February 14, 2017 07:30 CST

Consensus Consensus Range Actual Previous Revised
PPI-FD - M/M change 0.3% 0.2% to 0.4% 0.6% 0.3% 0.2%
PPI-FD less food & energy - M/M change 0.2% 0.1% to 0.2% 0.4% 0.2% 0.1%
PPI-FD less food, energy & trade services - M/M change 0.2% 0.1% to 0.3% 0.2% 0.1%
PPI-FD - Y/Y change 1.6% 1.6%
PPI-FD less food & energy - Y/Y change 1.2% 1.6%
PPI-FD less food, energy & trade services - Y/Y change 1.6% 1.7%

There are indications in the January producer price report that underlying inflation pressures may be building. The headline, at a much higher-than-expected 0.6 percent, is skewed higher by a 4.7 percent monthly surge in energy (gasoline plus 12.9 percent and home heating oil up 14.5 percent), but service readings are also notable, at a moderate plus 0.3 percent overall but at plus 0.9 percent for trade services and plus 1.1 percent for transport services.

Food, unchanged in the month, is one of the few readings not to show much pressure but this follows consecutive gains of 0.5 percent in the two prior months. Goods rose 1.0 percent and, when excluding food and energy, still rose a sizable 0.4 percent. Clothing jumped 4.8 percent in the month reflecting much less discounting than is typical for a January. Other readings include 0.6 percent gains for both government purchases and exports.

This report points to the risk of higher-than-expected readings in tomorrow's consumer price report where only modest gains of 0.3 percent overall and 0.2 percent ex-food and energy are the consensus. Sudden traction for inflation could increase expectations for Federal Reserve rate hikes, including one at the March FOMC, and add a new element to policy formation in Washington.

Market Consensus Before Announcement
Higher oil prices drove up last week's import price report and are expected to boost headline PPI-FD where the January consensus is 0.3 percent. Less pressure is seen when excluding food & energy with this consensus at 0.2 percent which is also the consensus when excluding food, energy, and also trade services. Most readings in this report have been flat though easy comparisons with last year's lower oil prices are positives for coming reports.

The Producer Price Index (PPI) of the Bureau of Labor Statistics (BLS) is a family of indexes that measures 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 rentâ€a 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.