KEY DATA: PPI: +0.3% Over-Year: +3.4%; Goods: +0.1%; Services: +0.4%

IN A NUTSHELL: “Wholesale cost increases are accelerating and with more tariffs being announced, it is hard to see how consumer inflation will not accelerate as well.”

WHAT IT MEANS: Is inflation a problem? Maybe not yet, but it is hard to see that it will not be a real issue very soon. Wholesale prices rose solidly in June even with a sharp decline in food costs. Excluding foods, it was up at a concerning rate. I point out foods because a large part of the trade war is being fought over agricultural products and a loss of foreign markets would create surpluses in the U.S. and price declines. To the extent the price increases were due to bumper crops, those declines would likely be temporary. So, we should focus on the goods excluding foods and those were up pretty much across the board. Energy prices are rising as well and that is not good news for consumers, especially since they are helping drive a sharp rise in transportation costs.

Over the year, producer prices are up the fastest since December 2011. That is a warning and if we look into the pipeline to see if cost pressures will accelerate of slow, it is clear that they are likely to worsen. At the intermediate level, non-food and energy goods costs are soaring. Processed materials less food and energy were up by nearly five percent over the year and much of that will likely be passed through to finished goods. And the sharp rise in energy costs we saw in June is likely to be as great this month.

MARKETS AND FED POLICY IMPLICATIONS: Wholesale costs are accelerating and now we have threats of further tariffs on China that can only ramp up inflation fears. Of course, they are only wholesale costs. By that I mean the pathway from producer to consumer price increases is hardly straight. But we are getting to wholesale inflation levels that will be hard to absorb without materially reducing earnings. That is a warning for investors that the sugar high from the tax cuts may start wearing off, as businesses have to show increases that are not simply tax related. Higher producer costs, regardless of the source of the cost pressures, are not good news for the markets. If earnings come under pressure, it is likely that at least some of those cost increases will start showing up in the consumer price measures. That cannot make the Fed happy. So, today’s report is not good news as it provides warnings that inflation is likely to rise further and corporate earnings could weaken as we go through the second half of the year.