KEY DATA: PPI: -0.2%; Goods: -0.2%; Excluding Food and Energy: 0%; Services: -0.2%/Michigan Sentiment: 81.2 (down 0.7 point)
IN A NUTSHELL: “Producer inflation pressures took a holiday in May, but it is unclear if that is just a temporary lull or a movement back to a trend of modest wholesale cost increases.”
WHAT IT MEANS: Inflation pressures, what inflation pressures? After two months of sharp increases in wholesale prices, there were growing concerns that we might be in for some acceleration in inflation. Those fears were eased, at least to some extent, with the May decline in the Producer Price Index. The retrenchment was in both goods and services. Food costs, which had been skyrocketing, reversed field and fell. The huge volatility in this segment is not unusual but it does create some caution in determining future trends. On the energy side, the reduction we saw is likely to turnaround as the craziness in Iraq is roiling the oil markets. While food and energy prices have been changing wildly, consumer costs remain tame. There was one place where rising prices have to be watched closely. Transportation services costs are jumping and to the extent they represent rising economic activity – and the growing need to move goods and people – the increase in this component could be signaling that improving conditions could trigger some grab for higher prices. Looking into the future, there does not appear to be any major pressures building that would be a cause for alarm.
In a separate report, the Thompson Reuters/University of Michigan mid-June reading of consumer sentiment dipped again. It is interesting to note that in the May report, people felt reasonably good about the economy. However, they are becoming more and more depressed about their incomes as they don’t expect to see any gains this year. There is a real disconnect in the business community. They are doing everything possible to keep wages from rising but then they complain that consumers are not buying. It is hard to buy more goods when your income is stagnating. I have said this many times and now we see that the hard cap on wage gains is affecting confidence.
MARKETS AND FED POLICY IMPLICATIONS: Inflation is not likely to be a major issue for the Fed for quite some time. While wholesale costs are rising at a moderate pace, firms are not passing much of that through and consumer inflation is below the Fed’s desired level. It will take a lot stronger growth for an extended period for inflation to become a problem. That allows Fed Chair Yellen to have free reign to keep rates low. Confidence, wages and consumer spending will remain in its death trap until firms are forced to start bidding for workers. At that point, spending will pick up and improving confidence will boost it. But don’t expect anything spectacular until the unemployment rate gets below 6%. At that point, labor shortages should be widespread enough that wages will start rising fast enough to trigger not only better growth but also words of warning from the Fed about rate hikes. That time may not arrive until later this year. Investors will likely be more concerned with Iraq than May wholesale prices. I am not sure how much sense that really makes, as it is not clear there will be any major dislocation of oil supplies. It is an excuse, though, to take prices up.