March 12, 2020

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand fell 0.6% in February after having risen 0.5% in January.  During the past year this inflation measure (the red line) has risen 1.3%.

Excluding food and energy producer final demand rose 0.5% in January after having increased 0.1% in December..  The core PPI has risen 1.7% in the past year (the pink line in the chart above).  This series was steadily accelerating for a couple of years, but it has steadily drifted lower in the past 12 months before, perhaps, beginning to quicken in early 2020..

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods fell 0.9% in February after having risen 0.1% in January. These prices have now risen 0.6% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods declined 0.1% in February after having risen 0.3% in January.  During the past year the core PPI for goods (the light green line) has risen 0.5% (right scale).

Food prices declined 1.6% in February after having increased 0.2% January.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have risen 1.1%.

Energy prices fell 3.6% in February after having declined 0.7% in January.  Off the  February drop 0.6% was attributable to a 6.3% decline in gasoline prices.  This drop in energy prices in February is just the beginning of a sharp contraction during the next few months as Saudi and Russia have both increased production sharply and pushed prices lower.    During the past several years energy production in the U.S. has surged and crude prices have fallen as a result.  The Saudi’s wanted to cut production to boost prices.  The Russians figured if they did this they would lose even more market share to the U.S.  They did not agree to the production cuts.  The Saudi’s got mad and said they were going to significantly boost production and push prices lower to, hopefully, drive out some of the U.S. producers and hurt the Russians as well..  Energy prices have risen 0.3% in the past year.

The PPI for final demand of services fell 0.3% in February after having umped 0.7% in January .  This series has risen 1.5% over the course of the past year.   The PPI for final demand of services excluding trade and transportation (the light blue line) fell 0.1% in February after having risen 0.6% in January.  It has climbed 1.7% in the past year.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 3.6% the labor market is presumably well beyond full employment.  As a result, wages pressures have begun to climb. Compensation rose 3.5% in 2019. while productivity rose by 1.8%.  As a result, unit labor costs, labor costs adjusted for the increase in productivity rose 1.7% in 2019.  However, with a sharp contraction in GDP growth in at least the second quarter the unemployment will begin to rise.  In that event, we expect compensation growth to slow to about 2.5% in 2020, productivity should also drop back to about 1.0%.  That means that unit labor costs will drop back to about a 1.5% increase for 2020.  

.The core CPI increased 2.3% in 2019.  We expect it to increase 2.0% in 2020.

Stephen Slifer

NumberNomics

Charleston, SC