January 15, 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 rose 0.1% in December after having been unchanged in November.  During the past year this inflation measure (the red line) has risen 1.3%.

Excluding food and energy producer final demand rose 0.1% in December after having fallen 0.2% in November..  The core PPI has risen 1.2% in the past year (the pink line in the chart above).  This series was steadily accelerating for a couple of years, but it has been steadily drifting lower in the past 12 months.

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

The PPI for final demand of goods rose 0.3% in both November and December. These prices have now risen 0.3% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods rose 0.1% in December after having risen 0.2% in November.  During the past year the core PPI for goods (the light green line) has risen 0.7% (right scale).

Food prices increased 0.2% in December after having jumped 1.1% in November.  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 0.9%.

Energy prices climbed 1.5% in December after having risen 0.6% in November. Like food prices, energy prices are volatile.  Energy prices have risen 3.5% in the past year.   Crude oil output in Venezuela and Iran has been falling steadily and Saudi Arabia  cut its oil output in an effort to boost prices, but U.S. production has continued to surge to a new record high level of 12.8 million barrels per day and that increase in output has more than countered the OPEC shortfall.

The PPI for final demand of services was unchanged in December after having fallen 0.3% in November.  This series has risen 1.3% 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 both November and December.  It has climbed 1.6% 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 3.5% the labor market is presumably well beyond full employment.  As a result, wages pressures have begun to climb. Compensation has risen 3.7% in the past year while productivity has climbed by 1.5%.  As a result, unit labor costs, labor costs adjusted for the increase in productivity, have risen 2.2% in the past year.  Our sense is that wages are beginning to climb more quickly.  The question is whether productivity can keep pace.  We expect unit labor costs to increase 2.5% in 2020, slightly faster than it is currently, but nothing to get too excited about.

The core CPI increased 2.3% in 2019.  We expect it to increase 2.7% in 2020.

Stephen Slifer

NumberNomics

Charleston, SC