Fundamentals Strategy - Consumer Price Index

The Consumer Price Index (CPI) tracks the cost of a fixed set of goods that are considered representative of a typical consumer’s purchasing actions by comparing current prices with prices from an earlier period.
Mathematically, it represents changes in prices of all goods and services purchased by an average household for consumption. Costs of living and sales and excise taxes paid by the consumer are included in the measure; however, investment tools - stocks and bonds - and income taxes are not. Proliferate use of this measure of inflation is attributed to the fact that all of the factors of production that determine the inflationary forces from both the supply and demand side are considered.

In the United States, the report itself is broken down into multiple aggregate groups, allowing industry dissection with greater convenience. The CPI's are available by:

Location - for the four Census regions of the US, city classifications of various sizes and classes, and down to 26 local area classifications.
Category - namely Energy, Food, and Core (Goods and Services).
Population Group - the CPI for All Urban Consumers (CPI-U) and the CPI for Urban Wage Earners (CPI-W). The CPI-U takes into account 87% of the population, including professionals, the self-employed, and the unemployed. The CPI-W at 32% converts only hourly wage earners and clerical workers.
Prices for the CPI are collected from a gamut of urban areas, stores, and service establishments and items are weighted according to expenditures on that item as reported by the Consumer Expenditure Survey. Changes in the price level, expressed in percentage terms, are weighted appropriately.

As the CPI is extremely diversified, it is difficult to see consequential movements given the "noise" created by volatile factors like energy and food prices. Keeping your attention to the "core rate" is recommended - this eliminates much noise. In the United States, the average increase in CPi is about 1 to 2%; if the increase if more dramatic than this it is a warning of plummeting purchasing power and possible inflation.


Fundamental Analysis of the CPI

The value of the CPI in fundamental analysis rest heavily on its reliability as an indicator of inflation - it is often used as a deflator to find the purchasing power of a currency. The information it provides with regard to price changes is utilized by consumers as in aid to making economics decisions, and by governments as a guide for structuring and implementing fiscal and monetary policies. In particular, national banks tend to see a rising CPI as a harbinger of high inflation, which they battle by raising short term interest rates. As such:

When prices increase and the CPI is therefore high, the purchasing power of a currency declines and there may be an increase in interest rate.

When prices decrease and the CPI is low, purchasing power increases.

Using the CPI, one can predict future interest fluctuations and the resulting changes in currency exchange rates. Changes in interest rate are a trigger for trading techniques like carry-trades. For more information, check Strategies.

When used in conjunction with a report on a nation's exports, the CPI is useful in checking on the country's position in international trade. Along with basic knowledge of the economic condition of a given country, the CPI will help in answering the question of whether the country making or losing money on its products and services:

When the CPI is high, exports are expected to be on the rise.

When the CPI drops, exports will fall and imports are expected to take the spotlight.

For example, Japan has a massively export-oriented economy. When Japan's CPI began to fall and the yen started rising, the government was in a panic trying to lower the value of the yen in order to keep its exports high. Relative economic health can be determined using these two indicators.

As a side note, it is extremely useful to keep track of a country's exports regardless; it is a highly observed indicator. Prices of exports often change relative to a currency's strength.

For more information concerning the report published in the United States, or to obtain it, visit the U.S. Department of Labor webpage. A comparable report can be downloaded from the European Central Bank, which publishes its monthly bulletin regarding the HICP (the EU’s CPI equivalent) and other economic indicators.

The CPI is released by the Bureau of Labor Statistics at 8:30 am EST on the 15th or each month, several days after the Producer Price Index’s (PPI) release.