Does a Pop in PPI Signal Potential Inflation?
The PPI data released today came in much higher than expected on both a month over month (MoM) and year over year (YoY) basis. While one report outlier generally isn't something to get concerned about, we do see some reason for caution on the inflation front.
For some time we've been discussing the eventual need for businesses to rebuild inventories and even said that could come with a cost if the tariff regimes were not lowered by then. Prior to the actual introduction of the increased tariff regime in 2018, companies loaded up on inventory which drove an increase in GDP, but had relied on that buildup for distribution without major restocking.
Retail sales have been solid and steady and with the low unemployment rate and rising wages lowering inventories we could be finding ourselves in a situation where inventories need to be rebuilt, but at a time when those products or the materials to make them are not readily available. We could, at least temporarily, be at an 'intersection' where inventory rebuild hits a wall created by the Coronavirus for another quarter or more.
If we look at the chart below we see that not only did PPI 'pop', but that the NY Fed manufacturing survey came in much higher than expected as did housing starts and building permits and shows the same strength as the Markit manufacturing surveys. While those are great numbers for economic activity and growth, without a sufficient supply chain, it could definitely lead to higher prices. And, corporate reliance on Chinese products and materials could definitely be hampered by the Coronavirus.
Housing is rebounding strongly as we expected, but building homes is both manpower and resource intensive. And, it's not just a structure that gets built, builders and buyers also have to furnish a home with appliances, furniture, etc. The materials for both the homes and the furnishings come from various places, but China plays an important part in both. Also, notice at the bottom of the chart that while Redbook same store sales are still growing strongly YoY, there is a definite slowing on MoM growth. Is that inventory-related slowdown due to lack of inventory? We believe that it could be, though it could also be related to the shift to ever-increasing online sales at least in part.
We believe that the outlook for US economic growth remains strong. We also believe that for the first time in a decade that there are at least temporary factors that could lead to increased inflation in 2020 - and it's driven by supply and demand where we expect demand to stay strong while the ability to 'supply' will at least be temporarily impeded.
*As a caveat, we would also point out that companies should be looking closely their supply lines. The tariff battle and the Coronavirus point out the dangers of single-sourced supply.