September Producer Prices

KEY DATA: PPI (Final Demand): +0.2%; Less Food, Energy and Trade Services: +0.4%; Goods: -0.1%; Less Food and Energy: +0.2%; Services: +0.3%

IN A NUTSHELL: “Wholesale cost pressures are no longer accelerating sharply, but that should do little to change the direction of interest rates.”

WHAT IT MEANS: Rising interest rates have become the biggest concern to maintaining the current strong growth. The 2- and 5-year Treasury notes are at their highest levels in a decade. The last thing the markets needed was an indication that inflation would surge, so it was nice that the Producer Price Index increased only moderately in September. Yes, the core index, which excludes food, energy and trade services, did jump, but there wasn’t any major acceleration in the yearly gains in the major components. Indeed, food, energy and overall final goods prices eased a touch over the month. Services costs, though, did rebound. Looking at the pipeline, there isn’t a lot of cost pressure at the intermediate goods level but services pressures are building. With energy prices are up again and the collapse in eggs costs probably behind us, wholesale prices will likely rise more sharply over the next couple of months.

MARKETS AND FED POLICY IMPLICATIONS: It’s time to repeat one of my favorite sayings: No good economy goes unpunished. The strong growth, coming on top of already tight labor markets, is helping drive up inflation and interest rates. That has provided the basis for current and future rate hikes and the sudden jump in longer-term interest rates. While wholesale costs may not be surging, they are still growing at a much higher pace than we saw for most of the post-recession period. There is also little basis to expect that business costs will moderate anytime soon, especially if we see an end to the rise in the dollar. So the rise in expenses should be sustained. While the path from producer to consumer prices is hardly straight, there is every reason to believe that consumer inflation will continue to accelerate slowly. That means the Fed will not be backing down anytime soon. Finally, investors are beginning to wake up and smell the concerns that economists have been talking about for months. I have been saying that the Alfred E. Neuman approach to investing will have to eventually end and the surge in rates may finally be causing that to happen. We will see over the next few months the extent to which the exuberance in the markets is brought under control. With political factors coming into play soon (the mid-term elections are less than four weeks away), everyone should fasten their seatbelts as it looks like we are in for a bumpy ride ahead.