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Producer Price Index - PPI: An Overview on Reading It

Release Date: Monthly, mid-month
Release Time: 8:30AM ET
(View PPI reports)

If you're looking at the Bureau of Labor Statistics report on the Producer Price Index, you would likely see headline numbers similar to this:

The PPI report denotes the change in prices over the previous month or year, for goods and services as they are sold and paid for BEFORE they arrive in the hands of the consumer and other end users. The “FD” abbreviation next to all of the headline numbers above stands for “final demand,” which basically means the percentage price changes in goods one step before they are sold to consumers, government, exporters, capital investors, etc. This does not mean that prices earlier in the production cycle are not included in the report; those prices are catalogued in great detail. However, the financial community and media have chosen to highlight the Final Demand figures in the most frequently viewed versions of these reports, in large part because they trend most closely to the CPI.

For investors, traders, and business planners, the PPI report is often most useful because it gives them early signals of present and future inflation. For bond investors and those who need capital for business, inflation is a great bane. With the onset of inflation, bonds lose value and credit becomes more expensive as debt issuers raise interest rates to preserve the future value of their investments. Historically, inflation has coexisted with both good and bad stock markets, and there does not seem to be a well-known study that indicates conclusively that inflation is bad for stocks, in fact, some reputable pundits say that inflation is good for stocks. In the report above for May 14, 2015, the real problem is deflation. Most of these Y/Y and M/M numbers were negative, and even the few positive figures were all below expectations. This despite the fact that oil prices bounced back strongly in April and that most economists think we are in a recovery. The previous day’s Retail Sales report, although it did not directly indicate the presence of deflation, was softer than expected and contributed to this dreary picture of a sluggish economy.

This overall picture above is positive for bonds and repressive for interest rates. Although most media commentators identified this PPI report and other such soft reports as bolstering the dovish camp within the Federal Reserve, most seem to be underestimating just how dovishly Chairwoman Yellen and many of her colleagues are probably perceiving this data. Ms. Yellen has long emphasized that, between hyperinflation and deflation, she considered deflation to be the more ominous risk. In her view, it would be much easier to recover from a bout of hyperinflation, than from an “inflationary spiral.” (Speech of June 30, 2009, Huffington Post, and many other speeches) For this reason, it seems likely that, if we continue to see deflationary inflation numbers, the Fed will continue to postpone raising interest rates until these numbers become more buoyant.

It should be noted that within these headline numbers, and throughout the larger BLS report, figures are available in both seasonally adjusted and not seasonally adjusted format. Also, the headline final demand numbers are variously expressed including or excluding food, energy, and “trade services” data. These data are at times excluded because they are the most volatile and can therefore distract from larger trends. On the other hand, these data remain in some of these aggregate figures because they constitute a substantial portion of the economy’s activity. According the Wall Street Journal, “trade services” are margins for retailers and wholesalers.

It may seem strange to some that all of the headline numbers above have the “FD” Final Demand denotation next to them. What exactly does this mean? As suggested above, these are the final prices that are paid for these goods and services before the consumer or other end user pays for them. The “final demand” moniker also distinguishes this data from many other kinds of PPI data in the BLS news release.  In that release, which is the origin of this PPI data for the public, the Bureau also publishes “Intermediate Demand” data for goods and services that are a stage or more behind Final Demand products in the production cycle. In fact, there are four stages of “Intermediate Demand” for which the BLS keeps track of pricing data. Stage Four Intermediate Demand goods and services include such things as portfolio management, industrial chemicals, and steel mill products. The report also includes a category called “Unprocessed goods for intermediate demand,” which includes the more expensive  energy products mentioned earlier, along with “slaughter “chickens,” “raw cotton,” and “carbon steel scrap.”  Many investors find this wealth of pricing detail quite useful for generating investment ideas and for monitoring current investments. Just as we can see future CPI changes in today’s PPI numbers, we can see early cycle “Unprocessed goods for intermediate demand,” such as raw cotton and carbon steel scrap prices forecasting final demand PPI prices down another bend the road.

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