The Federal Reserve (Fed) of the United States announced this week an unexpectedly high Consumer Price Index (CPI), causing a general decline in the risk investment market and weakening expectations of a Fed interest rate cut. This article provides detailed explanations of what CPI is, its composition and calculation, and its impact on inflation and the stock market.
Table of Contents:
What is CPI?
How is CPI calculated?
What is the annual growth rate of CPI?
Changes in the weightings of US CPI
In-depth analysis of US consumer prices
What is Core CPI?
The impact of CPI on the stock market
The US Department of Labor released the latest CPI data this week, showing that the year-on-year growth rate of CPI in March reached 3.5%, higher than the expected 3.4%.
After excluding volatile food and energy prices, the year-on-year growth rate of the core Consumer Price Index in the US increased to 3.8%, also higher than the expected 3.7%. This indicates that inflation did not decline in March, deepening expectations that the Federal Reserve will maintain high interest rates for a longer period.
However, have you ever wondered how CPI is composed, calculated, and its impact on the stock market, asides from judging whether it is higher or lower than expected based on the data? The following text will provide a complete clarification.
CPI refers to the Consumer Price Index, which is a commonly used indicator to measure the price level of a country. CPI is usually published regularly by the government or authorized institutions. It calculates the percentage change in the cost of purchasing representative goods and services by surveying their prices.
CPI is usually calculated based on average prices over a certain period of time, such as a month, a quarter, or a year. As CPI is one of the important indicators to evaluate the inflation rate of an economy, it has attracted particular attention during the current period of high inflation, especially in the United States.
The simple calculation formula for CPI is as follows:
Where the base period is the reference point, which is usually set at 100. The result of CPI represents the percentage change in the prices of goods and services at the current time compared to the base period.
Specifically, the calculation of CPI requires the selection of a basket of representative goods and services, covering prices of consumer goods and services such as food, housing, transportation, healthcare, education, and entertainment, and calculates them with their respective weightings. The formula and methods of CPI may vary in different countries or regions, but the basic principles are similar.
As the name suggests, the annual growth rate of CPI refers to whether the current data is higher or lower than the CPI from 12 months ago, thereby measuring changes in prices. The calculation method is: (Current year’s CPI – Previous year’s CPI) / Previous year’s CPI.
Since the beginning of 2023, the US Department of Labor has announced significant adjustments to the weighting calculation rules of CPI (originally updated every two years, but now updated annually). The changes in the weightings of US CPI in 2023 are as follows:
Housing: 44.38% (+2%)
Entertainment: 5.38% (+0.3%)
Food: 14.37% (+0.1%)
Clothing: 2.47% (unchanged)
Other goods and services: 2.67% (-0.1%)
Medical: 8.1% (-0.4%)
Education and communication: 5.84% (-0.6%)
Transportation: 16.74% (-1.4%)
In general, focusing solely on the index of CPI itself is not significant. What needs attention is the annual growth rate of CPI, which is also considered as the inflation rate and an important reference for the government.
According to Financial M Square’s data, it can be observed from the detailed breakdown of the Consumer Price Index that housing, transportation, and healthcare indices continue to contribute the most to monthly price increases, and the energy index increased from -1.74% in February to 2.13% in March.
On the other hand, new and used car sales, as well as leisure and entertainment and education indices, have shown slight declines. However, overall, there has not been much progress in inflation falling in March 2024.
Readers usually also come across another index called Core CPI. It refers to the Consumer Price Index obtained by excluding the prices of volatile energy and food items.
The reason for designing it this way is that the prices of food and energy are usually more easily influenced by seasonal factors or unexpected events (such as wars). Therefore, in order to observe the actual changes in prices more accurately, the Core CPI is often used as a priority reference indicator by governments in most countries.
CPI index is one of the economically important indicators that the market pays great attention to, especially in the current context of the Federal Reserve’s efforts to combat high inflation. If CPI continues to decline, it means that the Fed’s tightening monetary policy is effective and prices are continuously decreasing.
On the contrary, if the CPI index remains high, it means that the Fed may need to further tighten its monetary policy. If it chooses to raise interest rates further, funds may quickly flow out of the risk investment market, which is usually not welcomed by cryptocurrencies and the stock market.
However, changes in the CPI index are not the only factors affecting the market. Prices are influenced by factors such as corporate performance, government policies, geopolitical risks, etc. Therefore, investors need to consider various factors comprehensively in order to formulate investment strategies.
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