Wed Sep 13 07:30:00 CDT 2017

Consensus Consensus Range Actual Previous
PPI-FD - M/M change 0.3% 0.1% to 0.4% 0.2% -0.1%
PPI-FD less food & energy - M/M change 0.2% 0.1% to 0.3% 0.1% -0.1%
PPI-FD less food, energy & trade services - M/M change 0.2% 0.2% to 0.3% 0.2% 0.0%
PPI-FD - Y/Y change 2.4% 1.9%
PPI-FD less food & energy - Y/Y change 2.0% 1.8%
PPI-FD less food, energy & trade services - Y/Y change 1.9% 1.9%

In a report not affected by Hurricane Harvey, producer prices once again couldn't live up to expectations, edging 0.2 percent higher in August vs Econoday's consensus for 0.3 percent. Also 1 tenth below expectations is the core (less food & energy) which could manage only a 0.1 percent gain. This is the third month in a row that the core has missed the consensus.

At 0.2 percent is the less food, energy & trade services reading where the gain relative to the core reflects yet another weak showing for trade services which is a closely watched component that hasn't posted a gain since May. Service industries showing special weakness in August are hotel services and securities/investment services.

The lack of pressure comes despite a 3.3 percent monthly jump in energy costs that however does not reflect Hurricane Harvey as the shock, as explained by the Bureau of Labor Statistics, hit too late in the month to be picked up in the report. Even before Harvey, wholesale gasoline prices surged 9.5 percent in the month. Offsetting the rise in energy is a drop in food, down 1.3 percent and reflecting wide declines through components.

Though energy costs are a major wildcard right now, this report speaks to what is a persistent lack of price pressures in the economy, in this case at the base of the economy. Today's report won't be firming up confidence for tomorrow's consumer price report where a rebound, like that expected for this report, is the call.

Market Consensus Before Announcement
Inflation readings have been very soft and producer prices have been among the softest, posting a 0.1 percent decline in July. Energy firmed in August even before Hurricane Harvey hit at month end and forecasters see a rebound to a headline 0.3 percent gain. The consensus for less food & energy is a 0.2 percent increase with less food, energy & trade services at a consensus 0.2 percent gain. Note that trade services were a glaring weakness of the July report.

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.