Consumer Price Index (CPI): Your Gateway to Understanding Inflation, Interest Rates, and Growth

What is the Consumer Price Index (CPI), and how does it impact your investments? Economic growth, inflation, and interest rates are all linked to the CPI.

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Key Takeaways

  • Understand the importance of the Consumer Price Index (CPI) and how it can impact your investments
  • CPI inflation is a good indicator of the overall economy
  • Know the relationship between interest rates and inflation

Whether you’re investing in the market or considering your next mortgage or car loan, you should know what’s up with the Consumer Price Index (CPI).

The government pulls this data together each month to help keep track of the price of goods and services purchased by consumers in the United States.

The CPI—often called the “inflation index” or “CPI inflation”—is considered a good indicator of how well the overall economy is doing because economic growth and inflation tend to go hand in hand. The good side of prices going up is that they allow businesses to make more money, which allows investors in those businesses to do the same.  

But as we’ve discovered over the past three very unusual economic years, it’s a balance—how high can prices rise before an economy turns overheated and potentially out of control?

It’s a lesson we’re learning in real time—and CPI is a gateway to understanding what’s happening in any economy.

Inflation, Black Swans, and the Fed

We’ve heard a lot of talk about Black Swans since the start of 2020. With the global spread of COVID-19 early that year to the invasion of Ukraine by Russia in late February 2021, the impact on individual wallets, companies, and governments by these unforeseen events has been dramatic, sparking and sustaining global supply chain disruptions that helped pressure prices to 40-year highs by midyear 2022 (see figure 1).  

Figure 1: CPI: A YEAR IN THE LIFE. The CPI is not the only inflation index experts watch, but it’s the broadest indicator of how prices are either expanding or shrinking purchasing power in America. And for now, that purchasing power is shrinking. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

When inflation gets too high, central banks all over the world, including the Federal Reserve, may step in with the strongest weapon they have to slow the economy—raising interest rates. When rates rise, both consumers and businesses change their behavior—generally, we buy and borrow less because doing so costs us more. As demand cools to a degree the central banks want to see, they may begin to lower rates.

And in making that decision, they’ll be watching a wide range of barometers including the CPI and many others in the pricing sphere. In fact, the Fed’s preferred inflation indicator is the personal consumption expenditures (PCE) index data as an inflation benchmark because it focuses on a slightly different pricing basket for products and services.

The Fed raised rates for the first time in three years in March 2022, and may continue to do so into 2023, as it monitors whether the economy—and prices—are cooling.

Ways to Look Deeper

What’s measured in CPI?

The U.S. Bureau of Labor Statistics creates the CPI each month by looking at 200 separate categories of spending data organized into eight major groups—food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. Included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. What’s not included? Plenty of things, including one surprising category in housing—owned homes are not measured by CPI while rentals are.

And this is where CPI becomes even more meaningful for investors and borrowers. CPI can have an impact on the value of bonds in your portfolio, as well as the interest rate on any loans you might want to take out. It’s also important to note that CPI drives the rates behind two government-issued securities—I-Bonds and TIPS. And in 2022, those rates have moved significantly higher.

CPI can also mirror other activities going on in the economy, such as hiring and its effect on wages. When businesses have to compete for workers, wages generally rise, and when consumers have more money in their pockets, spending goes up, fueling inflation. Historically, when you start to see the economy pick up after a slowdown and unemployment drops, CPI can start to rise. The conundrum the Fed and many experts faced at midyear 2022 was that unemployment was still stubbornly low. Good news for workers, but bad news for fighting inflation.

The point is that CPI is very important to watch, but far from the only data you should be learning about in a changing economy. You’ll find that watching a wide range of economic data is one of the best ways to learn how interactive the U.S. economy really is.

The thinkorswim platform is a great place to start—under the Analyze tab, you’ll find access to a wide range of weekly and monthly economic data from the Federal Reserve Bank of St. Louis, better known as the FRED® database. Here’s how to learn more.

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Key Takeaways

  • Understand the importance of the Consumer Price Index (CPI) and how it can impact your investments
  • CPI inflation is a good indicator of the overall economy
  • Know the relationship between interest rates and inflation

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