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Economy Poised for a Soft Landing and Great News for the Stock Market

Prof. Peter Morici - 9/19/2006

Today, the Labor Department reported the Producer Price Index increased 0.1 percent in August, after rising 0.1 percent in July. This bodes well for a soft landing and is great news for the stock market.

Food prices rose 1.4 percent and energy prices rose 0.3 percent. These components of both producer and consumer prices are quite erratic month to month, and Fed policymakers pay particular attention to movements in the core indexes.

Core producer prices—producer prices less food and energy—fell 0.4 percent in August, after falling 0.3 in July.

The 1.4 percent increase in food prices in August should be viewed together with the 0.3 decrease in July. Through August, food prices absorbed a major shock from rising petroleum prices, as these affect fertilizer, cultivation, harvesting, processing, and transportation costs. In the months ahead, food prices should not play a major role in inflation.

Producer prices for finished consumer goods, less food and energy, indicate where core consumer prices are headed. Those fell 0.4 percent in August, after falling 0.3 in July. These have fallen one percent over the last four months.

The decline in wholesale prices, less food and energy, indicates inflation is cooling as the Federal Reserve Open Market Committee anticipated at its August 8 meeting.

The outlook for inflation is significantly colored by energy prices.

Since early August, crude oil prices have fallen nearly 15 dollars a barrel and gasoline has dropped more than 50 cents a gallon. Falling energy prices will reduce cost pressures on many businesses, and moderating growth will stoke competition for customers. Pressure on wholesale prices should weaken for many commodities and services.
Inflation should cool significantly in September and October, and the Fed should become more comfortable keeping interest rates at current levels.

The growth side of the equation looks promising too. Falling energy prices should permit the economy to expand rapidly enough to lift corporate profits and stock prices but not so rapidly as to rekindle inflation. Fourth quarter and first half 2007 GDP growth will be a bit above 3 percent.

The stars are coming in alignment for a picture perfect soft landing. Moderating growth and inflation, and rising corporate profits will energize the stock market.

Moderating inflation will provide support for the recent increase in stock prices. Supported by robust holiday retails sales and stronger corporate profits, stock prices should rally through the end of the year.

No change in Fed policy is likely before the New Year.