The Consumer Price Index (CPI), one of the most familiar economic terms to the public, not only affects individual living costs but is also a key driving force in financial markets. In this article, we will explore its calculation, readings, and its influence on Forex trading.
CPI Meaning & Explanation
The CPI stands for Consumer Price Index, it is a measure that tracks the average price changes of a basket of consumer goods and services that closely related to the daily living of the public household.
It serves as an important economic indicator, as the Consumer Price Index is used to gauge the level of inflation felt by the public. In addition to that, it also serves as a key reference for government agencies in formulating economic policy.
National statistics agencies regularly release the CPI data, which often garners significant attention from the public and financial market. The US CPI, in particular, is one of the most closely watched CPI data, as it plays a crucial role in the global market.
To better explain the CPI in the following sections, this article will primarily use the US CPI as an example to provide a detailed explanation of the calculation, composition, and impact of the Consumer Price Index in the financial market, or the forex market.
CPI & Inflation Rate
The relationship between the Consumer Price Index (CPI) and the inflation rate is fundamental to understand the economic conditions of a country or region.
With the CPI is used to gauge the inflation rate, it provides a measure of price changes across the broad range of goods and services, which may reflect the economic growth of a country or region.
- Increase in CPI would signify an inflation, reflecting the growth in economic activity and employment.
- Decrease in CPI would signify a deflation, reflecting the slowdown in economic activity and employment.
Inflation can signal increased consumer spending and business investment, boosting demand and raising prices. However, if inflation rises too quickly, it can erode purchasing power and have negative effects on economy.
Deflation or low inflation indicate weak consumer demand, excessive supply, and potentially declining employment, which can lead to decreased domestic production and reduced spending, causing an economic contraction.
Too high or too low inflation can have a broad range of effects on the economy, which we will cover in another topic on the Consumer Price Index and inflation.
In general, moderate inflation is considered ideal for a healthy economy from an economic perspective. Most government or central banks in countries or regions aim to maintain inflation stability at around 2% to ensure economic stability and growth.
CPI Table & Calculation
As the primary inflation-gauging indicator, almost every country and region have its own Consumer Price Index measure that calculated by their respective national statistical agencies.
In general, the CPI is calculated by collecting data on the prices of a predetermined basket of goods and services that represent the consumption habits of a typical household from various categories.
In the US for example, the US CPI is calculated by the United States Bureau of Labor Statistic, with its CPI basket of goods and services includes over 80,000 types of goods and services across 8 categories, covering all aspects related to daily household expenditures such as apparel, F&B, housing, and transportation.
Below is the US Consumer Price Index table consisting of the basket of goods and services and their respective weighting:
| US CPI - Basket of Goods & Service | |||
|---|---|---|---|
| Consumer Price Index List | CPI Weighting | Consumer Price Index List | CPI Weighting |
| Housing | 34.6% | Medical Care | 6.5% |
| Household & Apparel (Except F&B) | 21.3% | Transportation | 5.9% |
| Food and Beverages | 13.5% | Education and Communication | 4.9% |
| Fuels and Utilities | 6.9% | Other Goods & Services | 6.4% |
Different countries or regions have their own methods for calculating the CPI, including the selection of the basket of goods and services, and the weighting method. However, the general concept of calculating the CPI remains largely the same.
US CPI vs. Core CPI
In the US, the US Bureau of Labor Statistic will release the Consumer Price Index (CPI) along with the US Core Consumer Price Index (Core CPI).
The Core CPI is essentially the same as the CPI Index, only that it excludes the food and energy components due to their prices can be heavily influenced by short-term factors like seasons and climates, which would often cause larger volatility in price compared to other goods and services.
Here are some quick key differences of the CPI and Core CPI:
Consumer Price Index
Known as Headline CPI or Headline Inflation. Tracks all selected of basket of goods and services.
Core Consumer Price Index
Known as Core CPI or Core Inflation. Excluding the F&B and Energy component in its basket list.
The chart below compares the annual rates of the US CPI and US Core CPI for the past three years. The blue line represents the headline CPI annual rate, while the yellow line represents the Core CPI annual rate.
From the chart, it is evident that although the overall trends are similar, the CPI poses a significant volatility compared to the Core CPI. In the data for April 2024, the difference between the two was 0.8%, and during peak periods, the difference could be as high as 3%.
Despite higher volatility, the headline CPI is usually considered the more focused inflation data compared to Core CPI, as changes in food and energy prices have the most direct impact on the public.
CPI Rate Readings
The Consumer Price Index release is usually in a numeric form which represent the average prices change over the time. However, what the financial market participants and public actually pay attention to is the growth rate of the latest CPI value compared to the past.
When the government agency releases the latest CPI data, they typically release two set of growth rate in percentage, which represent the percentage increase compared to certain periods:
- CPI by Month (MoM): The percentage increase in the index compared to the previous month, represents the inflation changes by month.
- CPI by Annual (YoY): The percentage increase in the index compared to the previous year, represents the inflation changes by yearly.
For example, in May 2024, the US annual CPI rate stood at 3.3%, it means that, on average, prices for a basket of goods and services increased by 3.3% compared to May 2023. Meaning to say, the same basket of goods and services that costs $100 in May 2023 would have cost $103.3 in May 2024.
US CPI Data Release
The US Consumer Price Index is released monthly by the US Bureau of Labor Statistic, typically between the 10th to 15th of the following month. For example, the CPI report released on May 15th, 2024, would reflects on the inflation for April 2024.
Below is the CPI report release date for the US CPI in 2024:
| 2024 US CPI Release Date | |||
|---|---|---|---|
| CPI Data Month | Release Date | Forecasted CPI | CPI Rate (By Yearly) |
| December 2023 | 11/1/2024 | 3.2% | 3.4% |
| January 2024 | 13/2/2024 | 2.9% | 3.1% |
| February 2024 | 12/3/2024 | 3.1% | 3.2% |
| March 2024 | 10/4/2024 | 3.4% | 3.5% |
| April 2024 | 15/5/2024 | 3.4% | 3.4% |
| May 2024 | 12/6/2024 | 3.4% | 3.3% |
| June 2024 | 11/7/2024 | ||
| July 2024 | 14/8/2024 | ||
| August 2024 | 11/9/2024 | ||
| September 2024 | 10/10/2024 | ||
| October 2024 | 13/11/2024 | ||
| November 2024 | 11/12/2024 | ||
For other region such as the Eurozone or Japan, the CPI report are also released on monthly basis while some are released on quarterly basis, such as the Australia and New Zealand CPI. Anyone can easily access the CPI data release date through the Economic Calendar on most financial websites.
Forecasted CPI Data
Besides the consumer price index release, the forecasted CPI data is one of of the closely watched figure by financial market.
At the end of each calendar month, in addition to the U.S. Bureau of Labor Statistics, some financial institutions and market research firms compile CPI data for the previous month. A few days before the official U.S. CPI results are released, the market forms a forecasted CPI based on these private statistics. The forecasted CPI data can be just as important as the actual data.
Comparing the CPI data with both previous data and the forecasted CPI is crucial. If the official result matches the forecast, the financial market typically remains calm. However, if there is a significant deviation from the forecasted CPI, the market may react sharply, causing considerable volatility.
When the market has formed a consensus on the expected CPI result, the markets will have already adjusted or moved based on the CPI expectation before the official data is released. In other words, the market has priced in the forecasted CPI in advance.
If the actual data significantly deviates from the forecast, only the market will immediately reprice based on the actual data, leading to substantial financial market volatility.
CPI & Interest Rates
As mentioned above, a healthy economic condition requires moderate inflation. Most central banks around the globe set a 2% inflation target based on the CPI to achieve price stability and maintain a healthy economy. Therefore, CPI data is closely monitored by central banks, including the Federal Reserve, to assess whether inflation is in line with this target.
The consumer price index data may directly influences on central bank’s monetary policy decisions, making it one of the most important economic data, especially for financial markets. Here’s an overview of how CPI influences the monetary policy:
US CPI and Rate Hike
If CPI shows inflation rising above the target, central banks may implement a tightening monetary policy or raise interest rates to cool down the economy and curb inflationary pressure.
US CPI and Rate Cut
If CPI indicates inflation below target or deflation, central banks may implement a loosening monetary policy or lower interest rates to simulate economic activity to raise inflation to the target.
In the United States, the US CPI and US Interest rates are positively correlated most of the time, with the CPI index can be even considered as a leading indicator for the benchmark rate. This is why the US CPI is often seen as a key economic data by investors or traders in trading the financial market.
The chart below shows the relationship between the two, with blue curve represents the annual US CPI rate since 2016, and the red curve represents the U.S. Federal Fund Rate, and the green horizontal line represents the 2% inflation target.
- In 2020, the outbreak of COVID-19 led to a significant contraction in the US economy, with the US CPI nearing 0%. This prompted the Fed to implement loose monetary policy and lowering interest rates to zero to stimulate the economy.
- From 2020 to 2022, due to the COVID-19 pandemic, the Fed temporarily set aside the inflation target and maintained zero interest rate policy for two years.
- In April 2022, the US CPI reached its highest level in 34 years, nearing 9%, prompting the Fed to implement an aggressive tightening cycle to curb the high inflation rate.
CPI in Forex Trading
Changes in monetary policy, especially interest rates, often have a significant impact on the financial markets, particularly the Forex market. Therefore, it is essential for the traders that trade the forex market to understand how’s the US CPI may impact on the forex market.
Given that the United States is the world’s largest economy and financial market center, changes in the U.S. Federal Reserve’s monetary policy have a profound impact on the currency market and even the global financial market. This makes the U.S. Consumer Price Index one of the most important economic data closely watched by traders and investors globally.
1. US CPI on Monetary Policy Changes
With its significant correlation with the monetary policy and interest rate, the US CPI has a complex impact on the Forex market. Depends on the specific market conditions, the nature and extent of impact in Forex can be vary.
However, we can use the simplest way to understand the logic of CPI impact in Forex market:
- High CPI figures may prompt the Fed to implement a tightening policy; higher interest rates can attract foreign investment into the USD, resulting in increased demand and appreciation of the USD.
- Low CPI figures may prompt the Fed to implement an easing policy; lower interest rates can reduce the attractiveness of the USD for foreign investment, potentially decreasing demand and depreciation of the USD.
Comparing the US CPI, interest rates, and the US Dollar Index in the chart above. From 2021 to 2023, US inflation reached multi-decade highs, with the US CPI yearly rate peaking near 9%. This prompted the Federal Reserve to aggressively raise rates to curb inflation, resulting in the Dollar as measured by the US Dollar Index (DXY) to rally throughout 2022 and 2023.
2. US CPI on Monetary Policy Expectation
Significant changes in CPI figures and monetary policy can result in substantial currency movements in the mid to long term. However, in the certain period of time, the forex market may be driven by market expectations of monetary policy changes rather than the actual policy changes.
Comparing the same chart of the US CPI, US interest rate, and US Dollar Index, the periods marked with red and blue vertical lines show how expectations of monetary policy changes may affect the US Dollar:
- From May 2021 to February 2022 (marked with red lines) – Despite the rapid rise in inflation, the Federal Reserve had yet to implement any tightening policies. However, as the financial market began to anticipate and price in a rate hike, the US Dollar started to rise.
- From January 2023 to January 2024 (marked with blue lines) – The decline in US CPI data prompted the financial market to anticipate a possible end to the rate hike cycle. Despite the Fed still implementing a couple of hikes after that, the US Dollar experienced a significant pullback during that period
Trading the CPI Data
The release of US CPI often leads to significant volatility in the Forex market, particularly the US Dollar. This allows forex traders to speculate on the immediate volatility or the price movement in the USD after the CPI.
For position traders, understanding how the US CPI may impact the Fed’s monetary policy changes can provide them with mid to long-term trading opportunities.
However, for short-term traders who intend to speculate on the CPI release or market trend after the release, understanding market expectations on monetary policy changes driven by the US CPI is important.
In early 2024, the cooling in the US consumer price index data from its 34-year high led the market to expect that the Federal Reserve would begin an easing policy cycle in 2024.
However, from January to April, the release of CPI data during this period showed that US inflation failed to decline sustainably towards the Fed’s 2% target, this led the market to push back on the expectation of rate cuts by the Federal Reserve.
Price action as marked by the red arrow in the chart above, shows that the US Dollar gained on the CPI release and significant trend movement were also formed after that.
