Every trader should know how to read key economic indicators. Understanding what is CPI can help you get a much clearer idea about the current state of the economy. Particularly inflation. This entry will teach you everything you need to know (and nothing more!) about this macroeconomic indicator. I hope that this way you will be able to make better investments.
Table of contents:
What Is CPI – Definition
CPI refers to the Consumer Price Index. It measures the average price change of goods and services purchased per household. Economists, policymakers, and investors closely monitor this macroeconomic indicator, one of the most commonly used predictors of inflation.
The CPI measures the overall change in consumer prices through a representative basket of goods and services. To calculate the CPI, you take a basket of goods and services the average household purchases and track their prices over time.
The items in the basket are weighted according to their relative importance in the household budget.
How To Read CPI Data?
Like other measures, such as interest rate hikes or non-farm payrolls you can benefit from this key macroeconomic indicator. It can help you to keep your finger on the pulse and make data-driven investment decisions. Below are some examples of using this key indicator’s data as an investor.
- CPI can help you determine the real rate of return: Inflation can erode the purchasing power of investments. By subtracting this macroeconomic indicator from the nominal rate of return, you can calculate the real rate of return.
- CPI can help you measure the inflation rate: If the nominal rate of return is higher than the inflation rate, the real rate of return is positive, meaning that the investment is growing in purchasing power. Conversely, if the nominal rate of return is lower than the inflation rate, the real rate of return is negative. It meansthat the investment is losing purchasing power. Suppose you invest $10,000 in a bond that pays a nominal rate of return of 5% per year, and the inflation rate as measured by CPI is 3%. The real rate of return on your investment would be as follows: Real rate of return = 5% – 3% = 2%.
- CPI can help you identify trends: You can use this macroeconomic indicator to identify trends in inflation. An increase in the CPI indicates the cost of living has increased. This means that inflation has also increased. Conversely, a decrease in this key indicator will suggest that the cost of living has decreased and deflation has occurred.
- CPI can help you adjust asset allocation: Understanding CPI enables you to use its data to allocate your assets. For example, if the CPI is rising rapidly, you may consider investing in assets likely to benefit from inflation, such as commodities or inflation-protected bonds.
- CPI can help you predict interest rates: Policymakers closely monitor The CPI, and any changes in the CPI can influence monetary policy decisions. You can use this macroeconomic indicator to predict changes in interest rates, which can affect the performance of your investments.
All in all, Consumer Price Index data is something you will inevitably find very useful throughout your investing career. It’s one of those things that you might be reluctant to learn at first but will grow more and more useful to you as time passes. Let’s find out what roles this key indicator plays in the economy.
The Role in the Economy
The CPI tracks changes in the prices of goods and services over time, and policymakers use this information to make decisions about monetary policy, such as setting interest rates and adjusting government programs like Social Security.
Companies closely monitor this key indicator to calculate COLA for Social Security benefits, military pensions, and private pensions to keep payments adjusted to inflation.
The CPI is also used in contract negotiations between employers and employees to ensure wages and benefits keep pace with inflation. So, if you’re still a part-time investor working a full-time job, you can use your knowledge about this macroeconomic indicator to determine whether you are treated fairly.
Both businesses and investors use the CPI to make pricing and investment decisions. For example, if the CPI rises, a company may raise prices to maintain its profit margin. At the same time, investors may adjust their portfolios to hedge against the potential impact of inflation.
How to Read the CPI Data?
Reading the CPI data may seem a little complex initially, but luckily it isn’t rocket science. With little practice, you’ll be quick to understand the key concepts. Below are some of the most important points to help you start.
CPI Data Explained
The CPI report usually comes as an index number, with a base year set to 100. For example, if the CPI for a particular month were 110, it would indicate that the prices have increased by 10% since the base year.
Since this macroeconomic indicator is usually presented as a percentage change from the previous month or year, you must pay attention to the trend over a longer period to see if inflation is increasing, decreasing, or staying the same.
For example, if this key indicator for the past three years has steadily increased by 0.5% each year, it suggests a stable but persistent inflation rate.
The percentage change in the CPI from one month to the next is used to measure inflation. A higher percentage change indicates that prices are rising more rapidly. A lower percentage change indicates that prices are rising more slowly.
The CPI is further divided into various categories: food, housing, healthcare, and transportation. Each category’s weight reflects its importance in the average household’s budget. Analyze the changes in each component to understand how they contribute to the overall trend.
For example, if the CPI has increased by 3% over the past year, but the food price has increased by 7%, it indicates that food inflation significantly contributes to the overall inflation rate.
Make sure to keep in mind that this key indicator’s data is just one piece of the puzzle. While it’s a great indicator, comparing the CPI data to other economic indicators, such as GDP growth and employment data, is important to get a better picture.
Types of CPI
To better understand what is CPI, you must learn that various types can be used to measure inflation in different areas. Here are the main types of CPI:
- CPI-U: The CPI-U (Consumer Price Index for All Urban Consumers) is probably the most commonly used type of CP. It measures the average price change for goods and services purchased by urban consumers, including professionals, self-employed, and wage earners.
- CPI-W: The CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) is a type of CPI that measures the average price change for goods and services purchased by urban wage earners and clerical workers. Various institutions use it often to calculate cost-of-living adjustments for Social Security benefits.
- CPI-E: The CPI-E (Consumer Price Index for the Elderly) is a type of CPI that measures the average price change for goods and services purchased by households inhabited by the elderly, i.e., individuals aged 62 years and older.
- Core CPI: The Core CPI measures inflation that excludes volatile food and energy prices to better understand underlying inflation trends.
- Producer Price Index (PPI). The PPI measures the average price change for goods and services at the wholesale level (before they reach the consumer). This can be an indicator of future price changes at the consumer level.
- Regional CPI: The Regional CPI measures the average price change for goods and services in different regions. This can be useful for understanding how inflation varies across different parts of the country.
- Commodity and Service Group CPI: The Commodity and Service Group CPI measures the average price change for specific categories of goods and services. There are for example, food, housing, transportation, medical care, and education.
Policymakers, economists, and investors can use each type of CPI to make informed investment decisions. It is because it provides valuable information about inflation in different areas.
Where to Find CPI Data?
You can find the CPI data through government agencies, financial news websites, and economic data providers. For example, you can find the CPI data at the Bureau of Labor Statistics (BLS). The BLS is a government agency that publishes the CPI data monthly. This key indicator’s data is in the Consumer Price Index section of the BLS website.
You can also find this important macroeconomic indicator’s data on the Federal Reserve website. Federal Reserve Economic Data (FRED) offers a range of economic data, including CPI data. You can find the data by searching for the ‘Consumer Price Index’ on the FRED website or clicking here.
Also, most financial news websites report on the CPI data whenever they appear. For example Bloomberg, CNBC, Yahoo Finance, and Reuters,
By understanding what is CPI is, you are one step closer to starting investing. In the long term, understanding the CPI data and how it works will likely save you from poor investments. Below are some of the key takeaways from this article:
- CPI measures inflation: The CPI measures the inflation rate in the economy by tracking changes in the prices of a basket of goods and services.
- CPI has different types: There are different types of CPI, such as the CPI-U, CPI-W, and Core CPI, each of which provides you with unique and extremely useful data.
- CPI is used for policy decisions: The CPI is used by policymakers to make decisions related to interest rates, monetary policy, and government programs like Social Security.
- CPI affects investments: Changes in this key indicator can impact investment decisions. Rising inflation can lead to higher interest rates and affect the returns of various asset classes.
- CPI may have limitations: This key indicatormay have limitations, such as not accounting for changes in the overall quality of goods and services or differences in consumer behavior.
Remember that while the CPI is a valuable measure for tracking inflation, it’s not the only measure you should focus on.
Other economic indicators, such as GDP, employment data, and interest rates, can also provide insights into the state of the economy and impact investment decisions. If you haven’t, I’d also highly encourage you to learn more about the GDP and its impact on the market.
Ultimately, it may seem like a lot of work. Once you’ve grasped how these indicators work, it will become second nature.