The Producer Price Index (PPI) of the Bureau of Labor Statistics (BLS) is a family of indexes that measure the average change over time in the prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. The headline PPI (for finished goods) is a measure of the average price level for a fixed basket of capital and consumer goods for prices received by producers.
The weighted index of prices is measured at the wholesale, or producer level. The PPI shows trends within the wholesale markets (the PPI was once called the Wholesale Price Index), manufacturing industries, and commodities markets. All of the physical goods-producing industries that make up the U.S. economy are included.
The PPI release has three headline index figures, one each for crude, intermediate and finished goods on the national level:
- PPI Commodity Index (crude): This shows the average price change from the previous month for commodities such as energy, coal, crude oil and the steel scrap. (For related reading, see Fueling Futures In The Energy Market.)
- PPI Stage of Processing (SOP) Index (intermediate): Goods here have been manufactured at some level but will be sold to further manufacturers to create the finished good. Some examples of SOP products are lumber, steel, cotton and diesel fuel.
- PPI Industry Index (finished): Final stage manufacturing, and the source of the core PPI.
The core PPI figure is the main attraction, which is the finished goods index minus the food and energy components, which are removed because of their volatility. The PPI percentage change from the prior period and annual projected rate will be the most printed figure of the release.
The PPI looks to capture only the prices that are being paid during the survey month itself. Many companies that do regular business with large customers have long-term contract rates, which may be known now but not paid until a future date. The PPI excludes future values or contract rates.
The PPI does not represent prices at the consumer level – this is left to the Consumer Price Index (CPI), which is released a few trading days after the PPI. Like the CPI, the PPI uses a benchmark year in which a basket of goods was measured, and every year after is compared to the base year, which has a value of 100. For the PPI, that year is 1982.
Changes in the PPI should always be presented on a percentage basis, because the nominal changes can be misleading as the base number is no longer an even 100.
The biggest attribute of the PPI in the eyes of investors is its ability to predict the CPI. The theory is that most cost increases that are experienced by retailers will be passed on to customers, which the CPI could later validate. Because the CPI is the inflation indicator out there, investors will look to get a sneak preview by looking at the PPI figures. The Fed also knows this, so it studies the report intently to get clarity on future policy moves that might have to be made to fight inflation.
Two downsides of the “basket of goods” approach are worth mentioning here. First, the PPI uses relative weightings for different industries that may not accurately represent their proportion to real gross domestic product (GDP); the weightings are adjusted every few years but small differences will still occur. Secondly, PPI calculations involve an explicit “quality adjustment method” – sometimes called hedonic adjustments – to account for changes that occur in the quality and usefulness of products over time. These adjustments may not effectively separate out quality adjustments from price level changes as intended.
PPI index data for capital equipment is used by the Department of Commerce to calculate the GDP deflator.
The removal of food and energy prices is almost implicit in most media releases today, but investors should determine on their own what the long-term rates of growth are for these two important items. We all have to purchase food and energy, so if these costs grow faster than the core PPI (or CPI) over time, consumers, and eventually GDP, are going to both feel the pinch. For investors who have holdings in these industries, there will be interest in seeing higher price levels, which should eventually lead to higher company revenues.
While the PPI used to cover just the “physical goods” industries such as mining, manufacturing, and the like, many services-based industries have been brought into the index over time. Investors can now find PPI information on air and freight travel, couriers, insurers, healthcare providers, petroleum distribution and many more in the detailed release.
The PPI gets a lot of exposure for its inflationary foresight and, as such, can be a big market mover. As a result, the PPI is very useful for investors in the industries covered in terms of analyzing potential sales and earnings trends.