Thursday, March 18, 2010

A Closer Look At Inflation

Inflation is a very important issue because high inflation would force the Fed's hand with monetary policy whereas low inflation allows the Fed to keep interest rates low for an extended period of time.

Import Prices:

All Imports: In February, import prices decreased for the first time since a 0.6 percent decline in July, falling 0.3 percent. The February downturn followed a 1.3 percent advance in January and was driven by a turnaround in fuel prices. Despite the February decline, import prices advanced 11.2 percent for the year ended in February after decreasing 12.7 percent for the February 2008-09 period.

Fuel Imports: Import fuel prices countered an upward trend in February, falling 1.9 percent following a 4.9 percent rise in January. A 2.2 percent decline in petroleum prices was slightly offset by a 2.6 percent increase in natural gas prices. Over the past year, the price index for petroleum increased 81.3 percent and natural gas prices rose 16.3 percent, driving overall fuel prices up 70.8 percent for the same period. The 12-month increase in fuel prices followed a 49.8 percent drop for the February 2008-09 period.

All Imports Excluding Fuel: Prices for nonfuel imports rose for the seventh consecutive month, advancing 0.2 percent. The increase was led by higher prices for nonfuel industrial supplies and materials. Lower prices for foods, feeds, and beverages, capital goods, and consumer goods mitigated the overall advance. Over the past 12 months, nonfuel import prices increased 2.0 percent.

Take a look at the oil chart (USO) from an earlier posting. Note that a year ago prices were at extremely depressed levels which explains the 81% increase in fuel prices. Here is a chart of the data:

Let's deal with the producer prices data by looking at the stages of production. The reason why is producer prices are best thought of as a time series. If prices increase at the beginning of production (crude goods) they typically work their way through to the end of production at some point. But it's also incredibly important to remember there is a tremendous amount of price arbitrage with production -- meaning, the price difference between inputs and outputs can be very large, giving manufacturers a fair amount of flexibility. Let's start with crude goods:

Note the fairly high rate of volatility in these numbers. The crude numbers increase at higher rates one month and then barely increase the next month. This is the result of fairly volatile commodity prices. Also note that the year over year numbers are high because of low year over year comparisons. This will exist will all the data we're looking at.

Note the volatility with intermediate prices as well. This volatility is good as it allows manufacturers to "catch their breath" from a price increase. For example, suppose input prices increase .5% in January. Manufacturers will have to perform calculations to figure out how to deal with these price increases. But if prices only increase .1% in February, then they have an additional month to factor in the January increase.

Finally, finished goods -- which include by definition previous month crude and intermediate numbers -- have been bouncing around as well. Here is a chart of the monthly and 12 month change in the PPI. Note that negative readings are typically associated with large drops in either food or energy prices.

Now to to CPI:

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in February, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the index increased 2.1 percent before seasonal adjustment.

The unchanged all items index was the result of a decline in the energy index being offset by slight increases in the indexes for food and for all items less food and energy. Within the latter group, declines in the indexes for apparel and household furnishings and operations were more than offset by continuing increases in the indexes for medical care and used cars and trucks. The 12-month increase in the index for all items less food and energy now stands at 1.3 percent, the lowest since February 2004.

The food index also edged up in February. The food at home index rose slightly, the net result of the major grocery store food group indexes posting a mix of modest increases and decreases. In contrast the energy index declined in February. Decreases in the indexes for gasoline, electricity, and fuel oil more than offset an increase in the index for natural gas.
Let's go to the charts:

These are not levels that should scare anyone.

The YOY numbers are also well-contained.

The bottom line is clear: inflation is not an issue right now.