Whether you’re invested in bonds or considering a car loan, you should know what’s up with the consumer price index (CPI). The government puts together this data to help keep track of the price of goods and services purchased by consumers in the U.S.
The CPI is considered a good indicator of how well the overall economy is doing because economic growth and inflation tend to go hand in hand. Plus, higher inflation tends to lead central banks to try to keep the economy from overheating by raising interest rates, which impacts the value of bonds as well as loans you might want to take out.
“As an investor, you want to keep track of levels of inflation,” said Shawn Cruz, senior market structure specialist with TD Ameritrade’s active trader group.
Historically, when you start to see the economy pick up and unemployment drop, you may expect to see CPI inflation rise. Essentially, when buyers of certain goods and services are more aggressive than sellers, prices can trend higher. That’s price inflation in a nutshell.
Some members of the Fed use personal consumption expenditures (PCE) index data as an inflation benchmark, but the CPI gets more press in part because it is so widely used within the government. “It’s the benchmark for Social Security payments,” Cruz said. “The two data sets differ in how they are calculated and what’s included in their baskets of goods and services.”
Also, there are a lot of financial contracts—such as Treasury Inflation-Protected Securities—that are tied to CPI levels, he noted.
So What’s Going On with CPI?
In the 12 months through July, the CPI has gained 1.7%, according to the Bureau of Labor Statistics.
That’s shy of the central bank’s target of 2%. (Although the Fed’s target is related to the PCE, both the PCE and CPI tend to track closely together, Cruz noted.)
It can be troubling when inflation undershoots the Fed target, Cruz said, because it brings up worries about deflation. The dreaded d-word happens when inflation rates are negative, or, more simply put, when prices fall. That’s not something to celebrate because a deflationary period can be marked by falling gross domestic product.
“Deflation can really wreak havoc on an economy,” Cruz said.
This could leave the Fed in a bit of a bind.
On the one hand, some say the Fed should raise interest rates more because we are far into an expansionary economy that could be due for a pullback, and the central bank needs to have more room to loosen monetary policy if that happens.
On the other hand, some say if the Fed tightens too much or too soon, that could send the economy into recession.
Low Inflation and the Markets
If inflation stays low, that might lower the likelihood that the Fed would raise rates, Cruz says.
That could bode well for bonds. Because bond prices fall as interest rates rise, accommodative Fed policy would put less downward pressure on their prices.
Some argue that the low interest rate environment has been a boon to asset prices, including stocks, over the last several years. But when prices aren’t rising, companies might have a harder time growing their top-line revenues.
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