INDICATOR: September Producer Prices and Small Business Optimism

KEY DATA: PPI: -0.3%; Goods Less Food and Energy: -0.1%; Energy: -2.5%/ NFIB: -1.3 points

IN A NUTSHELL: “Small businesses are becoming a bit more uncertain about the future, but that does not mean they will be cutting back anytime soon.”

WHAT IT MEANS: The next FOMC meeting is in three weeks and the jury is out on what may happen. Some economists are convinced the Committee will cut rates again, but others, such as myself, are just not sure. The reason for the uncertainty can be seen in today’s data. Start first with inflation, if you can find it. The Producer Price Index fell sharply in September, but most of that came from a large decline in energy. That was known, so the drop in the overall index should not have been a major surprise. But that doesn’t mean wholesale costs are under pressure. Excluding energy, prices were still down and even just looking at non-energy finished goods, costs were flat. Yes, food prices rose moderately, but that was largely it. Services prices dropped and only a handful of components and special indices posted increases of 0.3% or more in a two-page table. In other words, business expenses are not rising, so there is little reason to believe that inflation will accelerate anytime soon.

While inflation remains low, small business confidence remains high. The National Federation of Independent Business’s Small Business Optimism Index eased again in September. And no category posted an increase, as six of the nine declined. However, as it was noted in the report, “September’s figure falls within the top 20% of all readings in the Index’s 46-year history.” What it points to is what I have been arguing all along: Growth is moderating not collapsing. Still, uncertainty is rising and there has been a fairly steady decline in the index over the past year, largely driven by tariffs. Thirty percent of the respondents said that tariffs negatively impacted them.

MARKETS AND FED POLICY IMPLICATIONS: When consumers cut back, small businesses usually feel it first. So far, that doesn’t seem to be happening and that implies the slowdown should be just that, a slowdown. But when it comes to the Fed, slowing to trend growth is still slowing. With a new round of tit-for-tats between China and the U.S., it doesn’t look as if the negotiations will get very far. Since there is a real possibility that additional tariffs could be imposed before the next meeting on October 29-30, undoubtedly there will be those calling for more reductions in interest rates. As for the economic data since the last Fed meeting, they show the economy is expanding at the expected pace – roughly 2%. The only thing the economy has to fear is a tariff war and that is not something that can be addressed through traditional monetary policy. But Jay Powell seems to feel he has to show he is in charge so I am not ruling out a rate cut, even though I don’t have it in my forecast. If a cut does occur, then it is clear the FOMC blundered at the last meeting and should have reduced rates by 50 basis points, as St. Louis Fed President James Bullard wanted. That is because nothing has changed since then. So, if a rate cut is needed on October 30^th, then it was needed on September 18^th. As for investors, eventually they will understand the Fed cannot pull their chestnuts out of the fire. But they will likely persist in the belief that another rate cut will keep the economy and the markets going. Good luck with that.

Joel L. Naroff is the president and founder of Naroff Economic Advisors, a strategic economic consulting firm.