Fri Dec 11 07:30:00 CST 2015

Consensus Consensus Range Actual Previous
PPI-FD - M/M change 0.0% -0.2% to 0.1% 0.3% -0.4%
PPI-FD less food & energy - M/M change 0.1% -0.1% to 0.2% 0.3% -0.3%
PPI-FD - Y/Y change -1.1% -1.6%
PPI-FD less food & energy - Y/Y change 0.5% 0.1%
PPI-FD less food, energy & trade services - M/M change 0.1% -0.1%
PPI-FD less food, energy & trade services - Y/Y change 0.3% 0.4%

A sharp rebound for service prices lifted the producer price-final demand headline 0.3 percent in November which is 3 tenths above the Econoday consensus and 2 tenths above the high estimate. The core rate (less food & energy) also rose 0.3 percent which is 2 tenths above expectations. Services, following two prior months of contraction, rose 0.5 percent in a gain that should confirm confidence that domestic-centered strength in the services industry will continue to drive the economy. But when excluding services, along with food and energy, wholesale prices rose only 0.1 percent.

Year-on-year readings don't look alarming at all with total prices at minus 1.1 percent, which is however 5 tenths better than October's minus 1.6 percent. The core rate, again driven by services, popped up 4 tenths to plus 0.5 percent. Service prices are also up 0.5 percent on the year. When excluding services along with food and energy, year-on-year wholesale sales are up 0.3 percent which is 1 tenth below October.

Other readings of note include a 0.3 percent decline for export prices, where the year-on-year rate is minus 3.9 percent. Energy prices fell another 0.6 percent in the month for a year-on-year decline of 19.0 percent. Though down 3 tenths in the month, construction prices, as have other indications on the sector, have been showing life, up 2.1 percent which just about leads the report.

Rates are definitely subdued but because of services, this report is on the high side especially for inflation hawks who can argue at next week's FOMC that deflationary pressures may in fact be starting to ease, at least to a degree.

Market Consensus Before Announcement
Service prices proved an unlikely source of deflationary pressure in the producer price report for October, falling for a second month in a row. Both energy prices and food prices fell with both finished goods and export prices also down. For November, forecasters are calling for no change in the producer prices - final demand headline and a 0.1 percent gain for the core rate. Year-on-year rates have been falling deeper into negative territory, to minus 1.6 percent for the headline reading in October.

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.