There are two inflationary measures in our economy, the Consumer Price Index (CPI) and the Producer Price Index (PPI). CPI is a measure of the total value of goods and services consumers have bought over a specified period, while PPI is a measure of inflation from the perspective of producers.
The change in the price of goods affects every consumer, whether you are purchasing common goods such as milk and eggs or buying a big-ticket item that is highly sensitive to interest rates. Therefore, inflation-related data is one of the few releases that directly applies to the daily cost of living, unlike many other economic indicators such as Purchasing Managers Index (PMI), confidence surveys, and even Gross Domestic Product (GDP).
Both PPI and CPI are considered key data releases, meaning the monthly indicator is heavily scrutinized by traders, since they are used by the Federal Reserve to assess developments in the economy.
The Federal Reserve is a dual-mandated central bank, which means it is under considerable pressure to strike a balance between inflation and the jobs market. As a result, any unexpected fluctuations in leading economic indicators are often referenced by members of the Fed during speeches or public events in order to manage market expectations.
Since PPI measures the costs of producing consumer goods, and commodity and food prices directly affect retail pricing, PPI is seen as a good pre-indicator of inflationary pressures.
Despite being a complex report, traders can prepare for the release in several ways. By using information from various confidence and PMI reports, you can gauge price developments faced by consumer and producers alike over the past month.
Monitoring energy prices and the general commodity outlook via the Retail Sales Report, which is considered to be another vital pre-inflationary indicator, can also help to correctly position traders ahead of the release. If there are large swings in commodity prices, the market will most likely focus on the PPI core reading as the most reliable statistic.
As a general rule, the Federal Open Market Committee (FOMC) implements monetary policy to help maintain inflation rates of somewhere around 2% over the medium term. If the PPI or CPI numbers remain above this level, the Fed can deem it to be threatening to the economy. This could lead the FOMC to increase interest rates in order to rein in rising prices. On the other hand, an extended period of low or negative inflation means the central bank would consider actions that would stimulate the economy such as cutting interest rates or embarking on Quantitative Easing (QE).
There are a number of factors to think about when trading CPI and PPI, but with thorough preparation and a little insight, this release it is an event that offers numerous opportunities for traders.