Technical analysis: a look at the charts

US CPI Primer: Understanding inflation and its impact on portfolios

Macro
Charu Chanana

Chief Investment Strategist

Summary:  Inflation is a key metric watched by traders and investors for its impact on portfolios. The impact can be direct with high inflation eating up investment returns, or indirect as the resulting change in central bank policies creates varied impacts across asset classes. We dig deeper on the different measures of inflation, key metrics to watch, and how to trade the release.


What is inflation?

Inflation is an indicator of price increases over time, usually felt in everyday life with the higher prices for items in our shopping carts over a particular timeframe. Technically, inflation refers to the increase in prices of a selected basket of goods and services in an economy. In other words, it is the rate of decline of purchasing power of a given currency over a period of time because as prices rise, a dollar can buy fewer goods and services than it did before.

There are several factors that can cause inflation, from a change in food or energy prices or supply chain hassles, or even an increase or decrease in money supply or demand. Overall, inflation can either be demand-pull or cost-push. Demand-pull inflation is where the level of demand for goods and services exceeds short-term supply. Companies will respond to elevated demand by increasing prices. Cost-push inflation is associated with supply shocks, in which rising input costs are passed on to consumers via increased prices for goods and services.

Measures of inflation – CPI vs. PCE vs. PPI

Inflation in the US is measured by a few different agencies, and each have their own metrics. The most common metric, Consumer Price Index or the CPI, is constructed by the Bureau of Labor Statistics (BLS) and is released around the middle of each month.

Figure 1: A snapshot of CPI release. Source: Bloomberg

The other common inflation measure is the personal consumption expenditure index (PCE) which is constructed by the Bureau of Economic Analysis (BEA) and is released toward the end of each month. Historically the two measures of inflation have seldom deviated significantly, but that has changed recently.

Figure 2: A snapshot of PCE release. Source: Bloomberg

Essentially, CPI measures the change in direct expenditures for all urban households for a defined basket of goods and services. All expenditure items are placed into over 200 categories, arranged into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. The three largest components of CPI are housing, transportation, and food/beverages.

However, policy makers prefer to focus on the (core) PCE index as it reportedly captures the latest consumption trends more effectively given that the CPI uses an index formula which only updates item weights biannually (moved to annual updates from 2023) but the PCE index updates item weights every quarter. So PCE effectively captures substitution effects, whereby consumers switch products due to relative price differences, and this is why usually CPI is higher than PCE because it does not capture the switch to cheaper products which might be occurring.

Another reason of preference for PCE is that it considers expenditures made by urban and rural consumers as well as expenditures made on their behalf by third parties, as against CPI that uses a narrower definition of consumer expenditures and only considers urban expenditures made directly by consumers.

While CPI and PCE measure inflation from the consumer standpoint, there is another measure, the Producer Price Index or PPI, which is also reported by the BLS and measures inflation from the perspective of producers. PPI measures the average change over time in the selling prices received by domestic producers for their output.

Figure 4: A snapshot of PPI release. Source: Bloomberg

Measures of inflation – headline vs. underlying vs. core

The other common terminology we come across is the headline inflation, which reflects the overall change in the level of prices, vs. the core inflation, which excludes price changes in certain goods which are known to have volatile or seasonal price fluctuations, such as food and energy prices.

Meanwhile, underlying inflation is measured via median or trimmed mean metrics in which components of inflation that show the lowest or highest price changes in the basket are removed to get rid of the noise or transitory factors. For instance, a hurricane causes a large change in say the price of apples or a medical rebate for a year brings healthcare costs down temporarily, then these effects have to be removed to understand the true “underlying” price pressures in the economy.

What makes inflation so important for markets?

It is easy to understand that inflation affects consumer spending as it reduces your purchasing power. But implications are also inevitable for your portfolios as inflation can also reduce the value of investment returns. In addition, inflation prompts central bank action as they usually have mandates to bring inflation to a target level in the long-run. So, central banks attempt to control inflation by regulating the pace of economic activity, which is regulated by raising or lowering short-term interest rates. This has a varied impact on various asset classes.

The Federal Reserve has a dual mandate – to sustain maximum employment and price stability. In 2012, the FOMC published its “Statement on Longer-Run Goals and Monetary Policy Strategy”, which communicated a long-term target inflation rate of 2%. However, a flexible average inflation targeting regime was adopted in August 2020 which allows inflation to exceed 2% for some time until the average returns to 2%.

How to trade CPI releases?

Most commonly used instruments to express a view on US inflation are:

  • US dollar and other USD FX pairs such as USDJPY or EURUSD
  • Treasury Bonds
  • USD-traded commodities
  • Indices like NASDAQ (USNAS100.I) or S&P 500 (US500.I)

CPI reports are generally followed closely by traders and investors as these influence central bank decision on raising or cutting the interest rates, which strongly impact the market sentiment towards various asset classes. The actual inflation print is compared not just to central bank’s target, but also to the street forecast.

Typically, an inflation that is higher than central bank’s target or street expectations will prompt tighter monetary policy action, resulting in a negative impact on stocks (on expectations of weakening economic activity) and nominal fixed income (on expectations of higher yields) as well as a stronger currency. Conversely, inflation prints that are below expectations or target could prompt loosening of monetary policies that result in gains in equities and bonds, while the currency could come under pressure. Both momentum trading and fade the data trades, as discussed in the nonfarm payroll primer, are interesting on such key data/event days. Option trading is also quite popular around CPI release days as volatility picks up.

For investors, it is important to consider the impact of inflation on portfolio returns, and maintaining a constant allocation to inflation-hedging assets in order to cushion portfolios against unexpected spikes. Popular inflation-hedging instruments include inflation-protected bonds such as Treasury Inflation-Protected Securities (TIPS) or floaters, commodities or real estate. Gold also tends to fare well when real interest rates are low or negative, that is when inflation is high but interest rates are still low.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.