Could rising PPI push Fed to 'do more'?

Although many economists say the COVID-19 pandemic is a deflationary or disinflationary event, a rise this week in the producer price index put the core rate above pre-pandemic levels, and has some believing inflation will soon re-emerge.

Earlier this week, BNP Paribas at its 2021 outlook virtual conference predicted inflation expectations will rise in 2021, although inflation, as measured by the consumer price index will get as high as 1.9% the next two years, below the Federal Reserve's 2% target.

On Friday, the Labor Department reported the producer price index gained 0.1% in November, after a 0.3% rise in October, while the core PPI, which excludes food and energy, rose 0.1% in the month.

Economists polled by IFR Markets expected both indexes to rise 0.2%.

Year-over-year, however, PPI was up 0.8% compared to 0.5% a month earlier, while the core climbed 1.4%, up from 1.1% in October.

Economists expected PPI to rise 0.8% from last November and the core to gain 1.5% year-over-year.

"Prices paid for U.S. producers continue to rise, albeit at a slower rate," said Ed Moya, senior market analyst at OANDA. "Core PPI inflation didn't rise as much as expected but is now above pre-pandemic levels, up 1.4% year-over-year, a tick lower than the consensus estimate. This week's [consumer price index] and PPI data show that pricing pressures are growing in the U.S. and this could very well be what is needed to trigger the Fed in doing a lot more. [At its meeting Dec. 15 and 16,] the Fed could easily justify adopting yield curve control and increasing their purchases."

But Jason Celente, senior portfolio manager, Insight Investment, said PPI falling short of expectations suggests "pricing pressures from economic growth may still be some time away."

With lawmakers failing "to deliver anything other than partisan posturing and further delay in economic relief" through stimulus or a stop-gap funding bill, as labor market concerns rise, could harm the economy and "weigh on investor sentiment," he said

Yet 10-year Treasury yields are only "modestly" lower by about 10 basis points on the week, Celente said.

"This remains indicative of the willingness for investors to optimistically anticipate the vaccine and aggregate economic activity returning to normal, even with the emergence of perhaps a 'new normal in work and play," he said. "Optimists for this scenario will likely forecast higher Treasury yields and steeper curves as indicative of the 'reflation trade.' Others may point to relentless central bank policy that has suppressed yields and will continue to do so even if growth accelerates, thereby keeping yields low and prices high relative to economic fundamentals."

After the Fed meeting, the market may have a clearer picture as to "which 2021 narrative will prevail and it will also likely set the tone in the Treasury market for the balance of this year," he added. "We are more aligned with the latter camp as we believe central banks will want to maintain significant accommodation given an output gap that may persist for several years."

Consumer sentiment
The University of Michigan’s preliminary consumer sentiment index rose to 81.4 in December from the final November read of 76.9.

Economists had expected a 76.5 level.

The current conditions index gained to 91.8 in December from the final November 87.0 and the expectations index grew to 74.7 from 70.5.

The sentiment index is down 18% from December 2019's 99.3, while the current conditions index is off 20.5% from 115.5 a year ago, and the expectations index is down 16% from 88.9.