Lesson 67 – How to Interpret the Producer Price Index (PPI)

Topic Progress:

In our last lesson we learned about the ISM Manufacturing Index and how this indicator gives us insight into an important component of the economy, as well as early indications of employment growth and price pressures. The indicators which we have focused on thus far have been primarily focused on trying to gauge the growth in the economy, so now we are going to turn our attention to indicators which are designed primarily to gauge the level of price stability in the economy, starting with the Producer Price Index.

Reported at 8:30am in the second or third week of the month the Producer Price Index (PPI) is a measure of the increase or decrease in the selling price received by US producers for their output. Very simply, what this indicator does is measures any price changes from the company side of the equation.

While the headline number is a reflection of the change in prices at the producer level over last month expressed in percentage terms, like many of the other indicators we are studying, the PPI includes many sub-indexes which make up the headline number. This increases the importance of the release as it allows market participants to get a look at what is happening not only with overall producer prices, but also producer prices by Industry. There are currently over 10,000 sub indexes used to compile and released with the report, each of which is given a weighting depending on its size and importance to the economy. The important thing to realize here is that included in the release is price data on pretty much every product type and industry that makes up the economy.

Secondly the price of goods is tracked at different levels of production, the three categories of which are crude, intermediate, and finished goods. Although numbers for all three are released with the report, when people refer to PPI they are normally referring to the Finished goods PPI number, as this is most closely representative of the price which will be paid by the end consumer. It is this number which is ultimately the determinant of inflationary or non inflationary pressures in the economy.

Lastly, the prices for food and energy have much greater short term volatility than other components of the index, so many market participants and the Fed will often focus on the “core” number which is the PPI minus food and energy.

While the PPI provides much insight into what is happening with prices, what ultimately determines the inflationary pressures the economy is experiencing is how much the consumer is paying for goods. The prices paid by producers, it is logical to think ,will be passed along to the consumer so the real market moving element of the Producer Price Index is its predictive power of increases in prices paid by the consumer as represented by the Consumer Price Index (CPI). This will be the topic of our next lesson.