KEY DATA: PPI: +0.4%; Goods: +0.5%; Goods less Food and Energy: +0.1%; Services: +0.3%/IP: +0.2%; Manufacturing: +0.1%
IN A NUTSHELL: “The rise in wholesale consumer product costs may not lead to a large rise in inflation, but the upward trend needs to be watched.”
WHAT IT MEANS: As long as inflation remains well contained, the Federal Reserve can provide unlimited support to the economy. We have seen a steady, but slow, upward drift in the inflation rate and the June data on wholesale costs indicate that the trend will likely continue. The Producer Price Index rose sharply but much of that came from a jump in energy costs. We already know that the upsurge in petroleum prices has already unwound so the headline rise in July will likely be lower. But as usual, the real information is in the details and they tell a somewhat different story. Costs at the finished goods levels are beginning to show some real signs of rising inflation. Finished consumer goods prices have increased by over 3% during the past year even when you exclude energy. Finished consumer food costs have jumped nearly 5%. While not all of those increases make their way into retail prices, a lot do and that argues for additional pressure on consumers. Services costs, though, have been more contained, increasing just under 2% over the year.
On the manufacturing front, output rose modestly in June, but that doesn’t tell the whole story. The industrial sector rebounded from a terrible January, posting strong gains over the next four months. Even with the limited increase in June, manufacturing production increased at a nearly 7% pace during the second quarter. Despite a weather-restricted 1.4% first quarter increase, manufacturing output is rising at a better than 4% pace this year and that is an indication the economy is picking up steam. Construction activity was solid in June and the output numbers were backed up by a jump in the National Association of Homebuilders’ Index which hit its highest level since January. The winter is finally over as far as builders are concerned.
MARKETS AND FED POLICY IMPLICATIONS: It is hard to get worked up over any producer price report as the pathway from wholesale to retail is hardly direct and frequently goes nowhere. But the increases in finished goods costs are a warning that the days of putting inflation in the back of our minds may be coming to an end. We are not talking about high inflation, just rising inflation. We have seen that in the both the Consumer Price Index and Personal Consumption Expenditure Price Index. The CPI is now over 2% while the PCE is closing in at that level, though excluding food and energy they are still below the Fed’s target. The Fed probably wouldn’t mind a little acceleration in inflation. It is a lot higher that they worry about. Right now there is little reason to fret but that may not be the case in by the end of the year. Investors will probably not think much about today’s data as they are really non-threatening.