Producer prices soared past expectations in September, reviving concerns about inflation. However, a large amount of that worry is already priced into stock and bond prices, and markets largely took the news in stride.

The producer price index jumped 1.9% last month, the biggest jump since January 1990 and above the consensus estimate of 1.1%. Even removing energy costs, the core PPI rose 0.3% in September, above economists' expectations for a 0.2% gain.

Inflation worries have consumed the market ever since Hurricane Katrina hit Gulf Coast energy production. Majors averages opened slightly lower on the PPI news but was recently trading in a mixed fashion as the inflation data were offset by positive earnings from firms such as IBM ( IBM), Merrill Lynch ( MER) and Johnson & Johnson ( JNJ).

The Dow Jones Industrial Average was recently up 7.92 points, or 0.08%, at 10,356.02, off a morning low of 10,325, and just below its daily high of 10,361.

Besides getting a boost from IBM, the blue-chip average was also lifted by 3M ( MMM), which posted better-than-expected earnings, and by Intel ( INTC), which will post results after the close.

The tech-heavy Nasdaq Composite was recently up 0.86 points, or 0.4%, at 2071.16, off a morning low of 2064 and just under its high 2072.

The S&P 500, however, remained stuck under water, trading down 2.04 points, or 0.17%, at 1188.06 vs. its morning low of 1184. The index was weighed down by weakness in energy stocks and homebuilders, the latter hurt by American Standard's ( ASD) disappointing results and some cautious comments by NVR ( NVR).

Bonds pits, meanwhile, halted a five-day slide. The price of the benchmark 10-year Treasury was recently up 5/32, its yield falling to 4.47%, on news that foreign buying of U.S. Treasuries had increased in August. In addition, while investors have been used to very hawkish rhetoric from Federal Reserve officials lately, there was relief that a speech by Fed Chairman Alan Greenspan didn't add fuel to the fire of inflation concerns.

Sucking in the '70s

Greenspan, who delivered a speech to a business association in Tokyo overnight, highlighted that soaring energy prices present a risk for global growth. "Although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on," he said.

But the latest surge in energy quotes will "likely prove significantly less consequential to economic growth and inflation than the surge in the 1970s," Greenspan said, because the world's use of energy makes up a much smaller portion of global growth.

That reference to the 1970s oil shock comes just as producing costs, as in the September PPI, are rising at a pace not since 1974, according to Wachovia economist Jason Schenker.

While the consumer price index helped spark a relief rally on Friday because prices, excluding energy, were below expectations, there was no such reason to cheer the PPI. Expectations of "reconstruction demand" after hurricanes Katrina and Rita have also pushed up the price of steel, copper, aluminum and a number of other metals, fueling core inflationary pressures, Schenker notes.

The increase in the price of intermediate goods rose at a pace of 2.5% in September, even faster than final goods prices. "All of this inflationary pressure is likely to feed through to the final PPI, and from there it will either squeeze manufacturers' profit margins or seep into consumer inflationary data," Schenker says. "The Fed now has a very careful path to tread."

Bond prices, meanwhile, will likely fall further, and yields will move higher, in the weeks and months to come, according to Sid Mokhtari fixed-income strategist at CIBC World Markets.

"The inflation story has had a significant impact on the market already, but it will continue to be a bearish force," he says.

The September PPI was a "bearish catalyst" which first lifted the yield of the 10-year Treasury to 4.5% and the price of the bond into oversold territory. Investors selling the bond short have had it good over the past two weeks, but the short-term risks are now for a modest rebound.

The 10-year yield could retest the 4.40% level over the next few sessions but the market will then likely attempt to push it up above 4.60%, a level that hasn't been breached since March of this year. The next resistance levels would be 4.80% to 4.90% early next year, Mokhatari believes.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback; click here to send him an email.