Exploring U.S. CPI and Its Effect on Stocks

The original title: What is the U.S. CPI? How the Consumer Price Index affects the stock market, composition and calculation, core CPI differences.. Complete analysis

The U.S. Federal Reserve (Fed) released a higher-than-expected consumer price index (CPI) this week, causing a general decline in the venture capital market and weakening expectations for the Fed to cut interest rates. This article explains to readers in detail what CPI is, its composition and calculation, and what impact it will have on inflation and the stock market?

Contents of this article

1. What is CPI?
2. What is the calculation formula for CPI?
3. What is the annual increase rate of CPI?
4. Latest Changes in US CPI Weights
5. A closer look at U.S. consumer prices
6. What is Core CPI?
7. The impact of CPI on the stock market?

The U.S. Department of Labor announced the latest CPI (Consumer Price Index) data late on the 10th of this week, showing that the annual increase in the U.S. CPI in March (year-on-year last year) climbed to 3.5%, higher than the expected 3.4%.

After excluding the highly volatile food and energy prices, the core consumer price index in the United States in March increased by 3.8% annually, also higher than the expected 3.7%. This shows that inflation did not fall in March, deepening the expectation that the Federal Reserve may keep interest rates high for a longer time.

US CPI (Consumer Price Index) Data

But have you ever wondered, besides judging whether it’s high or low from the data, what exactly makes up the CPI? How is it calculated, what impact does it have on the stock market, and what’s the difference with core CPI? The following article will help you understand it all.

What is CPI?

CPI, or the Consumer Price Index, is a commonly used indicator to measure the price level of a country. The CPI is usually published regularly by the government or government-authorized agencies. It calculates the percentage change in the cost needed for consumers to purchase a certain number of representative goods and services by surveying their prices.

For example: if you bought a cup of coffee for 30 yuan last year, but today the price has been adjusted to 35 yuan, the CPI is calculating this kind of change.

Typically, the CPI is calculated based on the average price over a certain period of time, whether it’s a month, a quarter, or a year. As one of the important indicators for evaluating the inflation rate of an economy, the CPI is especially under scrutiny when it hits a new high in the United States.

What is the CPI calculation formula?

The simple calculation formula for CPI is as follows:

CPI = (Sum of the prices of goods and services at the current time ÷ Sum of the prices of goods and services at the base period) × 100

Here, the base period is the point of time used for comparison, usually set at 100. The result of the CPI represents the percentage change in the price of goods and services at the current time compared to the base period.

Specifically, the calculation process of the CPI involves choosing a basket of representative goods and services, covering the prices of food, housing, transportation, health care, education, entertainment, and other goods and services, and calculating them according to their respective weights. The formula and method of CPI may vary in different countries or regions, but the basic principle is similar.

What is the annual increase rate of CPI?

As the name implies, the annual increase rate of CPI refers to whether the current data has risen or fallen compared to the CPI 12 months ago, therefore serving as a measure of price changes. The calculation method is: (this year’s CPI - last year’s CPI) / last year’s CPI.

Latest Changes in U.S. CPI Weights

The U.S. Department of Labor announced at the beginning of 2023 that from January of that year, the rules for calculating CPI weights underwent a major adjustment (originally, CPI weights were updated every two years, but now they will be updated every year). The changes to the U.S. CPI weights in 2023 are as follows:

Housing: 44.38% (+2%)

Entertainment: 5.38% (+0.3%)

Food: 14.37% (+0.1%)

Apparel: 2.47% (unchanged)

Other goods and services: 2.67% (-0.1%)

Medical care: 8.1% (-0.4%)

Education and communication: 5.84% (-0.6%)

Transportation: 16.74% (-1.4%)

Generally speaking, focusing solely on the CPI index itself is not very meaningful. What needs to be noted is the annual increase rate of the CPI, which is also seen as the inflation rate and serves as an important reference for the government.

A closer look at U.S. consumer prices

According to data from M Square Finance, one can find from the breakdown of the Consumer Price Index that housing, transportation, and healthcare indices are still the biggest contributors to monthly price growth, and the energy index also surged from -1.74% in February to 2.13% in March.

The most significant declines are in new and used car sales, as well as slight decreases in leisure entertainment and education indices. But overall, there has not been much progress in inflation easing in March 2024.

What is Core CPI?

Readers will often see another index called the Core CPI (Consumer Price Index). This refers to the Consumer Price Index obtained by excluding the more volatile energy and food prices.

The reason for this design is because the price fluctuations of food and energy are usually easily affected by seasonal factors or sudden events (such as war). Therefore, in order to more accurately observe actual price changes, the Core CPI is often used as a priority reference indicator by most national governments.。

The Impact of CPI on the Stock Market

The CPI index is an economic indicator that the market pays great attention to, especially as the Federal Reserve (Fed) is currently committed to combating high inflation. If the CPI can continue to decline, it indicates that the Fed’s deflationary policy is effective, and prices continue to decline.

Conversely, if the CPI index remains high, it indicates that the Fed may need to further tighten monetary policy. If they choose to further raise interest rates, funds may quickly flow out of the risk investment market, which is usually unfavorable for cryptocurrencies and the stock market.

Generally, when the CPI index rises, the market usually expects future inflation to rise, which may have a negative impact on the stock market.

Because inflation can lead to a decline in consumer purchasing power and an increase in corporate costs, which may reduce consumption and investment, slow economic growth, and thus affect the stock market. In addition, a high inflation rate may cause central banks to take interest rate hikes to curb inflation, which may lead to an increase in interest rates, making the stock market relatively unfavorable.

On the contrary, when the CPI index declines, the market may have positive expectations for future economic growth and interest rate trends, thereby having a positive impact on the stock market. Because deflation may cause the central bank to take measures to relax monetary policy, thereby lowering interest rates, promoting consumption and investment, and benefiting the stock market.

However, changes in the CPI index are not the only factors affecting the market. Prices will be affected by factors such as corporate performance, government policy, geopolitical risks, etc. Therefore, investors need to consider various factors comprehensively to formulate investment strategies.

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