%, against the forecast for a 0.3% increase. Core less trade services, another volatile category, was up 0.3%.
Stock market futures were negative following the report, the release of which coincided with U.S. crude oil prices topping $100 a barrel. Treasury yields moved sharply higher.
Associated Press had perhaps the best coverage, acknowledging that there factors beyond energy prices and the war with Iran.
Inflation has shown some signs of easing in recent months but is still high, frustrating consumers who are struggling with more expensive gas, groceries, clothing and other essentials. U.S. oil prices topped $100 a barrel Thursday on renewed fighting in the Middle East, while President Donald Trump has intensified a trade war with Canada, a sign tariffs still could push up costs. Rising prices pose a political problem for the Trump administration and Republicans running in the midterm elections.
The reality is that Wall Street is convinced the Federal Open Market Committee will raise the federal funds rate 25bps next week, with current probabilities at 71%.
Wall Street is not enthusiastic about the coming rate hike. The publication of the PPI data caused Treasury yields to spike, and the 10-Year Treasury closed out the day closing in on 5% yield.
Equities, meanwhile, had another down day.
Wall Street has become so habituated to following the Fed’s lead on interest rates, that very little thought was given to whether the PPI data really supports a rate hike—which it does not.
Energy Surged, Everything Else Didn’t
While headline factory gate inflation of 5.4% dominated the media reporting, core inflation is still sporting a disinflation trend. Even at 4.7%, core inflation is moving steadily lower from its April peak.
Core inflation’s downward trend was more apparent month on month.
The difference between the headline and core inflation rates was easily seen as energy-related.
Energy was alone in showing a surge, however.
Food prices reverted back to inflation in August, after printing deflation in July.
Services continued their disinflation trend, with the lowest month on month print since June of last year.
Goods prices apparently surged, but only because energy goods are included.
Energy prices have been the culprit behind almost all of the increase in goods prices since March. Without energy prices, goods prices are flirting with systemic deflation.
But for energy prices, there would be little or no producer price inflation at the final demand level.
Intermediate Demand Signals Inflation Is Coming
With the PPI serving as a common leading indicator for consumer price inflation, the lack of clear inflation for final demand prices suggests that even next month, inflation’s rise will be limited to energy prices.
Intermediate demand, however, surged, suggesting that later in the fall we will see more factory gate inflation.
With the greatest increase coming in Stage 1 Intermediate Demand, the inflation pulse implied by rising intermediate demand prices is more likely to arrive in the CPI print in October or possibly even November.
Energy is a driving factor even here, however, with processed fuels pushing intermediate demand prices higher while unprocessed fuels are pulling intermediate demand prices lower.
Fuel prices were the driving force behind transportation and warehousing inflation during August. Trade itself printed deflation, and that left services less trade, transportation, and warehousing virtually unchanged on the month.
Energy price inflation is here, and is likely to get worse.
The Producer Price Index Summary is signalling that only energy price inflation is inbound at the moment.
Energy Prices Have Already Gotten Worse.
There is no crystal ball needed to know that energy price inflation will get worse. Fuel prices—especially diesel prices—are still rising.
With diesel crack spreads (the difference between the futures price for diesel and the futures price for feedstock crude oil) pushing well above $100/bbl, there is no reason to expect diesel prices not to rise further.
The rise in diesel crack spreads underscores the significance of the rise in diesel prices, because the crack spread is reaching record highs even with benchmark crude topping $100/bbl for Brent.
As I have noted many times previously, there is no denying that energy prices are moving up almost across the board, with the notable exception being US natural gas.
US natural gas prices have dropped by nearly 25% since the start of the year.
No Broad Based Inflation—Yet
Given the steady rise of energy prices over the summer, it is remarkable that we have not seen more energy price inflation, both in the PPI and in the CPI, than we have. At least some of August’s energy price inflation qualifies as “long overdue.” Looking directly at market prices for diesel, for gasoline, and for crude, the data supports a clear expectation for far more energy price inflation than we have seen.
However, even with energy price inflation starting to “catch up” to market prices, we are not seeing energy prices push other goods prices higher. Producer prices for trade are in outright deflation.
But for energy prices, there would be very little increase in inflation across the entire board.
This is an important qualification of the PPI data, as it is the crux of why now is not the time to raise the federal funds rate.
As I have discussed previously, rate hikes corral inflation by constraining consumption and employment. By putting the brakes on the economy as a whole, interest rate increases lower overall demand—not just for energy-related goods and services but for everything.
That is how all interest rate rises operate—discourage consumption and discourage job formation. As Volcker did in 1979, push interest rates high enough, hold them there long enough, and the end result will be a recession.
Without a clear hyperinflation cycle taking place, and without clear evidence of broader inflation, impeding consumption and employment is monetary policy overkill. With core inflation printing at 2.4% year on year, reducing consumption and softening employment simply cannot be justified.
The oilpocalypse is real. Energy price inflation is real. Yet the impact of energy price inflation has so far been minor, and the Producer Price Index suggests that will continue for at least a little while longer.
We are not yet seeing the “worst case” in energy prices. The Federal Reserve will be making a major mistake to act as if we are.
Thank you
You’ve got the data, and the only sound conclusions to be had from it, Peter. I really wish you had a forum in which to debate Warsh, as you would leave him stammering like an idiot. Which, apparently, he is.
Is the Fed really just all politics, posturing, and self-enrichment? You’re right, Peter: abolish the Fed!