KEY DATA: PPI: -0.4%; Goods: -0.7%; Services: -0.1%/ Claims: 264,000 (down 1,000)
IN A NUTSHELL: “Despite an even tightening labor market, inflation is totally under control, complicating the Fed’s decision-making.”
WHAT IT MEANS: Life would be so much simpler for the Fed members if there was “normal” inflation, but alas, that is not the case. Yesterday we saw that import prices declined and today it was producer prices that were negative in April. The wholesale cost declines were really broadly based as both goods costs and services prices dropped. At the final demand level, which is the most processed, you have to search long and hard to find any product where prices rose and even there, the gains were relatively modest. Even in the services sector, which is about 63% of the index, the price increases we had been seeing have largely dissipated. There is some pressure at the intermediate level for services, but the pipeline for goods inflation starts all the way back at the crude component. And we know that the pathway from crude costs to finished goods costs in rarely straight. About the only measure that showed some inflation was the special index which excludes food, energy and trade. This was up modestly and over the year, the gain was less than one percent. Basically, there are no inflationary pressures the Fed has to worry about.
As for the labor market, unemployment claims remained at a level that we haven’t seen in fifteen years. Adjusting for the size of the labor force, we are now at record lows. That clearly indicates firms are holding onto workers as much as possible. As labor needs keep expanding, firms will have to look to other methods to fill the growing job openings, so it is just a matter of time before wage gains jump. And don’t expect a slow acceleration. We are talking about a dam breaking here and the longer companies hold by the waters, the greater the flood.
MARKETS AND FED POLICY IMPLICATIONS: To hike or not to hike, that is the question. Right now, the economic and inflation data are mediocre enough that the Fed can stand pat. But Janet Yellen and her band of not so merry monetary policy makers are also concerned about the labor market. Looking just at the monthly hourly wage numbers, there doesn’t seem to be any compensation pressures building. But that is not the case when you look at the much more comprehensive employment cost index. That measure is accelerating and the rate of increase is back to the average for the last expansion. The unemployment rate is at or very near full employment, jobless claims are at record lows and job openings are near record highs. Oh, and it looks like the dollar has peaked. What this tells me is that the Fed must keep its finger on the trigger, even if it doesn’t have to pull it just yet. That said, investors love weak economic or inflation data, as it implies no immediate Fed rate hike, so the wholesale price numbers should make lots of traders happy.