In this article, we will briefly explain the concept behind the Consumer Price Index (CPI) and how it affects the USD and the Forex market. More emphasis will be laid on data obtained from the US Bureau of Labour Statistics (BLS). This is simply because the United States dollar is the most traded Forex currency.
Understanding how to read and interpret the Consumer Price Index data can be a leverage for Forex traders. This is because it acts as an indicator that tells the US Federal Reserve System when to adjust money policies to complement inflationary factors.
What Is the Consumer Price Index?
The CPI in technical terms is the weighted average price for a basket of certain products and services used by Americans or people of certain locations. It gives comparative insight into the purchasing power of a currency. That is what quantity of product a dollar can presently buy, compared to how much it could have bought in the previous month, quarter, or year. Depending on the time frame factored into the calculation.
Then in layman’s terms, the Consumer Price Index is a means to discover the average amounts spent on certain goods and services for a set period. It is directly proportional to the inflation rate of the specified region.
For example, Americans spending more dollars on certain products when compared to the amount spent in the previous month only signifies that there has been more money in circulation, a weakening in the currency, and hence less demand for the USD.
How Is the Consumer Price Index Carried Out?
The United States CPI data–for the previous month–is gathered and released on the second or third week of every month by the Bureau of Labour Statistics (BLS). It is derived from all consumers living in urban or metropolitan areas, as this group makes up 90% of the American population. Price data from people living in rural areas is not included.
Also, the CPI data obtained from the urban areas are of two types, namely:
- the CPI-U, which is the Consumer Price Index for all urban consumers,
- and the CPI-W, which is the Consumer Price Index for urban wage earners and clerical workers
The CPI-U is from all consumers living in urban areas, while the CPI-W is from households or individuals in which more than half of their income comes from the government. This particular CPI-W data–which is a subset of the CPI-U–is the basis on which adjustments are made to social security payments, pensions, and other government benefits.
Furthermore, the CPI data is generally collected on specific utilities.
They include the prices of food, clothing, shelter, fuels, transportation, medical services, and other commodities that people buy for day-to-day living. These prices are collected every month in 75 urban areas across the country from about 6,000 housing units and approximately 22,000 retail establishments. (Note that on-purchase taxes are included).
Also, the BLS economists calculate and present this data in two formats.
- The Non-Seasonally Adjusted CPI
- and the Seasonally Adjusted CPI.
The Seasonally Adjusted CPI accounts for the spike or retardation in sales that happen during weather seasons like summer and winter, or festive seasons like Christmas, Easter, and Halloween. The BLS economists do this adjustment using a tool known as the X-13ARIMA-SEATS seasonal adjustment software. Also, these economists factor the changes in the quality and quantity of those selected utilities into their calculations.
This is just a run-through of how the CPI is carried out. For more specific details, you can visit the US Bureau of Labour Statistics website.
How Does the Consumer Price Index Affect the Forex Market?
The CPI affects the Forex market by fluctuating the prices of currency pairs. As said before, the CPI is a function of the inflation rate of a country.
The higher the Consumer Price Index, the higher the inflation of prices and the less valuable a currency becomes. Monetary policies set by Central Banks also impact currency prices. These policies involve the adjustment of interest rates. They are set in an attempt to protect the economy of the country.
Normally, the United States Federal Reserve Bank System has an annual inflation rate target of 2 to 3%. So, the moment the CPI shows an inflation rate significantly exceeding this level, they tend to increase their interest rates. This rise in interest rate causes a slight scarcity of the dollar.
That is, people will tend to keep their money in the banks to gain more interest. Scarcity means increased demand, and hence a stronger dollar. The reverse becomes the case when the CPI goes below the Fed’s target level. So, Forex traders who pay keen attention to CPI news releases would notice any of these changes and set their trading strategies accordingly.
Besides the alteration of interest rates by the Fed, there are fundamental Forex traders who trade CPI news using the Purchasing Power Parity theory (PPP). The PPP entails that the prices of currency pairs will change depending on the inflation rates of the individual currencies involved. Meaning that all things being normal, a currency with a lower inflation rate will be more valuable than the one with a higher rate.
Important note
The change in CPI is one of the most trusted measures of currency value. But it doesn’t always mean that the price of currencies will respond to its fluctuations. This is because many other factors affect the exchange rate of a currency.
How Does the Consumer Price Index Affect The USD?
To know the effect of the CPI on the USD, we studied two years’ worth of CPI data. We observed the effect on the forex market.
We analyzed the USD/CAD pair as it reacts well to US news releases. During this period of backtesting, we noticed various effects the CPI had on the USD pairs.
We will now present this data we obtained directly from the forex charts in hopes that it can assist you as you plan to trade the CPI.
Firstly, forex traders actively anticipate the CPI news. This is evident in the forex market as we saw a huge increase in the size and momentum of the candles 100% of the time the CPI news was released.
This is not surprising as the CPI news can cause the Federal Reserve System to actively try to influence the price of the currency.
Next, we notice that when the CPI was released, the forex market moved in the direction of the news 75% of the time. That is, a high CPI will cause the US Federal Reserve Bank to try to reduce the price of commodities using interest rates, hence increasing the value of the USD.
Following this theory, traders should expect an increase in the price of the USD for a high CPI. This means they will buy the USD against other pairs. This happened 75% of the time in the case of USD/CAD. Other times when this was not the scenario was when the CPI was neutral. That is the forecast was equal to the actual value.
The CPI always caused spikes in the USD pairs and had an average pip movement of 74.006 pips. In most cases, the CPI moved in support of technical analysis, continuing impulse movements, and starting new trends.
How to Read The CPI?
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Among various financial and economic experts, the CPI is regarded as one of the most accurate means of measuring a country’s inflation and hence its currency strength. It helps a trader to fairly predict when the Fed will alter the interest rate on the dollar. So here are some of the steps you should take in reading the CPI news. You can also add it to your trading plan as a Forex trader.
Get the presently released Consumer Price Index data
This is quite easy. The CPI is normally measured in a currency’s unit. It can be obtained from trusted websites like forexfactory.com or directly from the BLS website. For example, according to ycharts.com, the current CPI of the United States–as of the writing of this article–is 308.85 dollars. (i.e. for December 2023).Compare the actual CPI to the previous value and its Forecast
After you have gotten the current index, the next step is to compare the change in percentages of actual CPI, the previous one, and the value forecasted by Forex news outlets. This is necessary because some of those news outlets’ predictions may be less than the actual CPI.Let’s assume the change in CPI between November and October was 0.3% and Forex news outlets predicted the change for December (from November) to be 0.41%. But the actual value was 0.52%. This could be regarded as a signal that the Feds would raise the interest rate. Therefore, traders should learn the difference between values released predicted by Forex news outlets and values previously released by the BLS.Compare the current change in CPI with the Central Bank’s target inflation rate
For example, the United States’ target inflation rate is 2 to 3%. So, once you do your calculations and discover that the current inflation rate significantly deviates from this value, you should expect the Feds to alter the interest rates. Here is a formula for calculating inflation:Inflation = [ (New CPI – Previous CPI) ÷ (Previous CPI)] × 100
Tools
- A Laptop or a PC
Materials
- Bureau of Labor Statistics
What Does A High CPI Mean?
A high Consumer Price Index simply means that more dollar was spent to purchase an average basket of goods and services when compared to the amount previously spent. This, in turn, signifies a rise in inflation, more dollars in circulation, and less demand for the currency. And therefore, an expected decrease in the value of the USD against other currencies.
What Is the CPI Formula?
As said before, CPI is technically defined as the price of a weighted average market basket of consumer goods and services purchased by households. It is calculated using three variables.
- The total of select prices of goods and services for the previous period (month, quarter, or year)—CPI(p).
- The total of select prices of goods and services for the current period—CPI(c)
- A 1984 indexed value of 100
Thus, the formula becomes:
(CPI(c) ÷ CPI(p)) × 100
For example, the total prices for some goods and services for the years 2022 and 2023 were found to be 756 and 795 dollars respectively, what will be the CPI for the year 2023?
Using the formula above this would be:
(795/756) × 100 = 105.16
This is the basic method/formula for calculating CPI. Another formula is the percentage change method. It is the same as the inflation formula stated above.
How To Get The Consumer Price Index News Very Fast
The CPI news can be quickly gotten from the official website of the labor department of the respective country. Here are some of those websites with their respective jurisdiction indicated.
- BLS: the official website of the United States BLS releases CPI data by 8:30 am (ET) monthly.
- ISTAT Italy: Italy’s ISTAT releases data monthly.
- European Central Bank: the European Central Bank releases data every two months.
- Statistics Bureau of Japan: the Statistics Bureau of Japan releases data monthly.
- German Federal Statistics Office: the German Federal Statistical Office is known to release CPI news yearly.
- Nigerian National Bureau of Statistics: the Nigerian National Bureau of Statistics releases CPI news monthly.
Frequently Asked Questions About the CPI
Is the CPI A High-Impact Forex News?
Yes, the Consumer Price Index is a high-impact Forex news as the survey is carried out by the US Bureau of Labour Statistics and watched by the US Fed.
Can the CPI Cause Spikes in The Market?
Yes, the CPI can cause spikes in the Foreign exchange market. The release and revision of this news can cause high volatility of currency prices, which in turn creates opportunities for skilled traders to benefit from.
Which Currency Pairs Are Affected by The CPI?
All currency pairs with frequently released CPI data are affected by the Consumer Price Index news. This is because the CPI determines the inflation rate of a set currency, and hence the price movements of the concerned currency pairs. For example, a rise in the CPI of the US may signify a potential fall in the price of the USD/YEN currency pair, and vice versa.
Conclusion
The main purpose of this article is to show Forex traders how the United States’ CPI data release affects the USD, and the Forex market as a whole. However, we couldn’t have done this without introducing the basic idea of the Consumer Price Index. Then we explained how the US Bureau of Labour Statistics carries it out.
It is also important to note that the USD is the most traded currency and it forms the basis for what we call major currency pairs. This is why more emphasis was laid on the BLS’ Consumer Price Index data.
References
US Federal Reserve System – Defined by wikipedia.com
The US Bureau of Labour Statistics website – US Bureau of Labor Statistics
Inflation rate – How it can be controlled by investopedia.com
Interest rate – As explained by economictimes.com
Fundamental forex traders – Fundamental analysis explained by babypips.com
Purchasing Power Parity Theory – Explained by investopedia.com
Proof that the CPI news is corrected – Revision
Major currency pairs – Definition of major currency pairs by investopedia.com