The overall Producer Price Index (PPI) fell by 0.3% in May on top of a 0.1% decline in April, and is the third decline in the last four months. Excluding food and energy — to get the Core PPI — prices were up 0.2% on top of a 0.2% increase in April.
On both counts the PPI was a little bit hotter than expected. The consensus expectation was for a headline decline of 0.5% and a core increase of 0.1%. That, however, is probably good news, as deflation causes even more economic problems than inflation does.
Energy is the real swing factor. It declined by 1.5% in May after a 0.8% decline in April, but on a year-over-year basis it is up 17.1%. As a result, the headline year-over-year inflation rate looks a bit hot at 5.3%, but the core rate is a very tame (almost ideal) 1.3%.
Those are the numbers for finished goods. The report also looks a little further up the production chain. Prices for intermediate goods tend to be more volatile than for finished goods, and prices of crude goods, which are essentially commodities, are more volatile still. To keep the three stages of production straight in your head, think bread (finished), flour (intermediate) and wheat (crude).
Prices for intermediate goods rose by 0.4% in May after a 0.8% increase in April and are up 8.5% from a year ago. Prices for crude goods fell 2.8% in May after falling 1.2% in April, but are up 21.5% from a year ago.
Inflation Still Not a Factor
This report is another indication that inflation is not a serious problem. The key challenge faced by the economy is unemployment and the very low rate of capacity utilization, which is starting to pick up (see: Capacity Utilization Climbs).
Tomorrow we will see if prices at the consumer level are also as tame as at the wholesale level. The consensus expectation there is that on a headline basis, CPI will fall by 0.1% for the third month in a row, while the core CPI will be unchanged, down from a very tame 0.1% increase in April.
With inflation so low, the Fed really needs to keep rates near zero for a very long time, at the very least for the rest of the year. That is good news for the big banks like Bank of America (BAC) and J.P. Morgan (JPM) which are able to borrow for less than 0.25% from the Fed and invest in longer term t-notes at much higher interest rates.
The steep yield curve that near-zero short-term rates cause is one of the most important factors in banks being able to rebuild their capital levels. Their reduced or eliminated dividends have also played an important role. (Now if they would just stop the outrageous payouts to their top brass, their balance sheets might get cleaned up even quicker.)
Those who claimed that the aggressive actions of the Fed and the Obama administration to fight the financial meltdown and resulting near depression with very aggressive monetary and fiscal policies would put the country on the road to Zimbabwe have been dead wrong. If anything, the actions were not aggressive enough.
We still need both a stimulative monetary and a stimulative fiscal policy. If the Fed starts buying longer term t-notes, effectively both things are accomplished. The government will owe more to the Fed, but the Fed returns the profits it makes to the government anyway.
It is a policy that, if overdone, would lead to inflation, and is not something that a central bank would ever consider if inflation were a problem. But right now it is not, and the Fed should be doing more of it. With high unemployment, low capacity utilization, an overly strong dollar and no inflation in sight, it is just the prescription that Dr. Bernanke should be writing.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
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