Shelter and Gasoline Pushed CPI to 3.8%. Producer Prices Are Running at 6%. Here Is What That Pipeline of Inflation Means for Rate Cuts and Your Portfolio

One day after the Consumer Price Index (CPI) rattled the stock market, investors got another taste of bitter medicine from the April Producer Price Index (PPI).

While the CPI report basically matched estimates, the PPI, which tends to be a leading indicator for the CPI, was much hotter than expected. Wholesale prices rose 1.4% from March, or 6% from a year ago, marking the fastest growth in the index since December 2022. Economists had expected monthly growth of just 0.7% and annual growth of 4.6%.

Core inflation, which strips out the volatile food and energy categories, was up 0.6% from a month ago and 4.4% for the year, showing it's not just energy that is pushing up prices. While energy prices jumped 7.8% from the previous month, transportation and warehousing were also up 5% for the month, in part a reflection of higher fuel prices. The 10-year treasury yield moved up modestly on the news to 4.48% after climbing more than 1% yesterday.

Image source: Getty Images.

Why stocks were still up today

Yesterday's CPI report seemed to be the main reason for Tuesday's sell-off; however, on Wednesday, the market was buoyed by a surge in tech stocks, which rebounded from a sell-off yesterday. That jump may have been sparked by a strong earnings report from Nebius, one of the leading neocloud companies, which provide AI cloud infrastructure services. Investors may also be responding to news that Nvidia CEO Jensen Huang is joining President Trump's entourage to meet Chinese President Xi Jinping in China, which could be a favorable sign for chip sales to China.

As of 1:48 p.m. ET, the Nasdaq Composite was up 1.2%, while the S&P 500 (SNPINDEX: ^GSPC) had gained 0.6%, even as most S&P 500 stocks were down, especially those sensitive to inflation and interest rates like financials and retail stocks.

Still, investors shouldn't mistake the surge in tech stocks for a sign that rising inflation isn't a threat.

How higher wholesale prices could affect stocks

The relationship between the PPI and CPI isn't as direct as you might think, as increases in inputs have a varying effect on increases at the consumer level.

However, if wholesalers are paying more for the same product to producers, they either need to absorb those higher costs or pass them on to the consumer. Over the long term, the two indexes tend to move together, but over the short term, the correlation is less clear.

Higher raw material prices are good for producers such as energy companies, but the spike in PPI, especially well ahead of estimates, signals that consumer prices are likely to move higher.

For investors hoping for interest rate cuts this year, that's a bad sign. In fact, investors now see a rate hike being more likely than a rate cut from the Fed this year, though the base case still calls for rates to hold steady.

Outgoing Fed Chair Jerome Powell has tried to tamp down concerns about the energy shock, saying they are usually short-lived, but incoming Chair Kevin Warsh may have a different view.

As far as its effect on your portfolio, investors should remember that this is just one data point and not to act hastily, but the threat of higher inflation and interest rates is likely to have an impact on exposed sectors like financials, retail, and the housing market.

Still, the situation in the Middle East remains volatile and unpredictable. If the PPI continues to move higher, expect producers like energy companies to benefit, while consumer-driven sectors struggle.

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.