PPI for the month of January reached 7.4% on an annualized basis. This is the highest level since 1981, 26 years ago. For many investors this is ancient history. The link between PPI and CPI has changed significantly over the last two decades, but we may be moving back to an early 1980’s relationship.
The link between CPI and PPI has been generally high. The correlation has been above .8 for the entire 25 year period. The same has not been said for CPI ex food and energy where the correlation has actually turned negative over the last four years.
PPI over the last four years has been higher than CPI and the gap is getting larger. This is at odds with what occurred during most of the 1990’s when PPI was actually lower than CPI. The sustained increase of PPI over CPI and CPI ex food and energy makes it more likely that CPI will be pulled higher. PPI is more volatile but the sustained increases in PPI make it less likely that a short-term reversal in energy or food will bring down CPI.
A simple regression analysis suggests that the behavior over the last few years is different than for the longer period. For 1980 to the present, there is a strong positive relationship between PPI and CPI ex food and energy. The beta is approximately .54 for PPI as the explanatory variable. For the time period from 2000 to the present, the Beta with PPI as the independent variable is slightly negative. The relationship between PPI and CPI is similar but the betas are higher.
The coupling of higher inflation with the increased likelihood that the Fed will continue to ease is a recipe for a falling dollar.
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