Where Has All the Inflation Gone?

Dan Shainberg

September 12, 2018

The PPI is an economic indicator of the CPI. Also known as the Producer Price Index, the PPI measures the average change in prices received by domestic producers of goods and services. It differs from the CPI in that the measurement is from the perspective of the seller's prices versus the CPI which measures price changes from the purchaser's perspective.

Why is the PPI relevant? Because as a leading inflation indicator it may predict inflation trends which are strongly correlated to the outlook for interest rates. And the economy is highly correlated to the rate of change in actual interest rates and the pace of change in rates versus expectations. With a lack of inflation the Fed would not need to raise interest rates or raise them as quickly as expected. By keeping rates lower for longer, the economy is more likely to continue its record of strong growth. Investors can borrow at relatively cheap rates, consumers can pay for goods they otherwise would not be able to afford and business activity rolls on. Of course this all may be increasing the likelihood and severity of the next downturn, but it still allows investors and economists to glimps into the near term outlook for the economy and markets barring unexpected surprises.

Today the wholesale inflation report fell for first time in 18 months. The PPI dropped 0.1% in the August report. The drop was the first since February 2017. Over the past 18 months the Fed has clearly changed its posture to a more aggressive tightening stance to combat the early signs of inflation. The labor market is tight and wages are increasing. The central bank is still expected to raise rates again this month and once again prior to the end of the year.

But ultimately the future pace of rate hikes likely rests on expectations for inflation and this PPI data may provide a glimpse into that trend. Or it may not! It could easily just be a blip tied to the way the calculation is reported as many economists who analyze the index have pointed to its recent overweighting in the retail and transportation sectors which are more service oriented and carry lower margins. This could have the effect of nominally changing the output from the index while not really explaining anything materially important about true inflation in the economy.

Dan Shainberg
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