"YOU’RE HOT THEN YOU’RE COLD..."

Katy Perry’s hit song "Hot N Cold" is all about contradictions. And each week the markets receive their share of news that seems contradictory... but may not be. The inflation reports from last week provide an excellent example - so let’s see what they really said and why it matters!

Last week, two inflation reports came in. The Core Producer Price Index (PPI) reported that inflation was slightly hotter than the expected. However, the Core Consumer Price Index (CPI), which measures inflation at the consumer level, came in slightly cooler than expected. 

So why the contradiction between the two indices? What does this mean?

Although the reports seem contradictory, they’re not really. They actually focus on different aspects of inflation. 

The PPI shows us what’s going on at the wholesale or production level, while the CPI focuses on what’s happening with people like you and me who consume products.
 
So, looking back at the reports, we see that the PPI indicates inflation is on the rise at the wholesale level. But the CPI report indicates that the inflation isn’t being passed on to consumers - like you and me - at least not yet. The bottom line is that inflation is most certainly on the rise, but it remains somewhat tame for the moment in terms of what consumers are experiencing.

Speaking of production, last week we saw that manufacturing in the New York State region rose for the fifth consecutive time and came in at the best level in a year. Similarly, Industrial Production came in better than expected. Higher productivity keeps operating costs lower, lessens the need for hiring, and helps keep prices down. 

Also last week, Capacity Utilization - which simply means how much of a factory’s production capacity is being used - was reported at the highest reading since mid-2008, which means it is on the rise. However, until this reading climbs a little higher, the available slack within the production cycle will inhibit some hiring and also inflation growth.
Overall, the reports indicated that business conditions and production continue to improve. However, we’re not quite where we want to be, and more growth is needed to really help boost the labor market. 

In terms of how the news impacted Bonds and home loan rates, last week’s reports were friendly to Bonds and home loan rates in a couple of ways. First, they promoted low inflation for the time being - and inflation is the archenemy of Bonds and home loan rates. Second, the slack in production and slowed pace of hiring is Bond friendly. Remember, Bonds actually like negative economic news because it normally causes money to flow out of Stocks and into Bonds, helping Bonds and home loan rates improve.