Via Stephen Stanley at Amherst Pierpont Securities:
The PPI was firmer than expected in February, rising by 0.3% for both the total and core indices. This comes on top of a +0.6%/+0.4% performance in January. Energy prices were somewhat firmer than I had anticipated at the wholesale level, rising by 0.6%, but the main surprise relative to my forecast was broad-based firmness in the core. After January’s outsized gain, I had looked for a bit of a breather. However, price pressures continued to build. While there is very little in the core PPI that passes through directly, even roughly, to the CPI in the same month, I find these PPI results to be ominous for the near- and medium term inflation outlook. The bulk of the firmness in the PPI came once again in the services categories. While even the concept of a “producer” or wholesale price for a service product is often questionable, the BLS is certainly measuring something, and what statisticians are finding is that a variety of services are becoming more expensive. In January, it was mainly airfares and banking and investment services. Last month, it was banking services (again), insurance, legal fees, architectural and engineering services, hotel rates, restaurants, and the infamous wholesale and retail trade margins. Again, none of this will feed through directly into the February CPI, but the evidence is building to support my argument that a tight labor market will eventually show itself in services price inflation. A broad-based rise in the core PPI driven by an array of services categories should be viewed as much more impactful than a scenario where a handful of goods categories drove the advance.
Today’s results are especially troubling because I had drawn up a similar scenario for the February CPI as for the corresponding PPI. After both releases showed big advances in January, I had anticipated a pullback to, if anything, below-trend advances in February. Clearly, I am 0-for-1 on that count. As for the February CPI, I am going to stick to my guns. I am not making any dramatic changes to my estimates, though I do feel more comfortable with my numbers. I look for a 0.1% rise for the headline, held down somewhat by a fall in energy prices, and a 0.2% increase for the core. Before today, my estimates for both were closer to rounding down than up, so the small tweaks that I made to the CPI forecast (predominantly to the headline) make me feel better at the margin about my point estimates.
Meanwhile, the handful of PPI categories that are used in calculating the corresponding components of the PCE deflator were not particularly high. A quick perusal of those numbers suggests nothing out of the ordinary in terms of how the core CPI and core PCE deflator will compare for February.
More broadly, even if I am right, and the February CPI is reasonably well-behaved, the specter of services prices creeping higher for two months in a row (the PPI for services rose by 0.3% in January and 0.4% in February) should send a chill up the spines of Chair Yellen and others at the Fed. Labor markets are not going to ease up for a long time; they are only going to get tighter. The FOMC’s Goldilocks inflation projections are looking increasingly unrealistic. Yes, we will reach 2% (and sooner than the Fed thinks), but that will be no more than a quick bathroom break on this inflation road trip, not the final destination.