What is the US Producer Price Index or PPI?
The US Producer Price Index or PPI, is a monthly economic reading published by the Bureau of Labour Statistics. It tracks the shifting prices received by domestic producers of goods and services for their output. In this regard, PPI differs from CPI (Consumer Price Index) as it measures the changes in prices for sellers of goods and services instead of the changes as experienced by buyers.
The US Producer Price Index or PPI indicator measures three main categories of input prices: industry-based commodity based, commodity-based final demand – intermediate demand. Under these three categories the reading tracks roughly 10,000 measures for individual products released each month in the US including industries such as; mining, manufacturing, agriculture, natural gas, construction and more.
History of the Producer Price Index
Previously known as the Wholesale Price Index or WPI until 1978, the Producer Price Index marked it’s 127th anniversary on March the 3rd 2018. It’s one of the oldest economic data series that is published by the Federal Govenment and also holds the crown of being one of the oldest continuous statistical data records released by the Bureau of Labor Statistics.
The PPI was initially established due to persistent disputes arising from a lack of credible and historical data. In order to ensure that the US was able to effectively monitor it’s economic progression, the Senate Committee on Finance decided to create a robust record of objective data.
How Does PPI Work?
The US Producer Price Index or PPI index operates in the same way as other economic indexes, with each individual stat in the index given a starting number of 100 over the base period. All subsequent movement in producer prices are measured against the prior period’s number.
So, for example, if a product or service has a base of 100 and then the next month has an index reading of 90, this means it has decreased by 10%. Similarly, if a product or service has a starting number of 100, then it has an index reading of 115 the next month, it has increased by 15%. The current set of PPIs in operation had their base year set at 100 in 1982.
Industry Based Classification
This measure is applied at the industry level and measures changes in the PPI received for an industry’s output, outside of the industry itself. So essentially, this measure of PPI is tracking industry net output. There are over 535 industry price indexes, over 4,000 product related indexes, along with roughly 600 indexes that group industries together.
Commodity-Based Classification PPI
This measure ignores the classification of the industry and groups products and services by similarity and production composition. There are over 3700 commodity price indexes published for goods and around 800 commodity price indexes published for services. These are all categorised by product, service and end use.
Commodity-based Final Demand – Intermediate Demand Classification
The FD-ID classification is a new addition to the PPI and replaces stage-of-processing (SOP) which was the older system. This measure regroups commodity indexes for goods, services and construction into sub-product classes. It takes into account the specific purchaser of the product/service as well as the amount of physical processing or assembly input to the products. This PPI measure tracks more than 600 indexes of goods, services and construction provided to intermediate demand and final demand end-users, with some adjustments for seasonality.
Rising PPI = Higher Currency Price
PPI data is an important indicator of the health of the US economy and is closely tracked by traders on its release each month. If the PPI is rising, this means that the economy is growing and consequently, inflation is likely to increase leading to a rise in consumer price inflation. Rising inflation increases the likelihood that the Fed will raise rates and as higher rates attracts investment inflow and boosts currency prices, positive surprises in the PPI release are often accompanied by USD buying.
Falling PPI = Lower Currency Price
Similarly, if PPI is falling this means that the economy is slowing and therefore, inflation is likely to decrease leading to lower consumer price inflation. Lower inflation increases the likelihood that the Fed will cut rates or at least provides an obstacle to a rate rise which deters investment inflow and can cause some investment outflow. As such, negative surprises in the PPI reading are typically accompanied by USD selling.
When tracking inflation, traders will keep an eye on both PPI and CPI readings to monitor how both sides of the supply/demand scale are experiencing adjustments in price. This helps give a fuller view of the inflationary environment in the US, and is therefore more helpful in gauging how the Fed will view inflation at upcoming meetings.
As you can see, the chart above shows that the US Producer Price Index or PPI has been steadily rising over the last year, supporting the view that the US economy is growing, encouraging the Fed’s tightening cycle.
Example of Trading The Producer Price Index or PPI Release
The shaded area on the chart above shows the USDJPY on the day of the last US PPI release. This particular event saw an annual increase of 3% vs 2.8% prior and, as you can see, the USD rose against the JPY. This clearly demonstrates the dynamic which we have discussed earlier, whereby a positive surprise on the PPI fuels the USD demand. In turn this will offer the opportunity to buy the USD on the PPI release.