Soft Price Pressures Leave Plenty of Room for Fed’s QE

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The U.S. Bureau of Labor Statistics reported on Tuesday that its produce price index for finished goods fell to a seasonally adjusted 0.1 percent on the month in September, sliding below expectations for a 0.2 percent increase. Year-over-year growth decelerated to just 0.3 percent, down significantly from +1.3 percent in August. Excluding food and energy, which can be volatile and swing dramatically front month to month, the index for producer prices climbed 0.1 percent on the month and 1.2 percent on the year.

The PPI interprets price changes from the perspective of the seller and can be used as a leading indicator of inflation because it measures input price pressure. The producer price index report is broken down into three broad sections: crude goods, intermediate goods, and finished goods. Price increases at any stage of production can sometimes be passed down the line and could ultimately reach the consumer, as reflected in the consumer price index and the index for personal consumption expenditures.

With this in mind, investors can use the PPI as a leading indicator of inflationary pressures. September’s negative headline growth and marginal core growth in producer prices suggests that — as has been the case for most of 2013 — inflationary pressures remain soft.

Perhaps the largest implication of soft PPI data is that soft inflation gives the U.S. Federal Reserve increased breathing room to conduct its accommodative monetary policy. The Fed’s third round of quantitative easing — ongoing asset purchases of $85 billion per month — is ostensibly tied to inflation expectations, and policymakers have indicated that if consumer price growth exceptions, as measured by personal consumption expenditures, exceed 2.5 percent, they would consider curbing purchases.

But PCE inflation has averaged about 1.8 percent over the past year, slightly below the Fed’s target rate and well within an acceptable range. With fiscal headwinds howling, economic conditions still weak, and the relatively dovish Janet Yellen set to assume the Fed chair, most economists are expecting the Fed to withhold tapering QE3 until at least early 2014.

Back to producer price report, though. At the beginning of the pipeline, crude good prices increased 0.5 percent in September, a gain that follows a 2.7 percent contraction in August. Intermediate goods prices increased 0.1 percent, which follows no growth in the preceding period. Year over year, crude good prices are up just 0.3 percent, while intermediate goods prices are down 0.5 percent. All told, the September data are not a tremendous surprise.

The Fed, for its part, is still targeting 2 percent inflation in the mid- to long-term.

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