Last week one of David Rosenberg’s commentaries included a warning of a potential profit margin squeeze based on his analysis of two indicators. One is the ratio of crude to finished goods in the latest Producer Price Index data for January. The other was an indicator constructed from two data series in the Philadelphia Fed’s Business Outlook Survey. Rosenberg charted the spread between the Philly Fed’s prices paid (input costs) and received (prices charged) data.
I would add that a major factor in the prospect of margin squeeze is the rather stunning increase commodity prices over the past several months, a topic that has been a major focus of business news. The latest turmoil in the Middle East is now putting oil prices in the spotlight.
So let’s take a broader view of these two indicators by viewing them within the context of inflation as measured by the Consumer Price Index. As the first chart clearly shows, the all-time high in the PPI crude:finished-goods ratio was in July 2008, the same month that crude oil and gasoline prices in the US hit their all-time highs. The previous ratio high was in the summer of 1973, a few months before the outbreak of the October Arab-Israeli War and the Oil Embargo. Inflation had already been rising in a series of waves since the mid-1960s. But Middle-East events of 1973 were the primary trigger for the nearly 10 years of stagflation that followed.
The Philly Fed Prices Paid Minus Prices Received Index is an extremely volatile series, which I’ve emphasised by using dots for the monthly data points. To highlight the underlying pattern, I’ve included a 12-month moving average (MA). The two date callouts, one for the current monthly data point and the other for the 12-month MA, show that the comparable levels in the past were associated with inflationary peaks.
By official government metrics, the CPI and PCE, inflation is not a near-term threat. In fact, the Federal Reserve has been working hard to raise the level of core inflation.
Of course, there are many differences between the inflationary decade of the 1970s and the present, not least of which is the rate of unemployment. In August 1973 (first chart above), unemployment was at 4.8%. The latest Gallup Poll unemployment survey puts the mid-February rate at 10.0%, a full percentage point higher than the 9.0% January number from the Bureau of labour Statistics. Also, US demographics are quite different. The oldest Boomers were turning 27 in 1973. They were at the beginning of their careers with decades of wage increases in their expectations. This year they are turning 65, and many are already on Social Security as their main source of income.
At present, in light of the unemployment rate and the ongoing demographic shift, the surge in commodity prices probably poses more risk of margin squeeze than run-away inflation. Some degree of cost-push inflation may be a near-term risk, but the demand-pull inflation we saw in the 1970s is difficult to evision in the US economy of this decade.
I am adding these two charts to my growing list of regular monthly updates.
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