US producer prices took an unexpected fall in September due to the drop in the cost of goods and services. The producer price index (PPI) fell -0.3% last month vs. 0.1% expected after a 0.1% increase in August according to a report released on Tuesday by the Labor Department.

Key Takeaways

• The PPI dropped -0.3% in September, an 8-month low, after climbing 0.1% in August.
• The unexpected drop could influence the Fed’s decision on whether or not to cut interest rates again this month to hedge against economic headwinds.
• The PPI rose 1.4% annually in September, the smallest increase since November 2016.

The PPI was expected to rise 0.1% in September, but instead hit an 8-month low of -0.3%. Annually, the PPI saw the smallest increase in September since November 2016 with a rise of 1.4% vs. 1.8% in the 12 months through August. Market analysts had predicted an annual increase in September of 1.8%.

The decline in producer prices may give the Federal Reserve more room to cut interest rates for a second time this month to mitigate the negative effects of the escalating trade war and a general economic slowdown seen worldwide. The trade war has had a major impact on manufacturing, which accounts for 8% of US GDP, and may spill out into the wider economy such as services, which recently reported weak activity. The ISM manufacturing index recently hit a 10-year low as the sector continues to bear the brunt of tariffs on US exports and Chinese imports to the US.

Report Data

Wholesale energy prices dropped  -2.5% in September, the same decline as seen the month before. Prices were affected by a -7.2% drop in the cost of gasoline, which is volatile and saw a -6.6% drop in August. Gasoline accounted for the majority of the -0.4% drop in the price of goods in September. Goods also dropped -0.5% in August. Wholesale food prices increased 0.3% in September after a -0.6% drop in August, and core goods prices dropped -0.1% in September after no change the month before.

PPI misses big time (ex food/energy was supposed to be UP 0.2% month-over-month) pic.twitter.com/QMOWkxmgo0

— Brian Chappatta (@BChappatta) October 8, 2019

The cost of services fell the most since February 2017 with a -0.2% drop, following a 0.3% gain in August. Prices were affected by a -1.0% drop in trade services, as well as a 2.7% drop in machinery and vehicle wholesaling. Healthcare costs rose 0.3% in September and 0.2% in August, while the cost of hospital outpatient care rose 1.1%, the largest gain since 2014.

Monetary Policy

Core-PPI, which excludes the volatile components of food, energy, and trade services, saw no change last month following a 0.4% increase in August. Core-PPI rose 1.7% in the 12 months through September following a 1.9% increase in August.  Meanwhile, core personal consumption expenditures (core PCE) which is a key measure of inflation used by the Federal Reserve rose 1.8% annually in August. The Fed target for inflation is 2%, and has missed the mark this year.

The tame inflation pressure will be another factor in the Fed’s decision on whether or not to cut interest rates this month at the October 29-30 meeting. With the trade war coming up on its 16^th month, sub-target inflation, and a global economic slowdown, the Fed may choose to hedge against the rising risks of recession by cutting the rates again.

While the rate of unemployment dropped to 3.5% in September, near a 50-year low, hiring has slowed. The economy has created 145,000 jobs per month so far in 2019 vs. 195,000 a month in 2018. The three-month average in private payrolls is now down to 119,000 jobs, the smallest amount since July 2012, and growth in the private services industry has hit a three-year low.

Market Reaction

Gold prices have risen slightly since the release of the report. Spot gold last sold at $1,507.58/oz, up 0.09% with a high of $1,508.00/oz and a low of $1,488.07/oz. A number of geopolitical factors may have contributed to upward momentum in the gold markets today.

The US has blacklisted 28 Chinese firms due to their reported suppression of Uyghur Muslims in China, possibly as part of a trade war negotiation maneuver. US-Iran tensions are also in the news, as is the looming Brexit deadline, the US presidential impeachment investigation, and civil unrest in Hong Kong, all of which may be feeding into risk-averse sentiment in the financial markets.