Producer prices were lower than expected in February, with the headline index edging down 0.1 percent on the month and rising 4.6 percent year-over-year, down from 5.7 percent in January, both below expectations of 0.3 percent and 5.4 percent, respectively. Excluding food and energy, PPI final demand was flat on the month and up 4.4 percent year-over-year. When also excluding trade services, prices increased 0.2 percent from January and 4.4 percent from a year earlier, all below expectations.

Today's lower-than-expected price readings with the 12-month rate at its lowest level since March 2021 - come against the backdrop of Silicon Valley Bank's failure that revived recession fears and concerns about the financial system stability. This environment could complicate attempts by the Federal Reserve to tighten further in the short term to bring back inflation closer to its 2 percent target. What's more, Econoday's Consensus Divergence Index points to a slight underperformance of the economy.

The decline in the final demand index was led by good prices, which fell 0.2 percent on the month, although services were also down, by 0.1 percent. A 2.2 percent decline in food was a key driver of the monthly price decline, with energy down 0.2 percent. Goods prices excluding food and energy actually increased 0.3 percent.

At the retail level, prices gain were steady in February at 6.0 percent year-over-year for the headline CPI and 5.5 percent when excluding food and energy, in line with expectations.

After rising a sharper-than-expected 0.7 percent in January, producer prices in February are expected to slow to a monthly 0.3 percent. The annual rate in February is seen at 5.4 percent versus January's 6.0 percent. February's ex-food ex-energy rate is seen at 0.4 percent on the month and 5.2 percent on the year versus January's 0.5 and 5.4 percent, both of which were also sharper than expected.

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 rent—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.