Friday, May 11, 2012

PPI confirms: the weakness is continuing

- by New Deal democrat

A month ago, based on poor March payrolls, a significant increase in initial claims, and a bunch of other poorer-than-expected data, I wrote that The Weakness Begins.

This morning's PPI data confirms that if the pattern is similar to the past, going back nearly 100 years including the Roaring Twenties and Great Depression, the period of weakness will continue.

Let's begin by showing the YoY difference between finished producer prices (increasing by 1.9% YoY as of April), and commodity input prices (increasing by only 0.6% as of April):

Note that in the past, when, after a period of relative strength,commodity prices plunge significantly below finished producer prices (i.e., the value in the above graph is negative), it has almost always coincided with weakness. For example, even in the booming late 1990's, the one time of relative GDP weakness was during the Asian currency crisis of 1998.   Beyond weakness, almost all of the recessions in the last 100 years including the last two shown above show this pattern.

So I am expecting the coincident economic data this month to be soft or possibly even negative.

While inflation data is coincident rather than leading, by examining the last few periods of weakness, we can get a very good idea how long it is likely to persist.  As I pointed out last month, typicall the period of weakness bottoms almost exactly when producer and commodity prices are at their YoY weakest. That isn't as difficult to predict as it may seem. In 2011, the last strong inflationary month was April.

Unless there is a severe recession vs. a period of weakness, it is unlikely that YoY commodity prices will continue to decline after July, or September at the latest. Better real wages  (note that real wages are already improving compared with producer prices - and will likely be shown to have improved - but still negative for now - compared with consumer inflation next week) and improving business profitability caused by the greater decline in commodity prices should assert themselves beginning at that time. That means this period of weakness should start to abate sometime during the summer