Understanding US Core PPI

Introduction to Core PPI

The US Core Producer Price Index (Core PPI) measures the average change in selling prices received by domestic producers for their output, excluding volatile food and energy prices. Published monthly by the Bureau of Labor Statistics (BLS), Core PPI is a key inflation indicator that often leads consumer inflation.

The PPI measures inflation from the perspective of producers, reflecting the costs businesses face before marking up prices for consumers. This makes it an early warning system for inflationary pressures building in the economy.

PPI Components

Understanding PPI components helps traders interpret the data more effectively.

Headline vs Core PPI

• Headline PPI: Includes all goods and services, including volatile food and energy
• Core PPI: Excludes food and energy to show underlying inflation trends
• Core ex-Trade Services: Even more refined measure excluding trade margins

Stage of Processing

PPI is measured at different stages of production:

• Final demand: Prices for finished goods ready for sale to consumers or businesses
• Intermediate demand: Prices for goods and services sold to businesses for further processing
• Crude goods: Raw materials at the earliest stage of production

Earlier stages of processing can provide advance warning of price pressures that will eventually reach consumers.

Key Categories

• Goods: Physical products including manufactured items
• Services: Including trade services, transportation, and warehousing
• Construction: Building materials and construction costs

PPI vs CPI Relationship

Understanding how PPI relates to CPI helps traders anticipate market reactions.

The Transmission Mechanism

Producer prices feed into consumer prices through several channels:

• Cost pass-through: Rising input costs eventually get passed to consumers
• Margin pressure: When producers can't pass costs on, margins compress
• Wage effects: Higher producer prices can lead to wage demands
• Expectations: Rising PPI can shift inflation expectations

When PPI and CPI Diverge

Sometimes PPI and CPI move differently:

• Margin absorption: Companies absorb costs rather than pass them on
• Import competition: Foreign competition limits pricing power
• Service sector: Services inflation may not track goods inflation closely
• Consumer demand: Weak demand prevents price increases

Fed Policy Implications

The Federal Reserve monitors PPI for policy signals:

• Pipeline inflation: Rising PPI suggests future CPI pressure
• Policy timing: High PPI may encourage preemptive rate hikes
• Soft landing: Falling PPI without recession is ideal
• Cost shocks: Temporary PPI spikes may be "looked through"

Impact on Forex Markets

PPI data affects currencies through its implications for monetary policy and inflation expectations.

USD Reaction Scenarios

• Higher than expected: USD typically strengthens as rate hike expectations rise
• Lower than expected: USD may weaken as rate cut odds increase
• In-line reading: Limited reaction unless it changes the inflation narrative

Context Matters

The market reaction depends on the current environment:

• Inflation concerns high: Hot PPI amplifies fears, USD bullish
• Disinflation underway: Cool PPI confirms trend, may be USD neutral or negative
• Before CPI: PPI sets expectations for the following day's CPI release
• Fed focus: PPI matters more when Fed is actively discussing inflation

Cross-Market Effects

• Bond yields: Hot PPI pushes yields higher, cool PPI lowers them
• Equities: Rising producer costs can pressure corporate margins
• Gold: Higher inflation generally supports gold prices
• Rate expectations: PPI directly impacts Fed funds futures pricing

Trading Strategies

Several approaches can be used when trading around PPI releases.

Pre-Release Preparation

1. Check consensus: Know the expected month-over-month and year-over-year readings
2. Review prior releases: Note any revision patterns or trends
3. Consider timing: PPI often precedes CPI by 1-2 days
4. Assess positioning: Determine if markets are positioned for a particular outcome

Trading the Release

Reaction Strategy: Wait for the data release, assess the surprise factor, and trade in the direction of the surprise if it's significant. Focus on USD pairs with good liquidity.

CPI Preview Strategy: Use PPI as a preview for CPI. If PPI surprises hot, consider positioning for a potential hot CPI the next day. This is higher risk but can offer good entries.

Component Analysis

Dig into the components for additional insights:

• Services vs goods: Services PPI is increasingly watched by the Fed
• Core trends: Multi-month core trends matter more than single readings
• Stage of processing: Early-stage price pressures signal future inflation

Risk Management

• PPI moves are typically smaller than CPI—adjust position sizes accordingly
• Use wider stops to account for initial volatility
• Consider the upcoming CPI when holding positions through PPI
• Be prepared for the move to fade if the data is overshadowed by other news

Key Takeaways

• Core PPI measures producer-level inflation excluding food and energy
• Published monthly, typically 1-2 days before CPI data
• PPI is a leading indicator for consumer inflation with 1-3 month lag
• Focus on Core PPI for underlying inflation trends
• Higher PPI typically supports USD; lower readings may weaken it
• PPI sets expectations for the following day's CPI release
• Fed monitors PPI for pipeline inflation pressures
• Services PPI is increasingly important for policy decisions
• Wait for initial volatility to settle before trading
• Consider PPI in context of broader inflation picture