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CPI (Consumer Price Index)


Definition

The Consumer Price Index is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Monthly changes in the CPI represent the rate of inflation.

Why do Investors Care?

The consumer price index is the most widely followed indicator of inflation in the United States. Just knowing what inflation is and how it influences the markets can put an individual investor head and shoulders above the crowd.

Inflation is a general increase in the price of goods and services. The relationship between INFLATION and INTEREST RATES is the key to understanding how data like the CPI influence the markets ( and your investments.)

If someone borrows $100 dollars from you today and promises to repay it in one year with interest, how much interest should you charge? The answer depends largely on inflation, because you know that the $100 won´t be able to buy the same amount of goods and services a year from now, as it does today. If you were in Brazil where prices can double every couple of months, you might want to charge 400% interest for a total payoff of $500 at the end of the year. In the United States, the CPI tells us that prices are rising about 2% a year, so you only have to charge 2% interest to recoup your purchasing power at the end of the year. You might want to add in a few more percentage points for default risk and the opportunity cost, but the key variable in what interest rate you charge is the rate of inflation.

That basically explains how interest rates are set on everything from your mortgage and auto loans to Treasury bonds and T-bills. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates accordingly. The effect ripples across stocks, bonds, commodities, and your portfolio, often in a dramatic fashion.

By tracking the trends in inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform





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