Pricing Pressure Building within the Depths of the PPI

Rising producer prices eventually translate into higher consumer prices as businesses are forced to pass on a portion if not all of the price increments to their customers.  So what you might be asking, this morning’s PPI indicated that producer prices fell -0.1% on a monthly basis. While this is true the PPI is broken out into three sub-components crude, intermediate, and finished goods—the headline PPI only tracks finished goods.  As higher producer prices eventually pass-through to consumer prices; higher crude material costs ultimately impact intermediate good prices, while rising intermediate good prices in time increase the headline PPI.  As of April crude material rose roughly 30% y/y, while intermediate good prices climbed 9%, the highest reading since 2008 (See chart).   Core raw material prices rose 49.7% y/y–its largest yearly gain on record. While this isn’t an immediate recipe for higher consumer prices; it is definitely indicative that pressure is building in the pipeline. 

In terms of monetary policy, short-term inflation expectations as measured by the US TIPS breakeven curve have diminished significantly on waning commodity prices and a stronger dollar stemming from the ongoing crisis in Europe and concerns over Chinese tightening.  This will likely keep the Fed on hold through-out the remainder of the year as unemployment remains high and growth below what would be anticipated following a major recession.  Looking further ahead, inflation pressure is gaining some momentum and should become more of a factor in monetary policy decisions as the year progresses.