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Inflation: Is it Getting Better or Worse?

Inflation has been on the Wall Street radar in recent months, as prices across the economy are surging, and the Federal Reserve considers whether to begin rolling back its accommodative policy.

Are things getting better or worse lately? It depends on the gauge used to monitor inflation. 

According to the Consumer Price Index (CPI), which measures of inflation at the retail or consumer level, things look better. Data released this week by the U.S. Bureau of Labor Statistics showed that August CPI increased at an annual rate of 5.3%, down from 5.4% June and July; the smallest gain in seven months. That’s thanks to the easing in the price hikes of used cars and tracks, steady shelter and apparel price hikes, and declines in airfare prices.

However, the Producer Price Index (PPI) — which measures inflation at the wholesale or producer level — tells a different story. Statistics released last week by the U.S. Bureau of Labor Statistics showed that August producer prices increased at an annual rate of 8.3%. That’s the highest reading since at least November of 2010.

Apparently, inflation has accelerated at the wholesale level, and moderated at the retail level. So, what does this divergence between wholesale and retail inflation mean for Wall Street and the Federal Reserve?

For Wall Street, the answer depends on the sector in which each listed company operates.

For companies operating in the wholesale sectors, the higher wholesale prices allow them to pass on any production cost hikes down the supply chain.

For companies that operate at the end of the supply chain, selling to consumers, the tame CPI increase means a margin squeeze, as these companies cannot pass higher production costs on to consumers. 

Elsewhere on Wall Street, in the debt sector, the impact is mixed. Last week, the firm PPI number pushed U.S. Treasury bond yields higher, while this week’s tame CPI number made yields lower.

Turning to the Federal Reserve, the divergence between the two numbers doesn’t mean much. Based on the August FOMC minutes, the Fed is paying more attention to how the pandemic unfolds, and less attention to economic numbers.

Meanwhile, the Fed has repeatedly stated that inflation is transitory due to a structural shift in consumer demand from services to commodities during the pandemic, and supply-side bottlenecks as the economy opened up.

Therefore, inflation will ease once these factors wane away and the economy returns to normal. That’s why it closely watches inflationary expectations, which suggest that inflation will eventually revert close to the official average target of 2%.

Hopefully, the Fed is right. Markets will be watching.

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