Does Slowing Producer Price Inflation Hint at Calming Commodities?

By Daniel Indiviglio

Wall Street may be celebrating the cost of food declining and the cost of energy rising at a more modest pace

600 food crop REUTERS Shaun Best.jpg

Today, three major economic reports hit for May. One showed that retail sales fell for the first time in 11 months. Another showed that small business sentiment declined for the third month straight and that hiring plans turned negative. None of that sounds like good news; in fact, it sounds awful. So seeing the Dow Jones Industrial Average up more than 1% at midday might seem surprising. But it could be the third report that has Wall Street excited: producer price inflation, which had been rising, has slowed.

Here's the chart showing the Producer Price Index for finished goods, from the Bureau of Labor Statistics:

ppi 2011-05.png

You can see quite clearly that PPI grew by the smallest amount last month since July. Its increase was significantly smaller than that seen from December through April.

The driver here was food prices. They fell by 1.4% in May. That's just their third -- and their largest -- decline since last June.

Energy prices, however, continued to rise. But at 1.5%, their increase was the smallest since December. This is good news as well, as it implies that energy price growth might be slowing.

If you take food and energy out of the equation, core PPI for finished goods remained very stable:

ppi 2011-05 core.png

Why is this very good news? Calming commodity inflation could be the single best fundamental sign that the U.S. economy could hope for. In recent months, the recovery has begun to hiccup. That was due in large part to commodity prices rising, which put pressure on consumer spending and sacked sentiment. If inflation slows, then Americans' economic confidence should improve, demand should grow again, and hiring should ramp up.

The stock market is a strange thing. Stock prices aren't based on economic indicators, but how they compare to analysts expectations, as those are the assumptions already baked into equity values. Although producer price inflation was expected to come in low, the drop in retail sales was expected to be 0.7% -- far more devastating than the actual 0.2% decline. As a result, stocks are up.

When I used to work at an investment bank in the pre-financial crisis period of 2008, many of us sensed that a storm was coming. So on days when we'd see the Dow soar a few hundred points, we would joke, "Well, stocks are up, so everything's fine! Nothing to worry about here!" Similarly, it's a stretch to say that today's equity rally indicates that everything's fine. But if commodity inflation is subdued going forward, then there is reason to celebrate. That could mean that economic activity will strengthen from the anemic levels we've seen over the past few months.

Image Credit: REUTERS/Shaun Best

This article available online at:

http://www.theatlantic.com/business/archive/2011/06/does-slowing-producer-price-inflation-hint-at-calming-commodities/240450/