Inflation in the Channel has to go Somewhere
- cornerstoneams
- Aug 20
- 5 min read
Last week there were continued developments within the price inflation landscape as told by updated measures.
The Consumer Price Index (CPI) came in as expected, and with this, as we have noted in a previous edition, when releases are in line with expectations it is interpreted as though all is good. Sadly, this does not mean all is actually good.
The CPI certainly offered continued progress, in particular when looking at recent months. When looking at the continued year-over-year comparison, little changed, as it remains in the upper 2% range.
Many offer that when taking the trend of recent months and annualizing them, it gets us to a 2% inflation rate. That assumes the pricing landscape will unfold for the next several months as it has in recent months.
These types of consensus assumptions have been made many times during this price inflation era only to prove, to varying degrees, incorrect as time rolled on.
Those Pesky Services
We have addressed the services component of the price inflation landscape several times over the last few years while offering two thoughts when doing so.
First, in our evermore service-based economy, they play a massive role in how consumers experience the price inflation backdrop. Second, they are sticky, or pesky if you will, in that once price inflation takes hold in that large segment, it can be difficult to eradicate.
They have lived up to that billing and continue to do so. Let’s look at them below.
Above is a ten-year picture of CPI – Services on a year-over-year basis. Our red horizontal line highlights the general high-water mark that services displayed prior to this price inflation era.
To the far right, our red rectangle denotes how the services growth rate remains in the high 3% range. That is quite a distance from the previous high-water mark area of 3%.
This says nothing of how far we are from being comfortably under the 3% level, which was customary prior to this era.
The bottom line here is the large segment of services pricing and its growth rate remains far north of what was normal. As it stands in recent months, per our rectangle, we are stuck and showing no improvement year-over-year.
The Core, as it is Known
If we broaden out a bit within the CPI universe of measures we get what is commonly known as the core rate of inflation. This is where CPI is stripped of its food and energy components in light of their inherent pricing volatility over time.
The intention here is to get a better look inside the pricing backdrop without the more volatile components included.
The above is also a ten-year chart, so we have some recent historical perspective of the Core CPI.
Our red horizontal line denotes the general high-water mark in the previous decade before the breakout of this price inflation era.
Our red circle highlights the behavior of this core rate over the previous several months.
On a year-over-year basis, for the previous three updates on this measure, we are heading upwards again. This, while we have yet to touch, let alone penetrate, the previous high-water mark area via our red line.
As it stands, this core rate is registering 3.1% growth year-over-year.
And Then the PPI Update
The Producer Price Index (PPI) is updated every month on the heels of the CPI release.
Last week PPI and its universe of subcomponents were also updated. This updated release was downright ugly.
The PPI can be thought of as price inflation that producers and businesses incur, similar to that of the CPI for consumers.
On the PPI front we can expect businesses, as a general observation, to pass through their increased costs to consumers. This is why businesses can be looked at as “inflationary pass-through vehicles” as a broad generality.
Importantly, this is not an instant follow-on process whereby one month of notably higher prices for producers will equate to notably higher consumer prices the next month. It is the pipeline and the trend of increased costs through the producer channel that play a large role.
In addition, there is always the unknown of how much price increases producers can pass through to their end consumers before their customers will push back and reject increased prices. This potential always places producers of goods and services at risk of losing market share – a highly undesirable outcome for businesses generally.
The overriding consideration is when prices rise in the producer channel, someone will have to incur those costs. Businesses incur the costs through reduced profit margins if they cannot pass through their costs to end customers.
Consumers incur the costs through increased retail prices and also reduced “profit margins” via their wage rates getting eaten by the increased prices.
The bottom line is, there is a never-ending dance between producers and consumers that determines how much can be passed through (to consumers) and how much must be eaten by any given producer along the production channel.
The updated release on PPI offered building pricing issues in the producers’ pricing channel, or pipeline, said differently. The PPI and its subcomponents can be volatile, so one month certainly does not make a trend, but the updated release for July reflected an outsized month-over-month gain far in excess of expectations.
With this, the building secondary trend attempt of producer prices since mid-2023 was given additional upward support when looking at the year-over-year growth rate, as we share below.
To round out this edition, we share a ten-year view of the Producer Price Index (PPI).
Our red arrow denotes the building uptrend of producer prices since mid-2023.
To the far right, there is an additional uptick displayed on this year-over-year view in light of the most recent release, reflecting an outsized gain in PPI for the month of July.
Speaking to July’s release, as compared to the previous month of June, PPI jumped 0.9%, while the expectation was for a tame 0.2% increase. This was the largest monthly increase in over three years, dating back to June of 2022.
All of the above walks us to the ongoing observation of price inflation as we look forward.
Coming releases of PPI will be important to monitor to see if July was a total one-off or if it is speaking to a developing story. With this though, as displayed directly above, the year-over-year PPI growth rate has been carving out an uptrend for some time now.
If these trends continue, we have to ask how much of this price inflation in the producer pipeline will be eaten by producers and how much will they attempt to pass on to consumers?
Either way, provided producer price trends continue, it will not be good because it equates to lower profit margins for producers unless they can pass their costs on to consumers, which if it occurs, will then offer more challenged consumer budgets relative to their wages and wage growth rates.
This then offers the inevitable question of the expected Federal Reserve rate cuts that we addressed in our previous edition.
If price inflation measures cannot move lower, be it at the PPI and/or CPI level, then the multiple rate cuts expected by interest rate traders may be a tall order.
The bottom line is, when price inflation is in the producer channel it has to go somewhere. They do not magically disappear on their own. Someone in the economic system will need to incur them, be it producers or consumers. Normally, both incur some level of the increased costs.
Near-term price inflation updates will be crucial releases for policymakers and market participants. We will share accordingly.
I wish you well…
Ken Reinhart
Director of Market Research & Analysis
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