The Consumer Price Index “is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services,” according to the Bureau of Labor Statistics (BLS), which issues the monthly report. In this article, you will learn about how the CPI is put together, the different types of CPIs and the part it plays in investing trends and monetary policy.
What Is The Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a measure of the average fluctuation over time in the prices paid by urban consumers for a market basket of what consumers typically buy and use, such as food and beverages, housing, clothing, transportation, medical care and entertainment, and the sales and excise taxes consumers pay. The CPI does not include income or Social Security taxes. Nor does the CPI report investments, such as stocks, bonds, real estate and life insurance because those items are not day-to-day consumption expenses.
Because of the ways the CPI data on those items is applied, it affects nearly all Americans.
The CPI has three major uses, according to BLS. They are as an:
- Economic indicator, which measures inflation and acts as a scorecard of the effectiveness of the government’s fiscal policy.
- Deflator of other economic series. “The purchasing power of the consumer’s dollar measures the change in the value to the consumer of goods and services that a dollar will buy at different dates. In other words, as prices increase, the purchasing power of the consumer’s dollar declines,” noted the BLS.
- Means of adjusting dollar values for a host of social service programs and workers, such as those for Social Security, government assistance, federally mandated cost-of-living increases, private sector wage and salary increases, poverty measures, consumer and commercial rent escalations and the school lunch program for some 26.5 million children.
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How The CPI Is Measured And Calculated
The BLS describes the CPI as a “measure of the average change over time in the prices paid by consumers for a representative basket of consumer goods and services.” It also publishes other economic indexes, broken down by region, population and goods, but the one most widely quoted and consequential is the CPI-U, usually called simply the CPI, which covers the purchases of urban consumers and reports each month. A second large survey is the CPI-W, which is a monthly accounting of the average change in the prices that urban wages earners and clerical workers pay for a market basket of consumer goods and services.
To measure data, the BLS continuously collects information to come up with the CPI and other indexes. Its data collectors go in person or work through the Web and with apps to contact thousands of retail stores, service establishments, rental units and doctors’ offices, all over the country to compile information about prices on thousands of items used to track and measure price changes in the CPI; it also records prices of some 80,000 items each month representing a “scientifically selected sample of the prices paid by consumers for goods and services purchased.”
Components Of The CPI Basket
The list of items and services in the CPI basket include the following.
- Food and Beverages: grocery shopping, dining out
- Housing: rent, lodging away from home and tenants’ and household insurance
- Transportation: car, maintenance, insurance; public transportation; airline tickets
- Medical Care: visits to medical professionals, hospitalization, prescription drugs, medical equipment, rehabilitation
- Education and Communication: childcare, daycare, school tuition and fees, from preschool to graduate level, including technical and business school
- Recreation: sporting events, concerts, movies, theater, pet ownership and pet care
Types Of CPI
The indexes from BLS have many breakdowns. To better evaluate costs, the BLS presents the CPIs in two ways. They are:
Headline CPI
It “represents all goods and services in the report; in other words, ‘the whole shebang,’ ” wrote Britannica Money. “It represents the average inflation rate across the entire economy.”
Core
CPI
It “strips out food and energy prices. Why? Food and energy prices tend to be more volatile than other products in the CPI mix,” noted Britannica Money. Weather, international prices and geopolitics impact those two product categories. Even some economists at the Federal Reserve choose to leave them out of the equation to come up with a more constituent view on price inflation.
Regional And Sector-Specific CPI
BLS publishes a family of price indexes covering regions and specific industries, which include the four Census regions, nine Census divisions, two sizes of city classes, eight cross-classifications of regions and size-classes and for 23 local areas as well as those for the major groups of consumer expenditures, such as food and beverages, housing, apparel, transportation, medical care, recreation, education and communications, and other goods and services for items within each group, and for special categories, such as services. By studying sectors, too, the BLS is able to make educated guesses about the economic state of industries.
It also collects prices for goods and services in 75 urban areas and from about 23,000 retail and service establishments and data on rents from some 50,000 landlords or tenants
Why The CPI Matters
The CPI has wide-ranging implications for hundreds of millions Americans and the government, including Congress, the White House and the nation’s central bank the Federal Reserve, as well as for Wall Street and investors.
The CPI is used to help adjust income eligibility for levels of government assistance, federal tax brackets, federally mandated cost-of-living increases, private sector wage and salary increase, poverty measures and consumer and commercial rent escalations. “CPI indexes are used to adjust income eligibility levels for government assistance, federal tax brackets, federally mandated cost-of-living increases, private sector wage and salary increases, poverty measures, and consumer and commercial rent escalations,” according to the BLS.
How CPI Impacts Investing
According to Cooke Wealth Management LLC, because the CPI gauges inflationary trends, “it can lead investors to anticipate higher consumer goods and services prices in the future. This expectation can lead to adjustments in investment portfolios, potentially reducing stock market prices due to anticipated reduced purchasing power and demand.”
Dan Raju, CEO of the brokerage platform Tradier, told me that the recent Fed rate cut coupled with CPI movements have led to market volatility and posed a surprise for his traders, who didn’t expect an interest rate cut until the inflation rate hit 2%, as suggested by the Fed. “Lower interest rates typically encourage borrowing and spending, which can lead to increased market activity, but also heightened risk. For our clients, this means a potential for higher returns, but with amplified volatility,” he added.
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How Inflation Affects Different Asset Classes
The ups and downs of inflation impact the various asset classes differently.
Stocks
“When the CPI rises and inflation concerns increase, capital often shifts from bonds to stocks or other inflation-resistant assets, such as energy infrastructure, commodities and real estate,” Jon DuPau, managing director at SuperDex, told me.
Bonds
“Bonds have an inverse relationship with interest rates, and companies who utilize lending or discretionary spending may experience some uncertainties. Investors reassess the growth potential of companies under inflationary pressure. With CPI considerations, investors may seek safer, more conservative assets as a hedge,” John Jones, investor advisor representative, at Heritage Financial, told me. Bonds can provide that hedge.
Real Estate
During the early years of the Biden-Harris administration, both the CPI and PPI (Producer Price Index) statistics reported monthly by the U.S. Government were running at nearly 30-year highs,” Adam Ferrari, CEO of Phoenix Capital Group, noted.
He added that, “This erosion of value has resulted in elevated home prices, stock market valuations and hard assets like gold and other industrial metals also reaching higher levels. Overall, elevated CPI levels in the U.S. economy has caused investors to seek reprieve in hard assets like real estate, gold or even oil and gas properties.”
Commodities
“Retreating prices for some commodities are contributing to lower inflation today,” according to U.S. Bank Wealth Management. Rob Haworth, the bank’s senior investment strategy director noted that although food and energy prices rebounded in early 2024 and were “raising inflation risks,” prices later in the year leveled off a downturn in the inflation rate.
Historical CPI Trends and Market Performance
“The Consumer Price Index in the United States averaged 124.59 points from 1950 until 2024, reaching an all-time high of 314.80 points in August of 2024 and a record low of 23.50 points in February of 1950.” according to the tradingeconomics.com from data reported by the BLS.
“Investors must carefully analyze CPI reports, considering that government-released numbers are often revised later, potentially creating credibility issues,” Chris Hite, regulatory compliance manager at Nurp LLC, the software company that develops algorithmic software for Forex trading, told me.“A nuanced approach is key. Looking beyond headlines to understand core trends is vital. Some assets, like commodities, real estate and inflation-protected securities, can hedge against inflation. However, high inflation and sticky interest rate hikes can negatively impact stocks and bonds.”
Limitations Of CPI As An Inflation Measure
The CPI is meant to paint the economic picture in broad strokes, so by its very nature, it doesn’t address individual variations. In a post, the economic site Quickonomics addressed what it views as the CPI’s four limitations.
They are:
- The substitution bias, which means that when consumers switch to cheaper products or services when prices go up on ones they’ve been using, the CPI doesn’t thoroughly account for that
- The representation of novelty, new products, while popular, may take years to be added to the CPI lists
- The effects of quality changes, which means it is challenging for the CPI to factor in when a quality of a product changes
- The possible lack of individual relevance, which means that not all individuals may experience inflation during a high-inflation period because they don’t normally purchase those items or services. For example, a city dweller who doesn’t own a car, won’t relate to the upkeep of an automobile or the cost of fuel.
The Role Of CPI In Monetary Policy
The Federal Reserve Board has long looked for trends in the CPI to help to formulate fiscal and monetary policy and gauge inflation. However, in January 2012, the Fed’s Federal Open Market Committee (FOMC) adopted PCE [personal consumption expenditures price index] as its primary measure of inflation over CPI.”
James Bullard, former president of the St. Louis Fed, wrote in 2013 that the PCE, issued by the Bureau of Economic Analysis, is a better way to gauge the prices that consumers face and determine inflation rates than the CPI.
Understanding CPI Reports And Market Reactions
Market reactions mean that investors can get spooked by the unexpected, or even the expected, which can be a number of events, including the CPI report. Most recently, in August 2024 when the latest report came out, stocks were “briefly plunging as much as 743.89 points, before ending with its biggest intraday comeback in almost two years,” according to MarketWatch. Other times, the CPI has virtually no impact on the market.
Bottom Line
When you hear the results of the monthly CPI, you’re getting a short-hand version of what’s happening in the economy and what the average person is dealing with financially. Of course, the CPI doesn’t present a nuanced picture, but it can suggest to you and the U.S. government when prices are static, falling or rising and where to make adjustments.
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