INDICATOR: November Producer Price Index
KEY DATA: PPI: -0.1%; Excluding Food and Energy: +0.1%
IN A NUTSHELL: "With import and wholesale prices going nowhere, inflation is likely to remain tame for quite a while."
WHAT IT MEANS: There are many out there that are saying it is time for the Fed to stop coming to the aid of the economy at such an aggressive pace by slowing the quantitative easing program. They have two fears: Inflation and damage to markets. Let's start with fear of inflation. It is irrational. Global businesses are not looking to increase prices; they want to expand markets. Consequently, as we saw yesterday, import prices have been largely flat over the past few months and are down over the year. A similar pattern exists for wholesale costs. In November, the Producer Price Index fell for the third consecutive month and even excluding volatile food and energy, costs barely budged. Finished consumer goods prices were down. A few food products, such as eggs, pork and unfortunately confectionary products did post solid gains but overall, food prices were down. Other than a rise in tires, no consumer good category posted a sharp gain. There was a similar lack of pricing pressure when it came to business products. In other words, consumer inflation will not be rising in the near term because wholesale goods costs are going up. Looking into the future, the situation looks even better as most intermediate and raw materials prices were either largely flat or down.
MARKETS AND FED POLICY IMPLICATIONS: So much for inflation pressures. The global economy and the energy revolution are restraining most prices and it is hard to see why that would change anytime soon, even if U.S. growth accelerates. What that means is the Fed should have more time than usual to unwind its bloated balance sheet at a pace that should not shock the markets greatly. It should also allow the Fed to limit the future rise in inflation, especially since it is doubtful that bankers will become spring break college students and go wild. Lending is not likely to surge, despite the massive amounts of excess reserves. That does not mean there are no risks. Forward guidance is a tricky thing that the Fed is attempting, but not very successfully. I am not even sure that it is possible to provide forward guidance in any realistic way as market participants seem to hear what they want to hear. Consider last June's comment by Mr. Bernanke about tapering beginning "later this year". How that became September is anyone's guess but it did. It was never a realistic possibility but that didn't prevent investors and market analysts from taking it as a given. Thus, when the September FOMC meeting came and went, there was all sorts of angst, all of it unnecessary. Thus, confusion is likely to continue even when the Fed starts to taper, which I expect to happen in the first part of next year, not next week. There is no reason to back down yet. The data are better and the budget agreement will reduce, but not eliminate the fiscal drag, but it is not a certainty that we will continue to see solid job gains and economic growth. We need more proof so it only makes sense to get some data on the holiday shopping season, fourth quarter growth and maybe even some indications about first quarter activity before any action is taken. Bad forward guidance would be to start and stop the tapering process, so I hope the Fed waits until they are more confident they will not have to change course.