Producer price inflation moderates

The Producer Price Index increased by 0.2% in May, slightly ahead of the Bloomberg forecast of 0.1%, as a 1.5% jump in energy prices was offset by a 1.4% decline in food costs. The modest rise in May was the smallest increase since last July.

The core rate of inflation, which minuses out food and energy, rose by 0.2%, in line with forecasts.



Year-over-year, the headline rate of inflation at the wholesales level rose from 6.6% to 7.0%, the fastest increase since July 2008. Removing food and energy, the y/y rate held steady at a more modest 2.1%.



Taking a look at the second and third charts, we’re still seeing price pressures at the early stages of production.

However, the recent slowdown in the economy is going to make it difficult for most producers to fully pass along higher costs. Not that some won’t attempt price hikes, but attention has now shifted away from inflation to the recent weakness in the economy and the sharp slowdown in job creation.



Oil has fallen from its recent peak and gasoline prices are down about 25 cents per gallon, according the latest EIA survey.

If commodity price remain well behaved in the coming months, pricing pressure at the early stages of production should begin to subside.

Any lessening of commodity inflation would give the Fed more leeway to maintain interest rates at rock bottom levels, but as Fed Chief Ben Bernanke said last week, monetary policy alone is not enough to get the recovery back on track.

Ten month winning streak for retail sales comes to an end

But underlying upward trend still intact

Retail sales fell 0.2% in May, the first decline since June 2010 and roughly in line with expectations, according to a survey by Bloomberg.

On the surface, the drop isn’t surprising given the recent slowdown in economic activity but if we dig into the numbers, consumers are not signaling a summer of gloom for the economy. Discontent, maybe but not gloom.



Ex-autos, sales grew by a modest 0.3%, almost matching expectations given a small downward revision in April.

And removing a 0.3% rise in gasoline stations sales, so-called core-sales, which helps to eliminate the swings in gas prices and the volatile auto sector, also increased 0.3%.



Overall, May came in mostly in line with expectations, but more importantly, there were not any downward surprises that would indicated economic activity was about to stall or contract. And that has stocks up sharply in early trading!

Given the latest upward move in the ISM Service Index and the relatively stable level of jobless claims – elevated, but stable – the economy continues to plod ahead.

The latest report should diminish the recent chatter that we're headed into a new recession.

Slowing economy takes toll on nonfarm payroll growth

The economy managed to create just 54,000 nonfarm payrolls in May, less than half of the scaled-back expectations following Wednesday’s disappointing release by ADP .

The government also reported that the private sector managed to add 83,000 new jobs last month.



The lack of a significant number of new jobs, following over 200,000 private-sector additions in February, March and April, is a reflection of the slowdown in an already fragile and uneven economic recovery.

As I’ve repeated often in my commentaries, weekly jobless claims have jumped and have been holding well above 400,000, and the much slower pace of new jobs should not come as a surprise.



As the chart above reveals, the nasty recession has created a gaping hole in the labor force that is far more severe than we saw in the tough recessions that marked the mid 1970s and early 1980s.

And the shallow and uneven recovery has left many wandering in the unemployment line.



Charts 3 highlights the pace of job creation that followed the end of each of the major recessions over the last five years.



Chart 4 compares job creation during the current economic recovery with those that followed the relatively mild contractions during 1991 and 2001.

Although there has been rising chatter that the current soft patch may turn into something more ominous, the latest look at the service sector by the Institute for Supply Management out today suggests that a new recession is not imminent.

Relatively stable jobless claims, though elevated, are not signaling a new contraction either.

Inflation expectations have been subsiding

Inflation expectations have fallen considerably, as evidenced by the steep drop in the ten-year break-even rate of inflation over the past couple of months.

Taken from the difference between the yield on the ten-year Treasury and the yield on ten-year TIPs, the break-even rate of inflation offers us a rough look at what type of annual price increases investors are expecting over the next ten years because the smaller yield on TIPs indicates how much Treasury buyers are willing to give up in order to get inflation protection.



The chart above shows the recent rollover in inflation expectations, with the rate falling from an already modest 2.64% seven weeks ago to 2.22% on Wednesday.

Blame the recent slowdown in the economy for much of the drop in yields.

Jobless claims remain elevated, housing prices are still falling, both manufacturing and service sector growth has slowed and ADP reported a much smaller-than-expected rise in May payrolls on Wednesday.

Further, the renewed interest in longer-term Treasuries comes amid the impending end of QE2 in about four weeks, as well as the looming default deadline in early August.

Clearly, investors don’t seem to be worried about a default and believe Congress and the president will reach an agreement at the eleventh hour.

Moreover, nagging fears that the USA may eventually lose its coveted AAA rating doesn’t seem to be diminishing the appetite for low-yielding US debt.

Commodity prices have surged, and core inflation has starting ticking higher. We’ve also heard plenty of anecdotal stories of companies starting to pass along higher costs.

Still, demand in general has been subdued, making it difficult to boost prices at a more robust pace.



Additionally, unit labor costs – the largest expense for most businesses – remains under control, which is also leading to increased confidence we won’t be seeing any burst of inflation in the near term.

A sigh of relief following weekly jobless claims

Yesterday’s one-two punch from an anemic job’s report and a sharper-than-forecast slowdown in manufacturing sent stocks tumbling and investors fleeing into the safety of Treasuries, but today’s release of weekly jobless claims is soothing fears in some corners that the economic slowdown isn’t turning into something worse.

Weekly initial jobless claims fell 6,000 in the latest week to 422,000, and the 4-week moving average declined 14,000 to 425,500. Continuing claims were nearly unchanged at 3.71 million.



Attention now shifts to tomorrow’s all-important labor report from the government. But before we talk about non-farm payrolls and the release of the unemployment rate, it’s important to spend a moment on the weekly claims number.

Jobless claims jumped above 400,000 in early April and offered up the first evidence that the recovery was beginning to slow.

Subsequent data have showed we’re in another economic soft patch, but yesterday’s talk from some analysts that we’re headed into a new recession is premature in my view.

As I’ve repeated in the past, weekly jobless claims are an excellent barometer of economic health, and claims, though elevated, seem to have plateaued in recent weeks.

Keep an eye on this report for an early warning sign of further economic weakening, but at this point, slow growth is probably the most likely path.

Upcoming labor report
Tomorrow’s report from the government is expected to show 190,000 new jobs, including 210,000 generated from the private-sector, according to Bloomberg.  The unemployment rate is forecast to fall from 9.0% to 8.9%.

Note: latest survey by Bloomberg reflects reduced expectations as analysts incorporate slower growth and weak ADP number in forecasts. Nonfarm payrolls up by 170,000 (even worse, a MarketWatch survey sees 125,000) and private sector up by 180,000.

Anything near 180,000 would alleviate some of the concern swirling around the recovery, but we’re likely to get a one-time boost from McDonald’s, which reportedly added between 50,000 – 60,000 new jobs in late April and early May.

That would put private-sector job creation at about 130,000. Not very impressive but not as jarring as yesterday’s figure from ADP.

ISM Manufacturing Index falls to lowest level in almost two years

Blame supply issues caused by the earthquake in Japan or the overall slowing in the U.S. recovery, but the closely-followed ISM Manufacturing Index fell a much larger-than forecast 6.9 points to 53.5, the lowest reading since September 2009 and confirming recent sluggishness in regional surveys.

A level above 50 suggests that manufacturing is expanding.



New orders, production and exports slowed significantly, signaling that further cooling is likely in the short-term, but the survey revealed that most manufacturers still believe that customer inventories are too low, mitigating some of the negativity from the report.

Prices paid did ease some, falling from 85.5 to a still-high 76.5.

Nonetheless, the larger-than-forecast slowdown in manufacturing is the latest piece of data to signal a continuation in the recent softness in economic activity.

Weekly jobless claims have been above 400,000 since early April, GDP growth in Q1 slowed to 1.8%, housing has been muddling along, and ADP said this morning that the economy created only 38,000 jobs in the private sector.

Now, manufacturing, which has been the lone bright spot in an otherwise dull economic outlook, is cooling, as Japanese supply-chain issues ripple across the Pacific. Wish there was better news to report this morning, but problems in Japan are likely to be temporary as rebuilding efforts gather steam later in the year.

Slowing economy slows employment per ADP

It shouldn’t come as too much of a surprise given the recent slowdown in economic activity, as the ADP Employment report revealed that the private-sector added just 38,000 jobs last month – see details at Examiner.



May’s rise was the smallest number since last July when ADP reported the private-sector created 31,000 new jobs.

Treasuries are up, with the yield on the benchmark ten-year bond dipping below 3.0% for the first time in nearly six months, and stocks are reacting accordingly.

Economic data have been weak lately, indicating that the economy has hit a soft spot.

But Friday’s labor report will garner the lion’s share of attention, as it is generally considered the gold standard when it comes measuring the temperature and barometric pressure of the labor market.