Expert Commentary

Producer Price Deflation Looms

Stuff is getting cheaper. Is that a good or a bad thing?

The U.S. Producer Price Index (PPI) unexpectedly fell in September, the biggest decline in eight months. On an annualized basis, the PPI increased by 1.4%, its smallest gain since November 2016. In year-on-year terms, the PPI is continuing its disinflationary trend from July 2018 when it posted an increase of 3.4%. At this rate, the PPI could soon be declining on an annualized basis. But does that matter?

The last time the PPI was declining on an annual basis was between 2015 and 2016. That coincided with a bit of a wobble in the economy but not a recession. The time before that was 2009 during the aftermath of the financial crash. Since the late 1940s, there have been 14 times when the PPI has declined on an annual basis and on only five of those occasions was there an official U.S. economic recession. Also, U.S. recessions have occurred at the same time that producer prices were rising rapidly, such as in the 1970s. A falling U.S. PPI, therefore, does not, necessarily, mean that the economy is headed for recession.

However, it is a sign that there is downward pressure on global commodity prices, such as energy, and periods of falling commodity prices have sometimes coincided with an economic slump, most notably in the 1930s. So we need to pay attention to this trend.

The chart below shows the Thomson Reuters / CoreCommodity CRB Index which tracks the prices of a broad selection of metals and commodities - aluminum, nickel, copper, gold, silver, crude oil, heating oil, natural gas, unleaded gas, cocoa, coffee, sugar, orange juice, cotton, lean hogs, live cattle, soybeans, corn and wheat. The index topped out in 2008 and has been tracing out a three-wave corrective decline (a-b-c) since then. The decline in wave c is in its final wave, but the structure is not yet complete. We anticipate further declines in metals and commodities in the months ahead and that will put further downward pressure on the Producer Price Index.

Expect deflation (of producer prices) to be a growing theme.

191018 - MG Chart