INSIGHTS

On March 16, 2011

Producers vs. Consumers. The Space Between.

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With the release of the producer price index and the consumer price index, the disparity between the two are near their all time widest spreads. Gasoline (increased 3.7% month over month) and agriculture (more lagging as prices have dropped over the last few weeks) had large impacts on the PPI (producer price index). The CPI (consumer price index) is released tomorrow with expectations for a monthly increase of 0.4% and a year over year print of 2.0%. I used this estimate for numbers on charts below.

There are a few points that become relevant at this time.

• Input prices are rising faster than companies are able to pass through to consumers.
• Producers are still showing a bit of trepidation in raising prices for fear of consumers adjusting their behavior to more cost effective goods.
• This is the result of the still early stages of the jobs recovery and housing.

Consumer and Producer Inflation

Source: Bloomberg. See Charts/Graphs Disclosure.

CPI – PPI Spread

Source: Bloomberg. See Charts/Graphs Disclosure.

From this near all time low as a measure of the CPI minus the PPI, one would think that we are near the bottom of the ability of companies to pass through higher costs. In its most parochial interpretation, a measure above zero would denote the ability of producers to pass on higher costs with ease and below, the inability to pass on higher costs. The average spread over the last 30 years has been just below 1%.

We continue to see the expansion taking over for the recovery. Some might argue that higher inflation will ultimately stall the recovery, and it would have a negative impact. However, the key gauges to monitor are: how quickly this pass-through occurs, to what degree the world markets slow down due to the Japanese natural disaster and what the asset prices impacting households are. Companies have done a commendable job in squeezing productivity gains to offset higher costs, mainly through investments in technology and utilizing current employees (read: longer hours) more versus hiring new employees.

Ultimately, we see a smoother, more methodical push to pass on higher costs from producers as asset prices continue to rise, the job market continues to improve and therefore, a war for talent ensues causing a push for higher wages. Hedging inflation may still be an early call, but it appears appropriate for us to continue having an allocation currently.

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