This column was originally published on RealMoney on Oct. 18 at 12:46 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Looking at the highlights of the producer price index, or PPI, is like taking a time trip through key dates in U.S. history.

Surging energy costs are the fuel for this trip, and they are also the source of a key debate facing both the Federal Reserve and investors, as the gain in overall inflation continues to be much larger than the gain in other prices. Whatever the case, the data will do little to ease concerns about inflation and will feed consumers' inflation expectations, which are already high.

The producer price index rose 1.9% in September, which was seven-tenths of a percentage point more than expected and the largest monthly increase since 1990. It was also the second largest increase since November 1974. On a year-over-year basis, the PPI is now up 6.9%, the most since November 1990, when it was 7.0%. Excluding food and energy prices, the so-called core PPI rose 0.3%, one-tenth of a percentage point more than expected. The year-over-year gain in the "core" is now 2.6%, not far from the 14-year high of 2.8% seen in July.

Large Gains in Pipeline Data

The worst of the day's news could well be the data on "pipeline" inflation.

Crude materials, or materials at the earliest stage of production (raw materials, for example), rose 10.2% in September, the largest monthly gain since March 2003. Core crude goods, or crude goods minus food and energy, rose 5.3% during the month, the most since July 2004. Except for that month, the gain in core prices was the most since July 1976 (the U.S. bicentennial). As an illustration, cotton from the field would be crude materials for a shirt.

Intermediate prices, which are those prices that occur at the middle stage of production and that have the closest correlation to the headline data, rose 2.5% overall, the most since August 1974 (Nixon resigns). Core prices rose 1.2%, the most since November 1980 (Reagan wins). Using the same shirt example, the intermediate material would be cotton yarn. The finished good would be the shirt itself.

Energy prices drove September's price surge (no pun intended), rising 7.1%. Importantly, prices for residential natural gas rose 9.0%, a gain that likely will feed through into the consumer price index.

Energy prices are finding their way into other goods, the report shows. Egg prices, for example, were impacted by energy during the month, rising 49.3%, due partly to higher transportation costs, the BLS said.

Causes of Muted Market Response

The market response to the PPI has been muted thus far because it is a grade-B inflation gauge that generally tends to garner very little market response. The Oct. 28 release of the personal consumption deflator, the Fed's top inflation gauge, will be more important to the markets.

The PPI's value is reduced by the fact that it reflects well-known trends in commodity prices and because it reflects more on the goods sector than the service sector, which is the largest sector of the U.S. economy. For many of you working in offices, it is easy to understand this concept; a substantial part of your company's expenses are related to labor, not raw materials and parts. Labor accounts for about 70% of the inflation process in the overall economy. Currently, labor costs are contributing to the inflation problem, with unit labor costs up 4.2% vs. a year ago, the most in five years and above the 15-year average of 1.7%.

Also limiting the market response is the fact that companies such as General Motors ( GM) and Ford ( F) are experiencing the higher costs seen today in the PPI report, yet they are passing very little on to the consumer these days.

The PPI is akin to the prices-paid component of the ISM index, while the CPI is closer to the prices that manufacturers receive from their customers.

50-Basis-Point Hikes Could Stamp Out Inflation Worry

Despite the grade-B nature of the PPI report, the gain will feed inflation expectations, a major worry for the Fed and the markets. Still, the wide disparity between the gain in overall prices and the gain in core prices (September's monthly change was the most since 1990 and the second most ever) stokes the debate over how much emphasis investors should put on the overall index vs. the core index.

Fed Governor Kohn helped to crystallize how policymakers are likely to treat the divergence and how investors should, too, when he spoke a week ago:
One of the things we learned in the 1970s is that expectations are really, really important. Energy prices might affect underlying inflation by affecting inflation expectations about future inflation."
Notice Kohn's emphasis on how important expectations are ("really, really"). Until the Fed has squashed inflation expectations, its battle against inflation will not be over. This means that the overall inflation rate will be held high in importance even if the core rate rises at a moderate pace.

One scenario for accomplishing this is the possibility that the Fed will deliver another one or two quarter-point hikes in the fed funds rate followed by a 50 basis point hike or two. This is the way the Fed has operated since Greenspan took the helm in 1987 and it has been an effective way to put an "exclamation point" effort to stamp out inflation.

Sure, the Fed might deliver these hikes when it appears that they are unnecessary, but that is the point. At that stage any notion of accelerated inflation and of further rate increases would begin to fade, setting the stage for a more stable period of inflation, economic growth and the financial markets.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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