Wednesday, March 9, 2011

Beige Book Part II; Prices

The Beige Book covers a lot of territory. I've covered manufacturing pretty heavily, as well as PCEs, so let's turn to prices.

Manufacturing and retail contacts across Districts reported rising input costs. Manufacturers in many Districts conveyed that they were passing through higher input costs to customers or planned to do so in the near future. Homebuilders in the Cleveland and Atlanta Districts noted rising material costs, but acknowledged little ability to pass through the costs to buyers. Retailers in some Districts mentioned they had implemented price increases or were anticipating such action in the next few months. There is little evidence of wage pressures across Districts. Wages remained steady in the Boston, Philadelphia, Cleveland, Kansas City, and Dallas Districts, while moderate wage pressures were reported in the Chicago, Minneapolis and San Francisco Districts. Philadelphia, Dallas, and San Francisco noted that most wage increases were for workers with specialized skills.
There are two primary places where price pressures manifest themselves. The first is in input costs to the production process in the form of higher raw material prices which is obviously happening in the manufacturing sector. We've seen futures across a variety of commodities increase (wheat, corn, soy beans, oil, copper, coffee, sugar, and cotton are but some examples). Also consider this information from the latest ISM manufacturing report:
"A continued weak dollar is increasing the cost of components purchased overseas. It is going to force us to increase our selling prices to our customers." (Transportation Equipment)
  • "We continue to see significant inflation across nearly every type of chemical raw material we purchase." (Chemical Products)
  • "Our plants are working 24/7 to meet production demands." (Fabricated Metal Products)
  • "Prices continue to rise, while business limps along at last year's pace." (Nonmetallic Mineral Products)
  • "Overall demand is off 10 percent." (Plastics & Rubber Products)
From the same report:
The ISM Prices Index registered 82 percent in February, 0.5 percentage point higher than the 81.5 percent reported in January and the highest reading since July 2008. This is the 20th consecutive month the Prices Index has registered above 50 percent. While 66 percent of respondents reported paying higher prices and 2 percent reported paying lower prices, 32 percent of supply executives reported paying the same prices as in January. A Prices Index above 49.4 percent, over time, is generally consistent with an increase in the Bureau of Labor Statistics (BLS) Index of Manufacturers Prices.

The 13 industries reporting paying increased prices during the month of February — listed in order — are: Fabricated Metal Products; Food, Beverage & Tobacco Products; Machinery; Chemical Products; Electrical Equipment, Appliances & Components; Plastics & Rubber Products; Paper Products; Transportation Equipment; Apparel, Leather & Allied Products; Nonmetallic Mineral Products; Primary Metals; Computer & Electronic Products; and Miscellaneous Manufacturing. Furniture & Related Products is the only manufacturing industry reporting paying lower prices on average during February.

And we also have the following list of commodities increasing in price:

Aluminum (6); Aluminum Products (2); Brass (3); Brass Products (2); Cocoa; Copper (7); Copper Based Products (4); Corn (6); Diesel (3); Fuel Oils (2); Gasoline; Nickel; Plastics (2); Plastic Products (2); Plastic Resins (4); Polyethylene; Polyethylene Resin (2); Polypropylene (2); Rubber Products; Soybean Oil (4); Stainless Steel (4); Stainless Steel Products (2); Steel (6); Steel — Hot Rolled; Steel Products (3); Steel Surcharges (2); Sugar (2); Sulfuric Acid; and Wheat.

However, the increase in raw materials prices is not cause for panic.

Above is a chart for PPI of raw materials (blue) and final PPI (red). Notice that industry absorbs a lot of the increase in raw material price increases, usually by compressing margins and increasing productivity.

The chart above shows the same information (crude PPI vs. final PPI), but in a percentage change from last year format. Notice we see the same thing -- raw material price increases are absorbed by industry -- usually by compressing margins and increasing productivity -- and not passed on in a large way to final customers.

From the wage side, we're not seeing a big increase for one simple reason: at 8.9% unemployment, there is going to be little to no wage increase demand from the labor side. Consider the following charts:

Average weekly hours are still very low, meaning employers can simply increase the number of hours people work before they start to hire new people. This is a form of labor market slack.


Second, the year over year rate of increase in wages (not adjusted for inflation) has been decreasing. Again, this is because of the large amount of slack in the labor market.

Third, notice the employment cost index's YOY's percentage change for wages and salaries has been showing a slowed pace of increase.

So, while we are seeing an increase in raw material prices, these price increases are usually absorbed by industry and not passed on to consumers. Wage pressures are non-existent.