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Wed Oct 14 07:30:00 CDT 2015

Consensus Consensus Range Actual Previous
PPI-FD - M/M change -0.2% -0.4% to 0.2% -0.5% 0.0%
PPI-FD less food & energy - M/M change 0.1% 0.0% to 0.2% -0.3% 0.3%
PPI-FD less food, energy & trade services - M/M change 0.2% 0.1% to 0.2% -0.3% 0.1%
PPI-FD - Y/Y change -1.1% -0.8%
PPI-FD less food & energy - Y/Y change 0.8% 0.9%
PPI-FD less food, energy & trade services - Y/Y change 0.5% 0.7%

Producer prices show wide weakness and may raise talk that deflationary pressures are building, not easing. The PPI-FD fell 0.5 percent in September which is just below Econoday's low estimate for minus 0.4. Year-on-year, producer prices are falling deeper into the negative column at minus 1.1 percent. And it's not all due to energy excluding which and also excluding food, prices fell 0.3 percent though the year-on-year rate is still in the plus column, at plus 0.8 percent but down 1 tenth from August. Excluding food, energy and services, where the latter had been showing price traction, prices still fell 0.3 percent with the year-on-year rate at only plus 0.5 percent.

The services weakness, down 0.4 percent in the month, follows two prior gains of 0.4 percent that had been cited as evidence of resilience in domestic demand. Exports remain very weak at minus 0.8 percent in the month following August's 0.4 percent decline. September energy prices fell 5.9 percent and are down 23.7 percent year-on-year. Gasoline fell a monthly 16.6 percent for a 42.8 percent year-on-year decline.

Other readings include a 1.3 percent decline for finished goods where the year-on-year rate, following a long string of monthly declines, is down 4.1 percent. This is an important reading that points to pass through of low raw material prices.

Hawks at the Fed are saying that the negative price effects from oil and low import prices will prove temporary. That may be, but the depth of ongoing price weakness continues to sink. Watch for the consumer price report on tomorrow's calendar.

Market Consensus Before Announcement
Producer prices in September are expected to show even less pressure than the prior month, down a consensus 0.2 percent for the headline vs no change in August. The ex-food and ex-energy core reading is also soft, seen up 0.1 percent vs August's plus 0.3 percent.

The Producer Price Index (PPI) of the Bureau of Labor Statistics (BLS) is a family of indexes that measure the average change over time in the prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. Effective with the January 2014 PPI data release in February 2014, BLS transitioned from the Stage of Processing (SOP) to the Final Demand-Intermediate Demand (FD-ID) aggregation system. The headline PPI (for Final Demand) measures price changes for goods, services, and construction sold to final demand: personal consumption, capital investment, government purchases, and exports.

The PPI measures prices at the producer level before they are passed along to final consumers. A portion of the inflation at the producer level gets passed through to the consumer price index (CPI). By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months.

While the CPI is the price index with the most impact in setting interest rates, the PPI provides significant information earlier in the production process. As a starting point, interest rates have an "inflation premium" and components for risk factors. A lender will want the money paid back from a loan to at least have the same purchasing power as when loaned. The interest rate at a minimum equals the inflation rate to maintain purchasing power and this generally is based on the CPI. Changes in inflation lead to changes in interest rates and, in turn, in equity prices.

The PPI comes in two key main versions: final demand (FD) and intermediate demand (ID). The final demand portion is composed of six main price indexes: final demand goods; final demand trade services; final demand transportation and warehousing services; final demand services less trade, transportation, and warehousing; final demand construction; and overall final demand.

The intermediate demand portion of the FD-ID system tracks price changes for goods, services, and construction products sold to businesses as inputs to production, excluding capital investment. There are two parallel treatments of intermediate demand, each constructed from the identical set of commodity price indexes. The first treatment organizes commodities according to commodity type, and the second organizes commodities using a stage-based, production flow model.

The PPI is considered a precursor of both consumer price inflation and profits. If the prices paid to producers increase, businesses are faced with either charging higher prices or taking a cut in profits. The ability to pass along price increases depends on the strength and competitiveness of the marketplace.

Under the prior PPI system, the producer price index was substantially more volatile than the consumer price index because the CPI included services while the PPI did not. Volatility has been reduced substantially in the PPI-FD due to the inclusion of services but the PPI still is more volatile than the CPI. Wages are a bigger share of the costs at the retail level than at the producer level and this plays a role in the CPI's lower volatility. Also, the PPI does not include owners' equivalent renta large and slow moving component in the CPI. Food and energy prices are major sources of volatility in the PPI, hence, the greater focus on the "core PPI" which excludes these two components.

The bond market rallies when the PPI decreases or posts only small increases, but bond prices fall when the PPI posts larger-than-expected gains. The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.