April 2010 Consumer and Producer Price Indices: At a Tipping Point?

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U.S. consumer prices fell 0.1 percent on a seasonally adjusted (SA) basis in April as energy, housing, auto and apparel prices declined. It was the first drop in the consumer price index (CPI) since March 2009. The CPI is up 2.2 percent on a year-over-year basis, however. Because the “core” CPI (excluding food and energy prices) was unchanged in April, the annual increase in core inflation shrank to 0.9 percent, the lowest rate increase since January 1966.

Meanwhile, the main producer price index (PPI) fell 0.1 percent (SA). The more closely followed core rate – which, like the CPI, excludes volatile energy and food prices – rose 0.2 percent. Over the past 12 months, wholesale prices have risen 5.5 percent. But the core rate has risen only 1.0 percent in the past year.

The gap between the PPI and CPI lines indicates that companies’ ability to pass higher costs on to consumers is limited. We expect this situation to continue while capactity utilization rates remain low. Although capacity utilization improved again in April, it stands roughly midway between the previous peak and trough.

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The recent run-up in the finished-goods PPI has been driven mainly by rapid increases in the cost of commodities (“crude materials” in the graph above) such as oil and copper. Many of those same commodity prices have fallen sharply over the past month, however, in the wake of the Greece debt crisis. April’s year-over-year rise in crude materials prices was 28.8 percent, down from the recent peak of 33.4 percent in March. By contrast, the intermediate goods PPI continued higher (to 8.8 percent); one analyst opined that “while this isn’t an immediate recipe for higher consumer prices, it is definitely indicative that pressure is building in the pipeline.”

It is true pressure is building; producers face higher costs, but are unable to recover them in higher prices. Profits are being squeezed (or negative) and thus more capacity will be shut down. Reduced capacity will tighten capacity utilization, laying the groundwork for the potential of costs being passed through to the consumer as higher prices down the road.

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Although the headline PPI has "tipped over," forest products-related PPIs (except pulpwood) have not yet followed suit. Granted, many of them rose at slower rates in April when compared to March, but their trajectories were still on the incline.

The scaling in the six-chart figure above gives the impression that year-over-year percentage changes in the PPIs of virtually all processing stages or commodity groups are “rocketing to the moon.” That is actually the exception rather than the rule, as shown by the figure at left (click on graph for larger image) and table below. While prices of softwood logs, bolts and timber are presently on a year-over-year “tear” at 35.9 percent (although we expect softwood logs to follow pulpwood’s lead and lose momentum as expectations of a robust rebound in construction demand continue to fade), prices faced by the pulp, paper and allied products sector are a comparatively tame 3.5 percent. Lumber futures have plummeted in recent weeks; as of today's (5/19/2010) close the July contract has lost over $100/mbf since mid-April (a 30 percent drop) and we anticipate that loss of optimism will be reflected in the softwood log PPI measure during coming months.

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