The Consumer Price Index (CPI) is a tool used to track changes in the prices of consumer goods, which in turn helps measure the inflation rate of an economy.
The CPI holds value in the finance community as it offers valuable insights into short-term and long-term market impacts. Generally, the CPI is determined by considering food, housing, transportation, clothing, and healthcare items.
It is regularly updated through scheduled press releases, usually around the middle of any month. Essentially, CPI indicates inflation or deflation trends within an economy by identifying the consumers’ cost of living.
Calculating the Consumer Price Index (CPI)
The current prices of goods and services are compared to a previous period or reference point to determine the CPI number. The CPI is calculated as a percentage change between these two price levels. The CPI figure that is obtained indicates the inflation rate, which can either be positive or negative.
Ultimately, a positive CPI value would mean a rise in consumer goods and services prices, and a negative value would mean prices are dropping. According to the U.S. Bureau of Labor Statistics (BLS), the Consumer Price Index (CPI) Yearly Formula is:
CPI = (Cost of Basket in Current Year / Cost of Basket in Base Year) x 100
This ratio represents the relative cost of the “basket” or category of goods and/or services in the current year compared to the base year. Ultimately, the calculated data point reveals how much more or less expensive the same basket has become.
Below is the monthly CPI reports throughout the recent years. Investing.com provides the image.
Impacts on the Forex Markets
In the world of trading, CPI holds importance due to the following reasons;
1. Predicting Inflation: Forex traders closely monitor CPI data to assess expectations for inflation. When CPI consistently rises it indicates an increase in consumer prices, potentially leading to inflation. Central banks often respond to rising inflation by increasing interest rates, attracting investment, and strengthening the value of their currency.
2. Influencing Interest Rate Decisions: Central banks heavily rely on CPI data when determining their policies regarding interest rates. A higher CPI may prompt banks to raise interest rates to control inflation, resulting in a currency. Conversely, lower CPI figures can lead to decreased interest rates and a weaker currency.
4. Managing Risks: Given the market volatility during CPI releases, Forex traders employ risk management strategies to mitigate potential losses or take advantage of opportunities arising from such events. Additionally, with the increased volatility of the CPI news release, there is an increased risk for slippage. Traders should be extremely cautious trading during the CPI news release.
CPI release – Schedule and Timing
CPI information is usually published every month, although the frequency may differ from country to country. In the United States, for instance, the Bureau of Labor Statistics releases CPI data approximately in the middle of every month, reflecting the data from the previous month.
However, it is important to note that the exact timing can vary slightly, making it necessary for traders to stay informed about the schedule of these releases.
Expectations and Deviation
Market participants pay close attention to the CPI figure and how it compares to expectations. Economists and analysts often make forecasts or estimates of what the CPI figure is likely to be. The market’s immediate reaction depends on whether the CPI deviates significantly from these expectations.
Market Response to the Consumer Price Index (CPI)
The Forex and financial markets can react quickly and significantly to CPI news releases.
Here are a few examples of how the market might potentially respond:
CPI Exceeds Expectations: If the actual CPI is higher than expected, it may raise inflation expectations. Consequently, traders might opt to purchase the currency associated with that country since central banks could consider raising interest rates to combat inflation. This, in turn, can lead to an appreciation of the currency.
CPI Falls Short of Expectations; Conversely, inflation or deflation concerns might arise if the actual CPI is lower than anticipated. Traders may then decide to sell off the currency associated with that country in anticipation of interest rate cuts or implementation of bank stimulus measures. As a result, this could lead to a depreciation of the currency.
Above: An example of CPI expectations on Gold
Meeting Expectations: When the CPI figure aligns with expectations, market participants are already prepared for that outcome. As a result, there is no unexpected information to prompt large-scale buying or selling. While there may not be a pronounced immediate reaction, CPI data can still influence longer-term market sentiment and expectations.
If CPI remains stable and aligned with forecasts over an extended period, it can contribute to a steady and predictable market environment. However, if CPI consistently deviates from expectations, it may shift market sentiment and trading strategies over time.
Market Example – July 12th, 2023
The US CPI News release was forecast to be 0.3%, but the actual news release was 0.2%, leading to an immediate drop in US dollar value. This led to an increase of pairs with USD as the second pair (Quote Currency), and a decrease in pairs with USD as the first (Base Currency).
The difference between the expectation and the actual can lead to significant and immediate currency movements. Below are a few examples of currency pairs affected by this release:
The Consumer Price Index (CPI) plays a key role in the world of Forex and financial markets as an economic indicator. Tracking inflation trends allows traders and investors to predict possible bank decisions and make informed trading decisions.
The CPI’s influence on monetary policies and currency values establishes it as a fundamental indicator for market analysis and an integral part of the global financial landscape. It is, therefore, essential for both traders and investors to understand the implications of CPI reports and to be aware of upcoming news releases.
Latest CPI releases can be found on the U.S. Bureau of Labor Statistics