March PPI: Little Relief for the Fed

While the core producer price index for March was flat, inflation is a worry. Plus, a roundup of trade and consumer sentiment news

by Michael Englund and Rick MacDonald

Inflation concerns should continue to keep the market on edge, while the consumer's mood is darkening amid high energy prices and real estate worries, based on economic reports released on Apr. 13. But gross domestic product growth should remain on a solid course.

While the unchanged core reading for the producer price index report for March was a relief, it reflects one small piece of good news in a sea of bad inflation figures for the Federal Reserve since the January Federal Open Market Committee meeting. And an improvement in the U.S. trade deficit, with drops in both exports and imports that we attribute to a seasonal pattern in trade with China, will help to support market forecasts for gross domestic product.

The confidence drop in the preliminary University of Michigan survey for April was a bit bigger than expected, but in line with declines in all the major confidence indicators that likely reflect both soaring energy and food prices, and subprime mortgage chatter in the headlines.

Here is Action Economics' rundown of the Apr. 13 releases:

Producer price index: The unchanged core reading in the U.S. March PPI report was a relief, but the 1.0% headline surge still left a pop in the year-over-year pace to 3.2% that leaves a pattern of big aggregate price gains for this measure of underlying producer costs. And the core rate relief only translated to a 0.1% improvement in the core year-over-year rate of 1.7%, which is still hot for this measure, given that it tends to underperform the core rates for consumer goods that the Fed is focused on. The core rate will also likely pop back up to 1.8% in April if the core price trend of 0.2% gains reemerges this month.

The headline surge accompanies the similar big gains in the trade price figures through March reported on Apr. 12, to leave a still troublesome picture of March inflation despite the lean core PPI figure. We will continue to assume 0.2% core gains for the March consumer price index (CPI) and personal consumption expenditure (PCE) chain price figures, alongside outsize headline gains of 0.5% and 0.4%, respectively. The monthly inflation measures have been a thorn in the side of the Fed ever since the January FOMC meeting.

Trade balance: The February trade deficit fell $0.4 billion to $58.4 billion—below economists' median forecast of $60.3 billion. Exports dropped 2.2%, led by a 5.8% decline in capital equipment. Imports decreased 1.7%, led by an 8.1% decrease in industrial supplies.

The U.S. trade report for February revealed improvement as expected, but with notable shortfalls from our forecasts for both exports and imports. We had assumed the growing share of trade with China would introduce a "Chinese New Year" pattern into the U.S. trade aggregates for exports and imports, and this effect proved stronger for both components this year than we had assumed. The deficit with China fell to $18.4 billion from $21.3 billion in January, as reduced trade with China during the New Year celebration reduces the gap due to the large import/export mismatch.

The February figures are consistent with about a $7 billion real net export contribution to first-quarter GDP growth, following the hefty $46 billion real contribution in the fourth quarter. Real exports should fall at a 1% rate in the first quarter, following a 10.6% fourth quarter clip, while real imports should fall at a 2% rate following a 2.6% fourth-quarter contraction. The data imply a current account deficit in the first quarter of $201 billion, vs. the $196 billion gap in the fourth quarter, and the hefty $229 billion peak deficit in the third quarter.

University of Michigan consumer sentiment: The drop in the Michigan sentiment index to 85.3 parallels the continued downdrift in other available confidence measures for April. The ABC/Washington Post index has most recently dropped to a -7 reading in the second week of April, following a -2 average in March that included the expansion-high reading of +2 in the second week of that month. The IBD/TIPP index dropped to a 45.5 reading in April from 50.8 in March, while the RBC-IPSOS index fell to 85.4 in April from 92.3 in March, and a post-2004 high reading of 103.0 in February.

We will lower our forecast for the Conference Board's consumer confidence index for April to 105, following the 107.2 reading in March and the hearty 111.2 reading in February that marked the cyclical high. In general, rising gasoline and food prices and ongoing market subprime concerns continue to weigh on expectations, though the indexes still remain at historically solid levels.

Englund is principal director and chief economist for Action Economics. MacDonald is director of investment research and analysis for Action Economics.