An Overview

The Consumer Price Index (CPI) and the Producer Price Index (PPI) are closely watched economic indicators, whose year-end results have recently been in the news. Both CPI & PPI are published by the U.S. Bureau of Labor Statistics and measure inflation by tracking price changes for various goods & services. They track different goods and services because each focuses on a different aspect of economic activity.

Before we get into the details of the most recent year-end releases, we feel it would be helpful to provide a brief overview of CPI and PPI in an effort to better understand each. We know economics can, at times, be intimidating. Part of our role is to translate, explain and simplify. These key indicators – CPI & PPI – are not as complicated as economists would lead you to believe.

A Definition of CPI

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services (i.e., domestic and internationally imported consumer-related items). ⁽¹⁾ CPI is the most commonly quoted key inflation indicator as it measures inflation from the perspective of buyers of goods and services.

The CPI measures the cost of items in food & beverage, housing, apparel, transportation, medical care, recreation, education, communication and other personal goods & services categories, such as tobacco and smoking products, haircuts and even funerals.

Core CPI tracks core inflation, which excludes goods in the food and energy sectors.

A Definition of PPI

In contrast, the Producer Price Index (PPI) measures the average change over time in sale prices received by domestic producers for their output (i.e., the entire domestic market of raw goods and services). In other words, PPI measures prices from the perspective of sellers of goods and services. The prices included in the PPI are from the first commercial transaction for many products and some services. ⁽²⁾

The industries that comprise the PPI include mining, manufacturing, agriculture, fishing, forestry, natural gas, electricity, construction, waste, and scrap materials. As the PPI is meant to measure the output of U.S. producers, imports are excluded.

The Most Recent CPI Report

A release on January 12th showed the CPI rose 7% for the 12 months ending December (i.e., the full year 2021), the fastest pace since June 1982. Core CPI (remember, this is excluding food and energy) was up 5.5% on the year, the biggest increase since February 1991.

One category that stuck out from the year-end report is used vehicle prices, which have been a major component of the inflation increase during the Covid pandemic due to supply chain constraints that have limited new vehicle production. This category rose 3.5% in December, bringing the increase from a year ago to 37.3%.

Conversely, energy prices mostly declined for the month of December, falling 0.4% as fuel oil was down 2.4% and gasoline fell 0.5%. Still, the category as a whole rose 29.3% in the 12-month period, mostly due to a gain of 49.6% for gasoline. ⁽³⁾

The December report highlighted what we already knew: consumers are feeling pricing pressures. Not all goods and services are up 7% (some are higher and some are lower). But some CPI categories are substantially higher and consumers are noticing. Sadly, with Omicron Covid cases still on the rise, the impact on the supply chain and labor shortages could persist, which only fuels higher prices.

The Most Recent PPI Report

A release on January 13th showed the PPI rose 9.7% for the 12 months ending December (i.e., the full year 2021), the highest calendar-year increase going back to 2010. But some relief may be in sight. The monthly gain in December of 0.2% was a sharp drop-off from the two previous months, which showed respective gains of 0.6% and 1%. ⁽⁴⁾

Since PPI is a wholesale measurement, it is generally interpreted as a short-term precursor to future CPI (a retail measurement). ⁽⁵⁾ Therefore, we believe inflation reports will continue to run high and keep the Fed on guard until summertime when pressures should begin abating.

Parting Thoughts

CPI and PPI track inflation and its potential to impact consumer behaviors. Inflation is a major threat to retirees and people on fixed or limited incomes – really anyone who relies on their current income to maintain stable purchasing power.

Fed officials largely attribute 2021's rising inflation trends to pandemic-specific sources, such as a shortage of workers (whether due to illness or to the Great Resignation) that has clogged supply chains and led to empty store shelves. Lingering Covid issues, combined with winter weather disruptions, point to continued upward pressure on food and energy prices over the next few months.

As we mentioned in last month's Special Market Update, the Fed's tool to address inflation is adjusting interest rates. We, along with nearly every other observer of the financial markets, expect the Fed to start raising rates in early 2022 in response to inflation pressures. Fed Chair Jerome Powell, at his confirmation hearing before the Senate banking panel, acknowledged that rate hikes are on the way. According to the CME Group FedWatch Tool, financial markets are already pricing in a 75% chance for the first 0.25% increase to come in March 2022 and a 33% chance to see two rate hikes in March and May 2022. ⁽⁶⁾

Historically, when the Fed tightened monetary policy the markets experienced increased volatility. However, the Fed has stated its belief that the economy is healthy, strong and improving and can absorb higher interest rates in an effort to temper inflation. During 2022, we will need to take our medicine now for the long-term health of the overall economy. "An ounce of prevention" is universally regarded as a better health practice for the economy and the equity markets than a "pound of cure."

Source References:

1. Consumer Price Index
   bls.gov
   
   
2. Producer Price Indexes
   bls.gov
   
   
3. ECONOMY Inflation rises 7% over the past year
   cnbc.com
   
   
4. Wholesale prices jump nearly 10% in 2021
   cnbc.com
   
   
5. US: PPI-Final Demand
   cmegroup.com
   
   
6. Countdown to FOMC
   cmegroup.com