Producer price index up moderately

Yesterday saw the release of the data about the producer price index (PPI), a major gauge of inflation.  In March the PPI was up 0.7% once adjusted for seasonality relative to the February figure.  It is typical of inflation data to back out the effects of both food and energy prices because of their volatility.  The adjusted figure is known as the “core” inflation number.  In March that figure was up 0.1%.  The data for the preceding year (March ’09 to March ’10) showed that PPI was up 6.0%.  Again, once you strip out food and energy prices to get to the core number the PPI was up 0.9% over the past year.

Analysis: Inflation and interest rates are intimately mated.  Inflation is the overall price level in the economy.  Many economists, including me, feel that inflation above a level of 2-4% is an indication that there is too much money in the economy.  When there is excess money, people spend it.  When businesses notice people are spending more money or spending money more frequently on their goods, they raise their prices, resulting in inflation.  Interest rates are essentially the price of money.  When interest rates are too low/when money is too cheap, people use too much of it, often resulting in inflation.  Think: the dot.com and real-estate bubbles.

Because the Federal Reserve has setting interest rates as one of its responsibilities, the Federal Reserve has to monitor inflation data.  While it is traditional to back out food and energy prices in gauges of inflation, the fact is that food and energy are huge proportions of the U.S. economy.  It really doesn’t get any more basic in terms of staples than those two categories of goods.  It would be interesting to be a “fly on the wall” within the Federal Reserve right now.  There are three broad areas of inflationary pressure right now: food, energy and asset prices.  By asset prices I mean the stock market.  The stock market is only moderately overvalued right now in my opinion.  But nonetheless, asset prices are starting to rise again.  This in an environment in which huge amounts of economic stimulus (money) was pumped into the economy by the Federal government, in conjunction with short-term interest rates that are basically 0%.  That means there is a huge amount of cash floating around that will eventually lead to inflationary pressures.  So the Fed needs to act soon.  The question is, are they looking at the “core” data, or the actual hard data on inflation?

My guess is that the Fed is looking at both pieces of data.  In particular, that 6.0% up over the last year is a big, big move in inflationary pressure.  Therefore, in my opinion, it is almost certain that the Federal Reserve will be raising interest rates sometime this year.  Most likely in the autumn.  The reason I am predicting this is that they need to see traction in the unemployment section and a rise in corporate revenues.  Once they have seen evidence of those data increasing they will be compelled to raise interest rates.  My own feeling is that the second quarter economic data will start to definitively show growing revenues at businesses and show an improvement in unemployment.

Importance grade: 3; the PPI data only confirms what is generally well known.  The economy is improving and prices are moving upward from bargain-basement recessionary levels.  My prediction on interest rates above is (stop the press) in-line with the consensus and the PPI data only serves to reinforce my view.

Jason