Finance 101: What Is The CPI And Why Does It Matter?
CPI is a measure of inflation that informs the Fed's decisions on interest rates, and can therefore impact the financial markets.
Anyone who has spent any time trading crypto or other financial assets will likely be familiar with the importance of CPI data. So what is CPI, and why do traders watch it so closely?
CPI: A Key Inflation Measure
CPI stands for the Consumer Price Index. It is a measure that tracks changes in the average prices of goods and services purchased by households over time. The CPI is commonly used as an indicator of inflation and provides insight into the purchasing power of consumers.
The calculation of the CPI involves collecting price data for a basket of goods and services that represents typical consumer spending patterns. This basket includes various categories such as food, housing, transportation, clothing, healthcare, and more. The prices of these items are tracked over time, and the changes in prices are reflected in the CPI.
The CPI is often reported as an index number relative to a base period. For example, if the CPI for a particular year is 120, it means that, on average, prices have increased by 20% compared to the base period.
Why Is CPI Important?
CPI data is published monthly by the Bureau of Labor Statistics in the US, and is closely watched, because it helps policymakers, economists, and individuals understand the rate of inflation and make adjustments to economic policies, wages, and budgets accordingly.
In the trading sphere, CPI is used as an early indication of potential interest rate changes. A high CPI reading means inflation is "running hot", so the central bank may increase interest rates to help bring it down.
Raising interest rates is central banks' main tool for combating inflation. By making it more expensive to borrow money, and more attractive to save, it can reduce overall spending and therefore demand for goods and services.
High interest rates also mean that traders can get a better return by investing in bonds or money market funds, and are less likely to buy riskier assets like stocks or crypto. Raising interest rates therefore contributes to a "risk off" environment that —all things being equal—pushes down the value of these assets.
In short, high inflation (CPI) signals the likelihood of more interest rate rises, which is a headwind to crypto price appreciation. The monthly CPI "print" has therefore become an important event for crypto traders.
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