Rising inflation expectations and producer price increases

Market Realist

Economic indicators and earnings shrug off events overseas (Part 10 of 10)

(Continued from Part 9)

Atlanta Fed’s Business Inflation Expectations Survey

The results of the Atlanta Fed’s Business Inflation Expectations Survey for July were released on Wednesday, July 16. The 237 survey respondents indicated that they expect unit costs to increase by an average of 1.9% over the next 12 months. The survey was conducted July 7–11.

The assessment of inflation uncertainty by respondents came in at 2.3%—almost the same as last month. Firms also reported a 1.8% increase in unit costs compared to the same period last year. In response to the survey’s quarterly question, businesses expected costs to increase by an average of 2.8% over the next ten years.

Sales and profits

More firms reported a decrease in sales levels compared to “normal times,” while the percentage of firms indicating improvement in profit margins improved compared to the June reading.

The Business Inflation Expectations (or BIE) Survey measures the year-ahead inflationary sentiments of businesses in the Sixth District, which encompasses Alabama, Florida, Georgia, and sections of Louisiana, Mississippi, and Tennessee.

It’s a monthly survey that gives an estimate of inflation expectations and uncertainty from the perspective of individual firms. The firms respond to questions about their business conditions, inflation outlook, and potential pricing pressures. It also shows the Atlanta Fed’s view of the sources of cost changes and provides insight into the factors driving business’ pricing decisions.

Producers Price Index 

Last week, the Producers Price Index (or PPI) for final demand goods was also released. This is a measure of inflation from the manufacturers’ point of view. Producer prices increased faster than expected in June, coming in at 0.4%—ahead of the expected 0.3%.

Producer price increases for final demand goods, usually lead to an increase in consumer inflation as manufacturers try and pass on cost increases to consumers. This would mean an increase in popular inflation measures such as the Consumer Price Index (or CPI) and the Change in Personal Consumption Expenditure (or PCE). The PCE is the Fed’s favored inflation measure. An uptick in the PPI-FD may mean that the Fed is approaching its target long-term inflation goal of 2%.

Why is inflation important to investors?

Inflation expectations are important for fixed income investors because increases in inflation can increase nominal interest rates on bonds and also reduce the real value of principal repayments for the holders of debt securities (TLT).

Fostering price stability is one of the Fed’s most important goals. Stable prices promote confidence in the debt markets, including Treasuries, investment-grade bonds, and high-yield bonds (HYG). Inflation and inflation expectations also influence the operating environment for businesses—for example, companies in the S&P 500 Index (VOO). This is because a stable price environment fosters business confidence in the economy. Firms are more prone to hire when they’re confident of the business environment. As a result, well anchored inflation expectations help in fulfill the Fed’s second mandate of full employment.

Commodities like gold (GLD) and silver act as a hedge against rising inflation. So does real estate (IYR) to an extent. To learn more about inflation and its implications, please read the Market Realist series, Why inflation measures impact the Treasury yield curve.

 

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