The Producer Price Index for finished goods fell 0.1% in April on a headline basis. The consensus was looking for an increase of 0.1%. Year-over-year prices are up 5.5%, mostly due to a rebound in energy costs, but that is down from a 6.0% year-over-year increase in March. The decline in the monthly headline number helps reverse the 0.7% surge in prices on a headline basis in March, but that in turn came after a 0.6% decline in February.
Since the food and energy components of the index tend to be very volatile, economists also like to look at core prices, which exclude food and energy costs, to get a better sense of the underlying trend in prices. On a core basis, prices were up 0.2%, which was a tick higher than the consensus expectations of a 0.1% increase. Core prices rose 0.1% in each of the last two months.
The surge in March on a headline basis was mostly caused by a 2.4% increase in food costs (bad weather in February spilled over into March prices). In April, wholesale food costs declined 0.2%. Energy prices also reversed direction falling 0.8% in April after a 0.7% increase in March. Core prices are only up 1.0% year over year.
Causes for Concern?
If one looks a bit further up the production chain, though, there are some things to be at least a little bit concerned about, although the further up the production chain you go, the more volatile prices tend to be. Prices for Intermediate goods (to keep Finished, Intermediate and Crude goods separate in your mind, think Bread, Flour and Wheat) rose 0.8% in April, on top of a 0.6% rise in March and just a 0.1% increase in February.
On a year-over-year basis, prices are also accelerating at the intermediate level, now sitting at 8.6% up from 7.7% in March and just 5.6% in February. In part, though, that acceleration is due to big price declines of a year ago rolling off. In April 2009, year-over-year intermediate goods prices were down 10.0%.
Prices for crude goods, which are essentially commodities, are even more volatile. Recently, they have been in a see-saw pattern, with a 1.2% decline in April after a 3.2% rise in March and a 3.5% decline in February. Year over year, prices are now up 28.8% versus up 33.4% in March. A year ago, though, prices were down 40.3% year over year.
As the graph below shows, the headline year-over-year change is a bit on the worrisome side, but that is mostly reflecting the plunge and then the rebound in the price of oil. With the recent sharp decline in the price of oil, falling from over $85 to under $70 in the course of just a few weeks, the year-over-year change on the headline level should start to fall back to more comfortable levels next month.
Core prices are very well controlled. Core prices are more important to the Fed in setting monetary policy than are headline prices. Monetary policy is a very blunt instrument to try to use in controlling the price of any individual commodity, even ones that are vitally important, like food and energy.
Fed Will Keep Rates Low
This report will help allow the Fed to keep interest rates low for an extended period of time. While that is not good news for people who depend on income from their savings, it is great news for banks of all sizes, ranging from the behemoths that dominate the industry with balance sheets of well over $1.0 trillion, like Bank of America (BAC) and JPMorgan Chase (JPM) to the smallest one branch community bank.
The low short-term rates mean a very positive yield curve. Banks borrow short term, for example, by holding checking deposits that can be withdrawn at any time, and lend at higher rates on longer term loans. The steeper the yield curve, the higher their profit margin (or net interest margin).
This steep yield curve has allowed the banking system to rebuild much (but not all) of the capital that was depleted due to the housing bust. While the U.S. banks do not have a lot of exposure to the situation in Europe, there are potential second-order effects if the crisis were to spread, and those could impact bank capital. In other words, they just might need that capital that is being generated by the steep yield curve (of course, they could also generate it by not raising dividends and by cutting back on the bonuses they pay their executives).
The recent decline in the price of oil and the rise in the dollar are two forces that should help keep inflation under control. Low inflation allows for an easy monetary policy, and that is good news for future economic growth.
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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