The finished goods PPI is the one that always gets all the media coverage. It measures the selling price of goods when they are first ready for sale to the ultimate consumer. The PPI provides comprehensive coverage of prices for all the major goods producing sectors, including: manufacturing, mining, agriculture, forestry, fishing, and natural gas and electrical power production.

Changes in the finished goods PPI provide an indication of the rate of inflation (price increases) at the time the goods go out the factory door. The Consumer Price Index (CPI), due to be released tomorrow, measures inflation later, after purchases by the public are rung up at the retail cash register. So, all other things being equal, the finished goods PPI should give an earlier warning of inflation than the CPI.

Bond market participants watch both of these indexes with great interest, along with any other information that might give clues about inflation. Rising inflation breeds higher interest rates and lower bond prices. Stock investors closely monitor what's happening to bond yields because historically the stock market has performed well in an environment of falling interest rates.

Today's report showed inflation at the producer level to be essentially non-existent. The change in the finished goods PPI from April to May was -0.1 percent. When we look at the PPI with the contributions from the highly-variable energy and food price components excluded we find that this so-called "core" rate was unchanged in May. In the past 6 months the core PPI rose by 0.1 percent on four occasions, fell by 0.1 percent once and was unchanged once.

Another approach is to examine the change in the PPI over a longer period, say a year. When we do this, the month-to-month food and energy variations tend to average out. For the twelve-month period ending in May, the finished goods PPI rose by 2.3 percent -- identical to the average value of the annual change during the last 6 months and the annual change during 1995.

This week I discovered another important indicator that we can glean from the monthly PPI report. I was reading a book by economists Steve Slifer and Stan Carnes, called "By The Numbers: A Survival Guide To Economic Indicators". In the book's chapter on the PPI, Slifer and Carnes point out that the core PPI for intermediate goods is an excellent leading indicator for the core rate of the finished goods PPI. It turns out that changes in direction of the intermediate core rate precede changes in direction of the finished goods rate by about a year. And, guess what folks. The core intermediate rate is presently in the midst of a nine-month downtrend. In fact, in that entire nine-month period, this indicator only rose once.

Summing up: The finished goods PPI is hanging tough at a modest growth rate of just 2.3 percent, and the intermediate goods core PPI is predicting still lower finished-goods price growth three to twelve months from now.

Perhaps today's PPI report will calm the bond market so that stock market participants will shift their concentration from imaginary fears of inflation to the very real evidence that the general economy is showing some signs of life.

Byline: Lafferty (MF Merlin)