Inflation is a key dynamic for investors to consider. Appreciating the nuances of inflation and where inflation is heading can help you navigate risk and enhance returns.
The first step is understanding how inflation is measured.
A variety of statistics and economic indicators help investors track and understand inflation. Familiarity with these statistics is essential to making informed investment decisions. Each indicator offers important insights into price levels and trends.
Below is an investor “cheat sheet” for the six leading inflation indicators.
Measures the overall change in prices for a representative basket of goods and services, including food and energy. Most widely used inflation index. Also known as “headline” CPI, this is the number you will hear quoted in business news each month on the morning it is released. CPI readings have been known to move financial markets. Based on 80,000 prices collected monthly.
Excludes the volatile food and energy components of the CPI to provide a more stable inflation measure.
Version of CPI selected by the US Treasury to calculate the inflation adjustment for TIPS: “non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers.”
Measures changes in wholesale prices, reflecting cost pressures for manufacturers and producers.
Measures spending on goods and services in the U.S. The PCE captures changes in prices as well as consumer behavior. A preferred inflation measure for the Federal Reserve.
Measures the average change in the prices of all goods and services produced in the U.S. Includes exports but not imports. Used by some firms to adjust contract payments.
Each of the six key inflation indicators provides insights into various aspects of the economy. Here’s how they can help investors make informed decisions:
Investors use the headline CPI to gauge overall inflation in the economy. A rapidly rising CPI might indicate economic overheating, which could influence central bank policy decisions, such as raising interest rates. Such changes can directly affect sectors like finance or real estate.
Core CPI provides a more stable measure of inflation by eliminating the noise of volatile components. It helps investors get a clearer picture of the underlying inflation trend. A persistently rising core CPI can signal sustained inflationary pressures that might not be immediately evident from the headline number.
CPI-U gives a more focused look into the consumption patterns of urban populations. Urban consumers often have different consumption patterns than rural consumers, so investors who are interested in sectors heavily influenced by urban spending might pay special attention to CPI-U.
In addition, the U.S. Treasury uses CPI-U for the inflation adjustments to TIPS securities. Fixed income investors track CPI-U to better understand the dynamics in the Treasury and TIPS markets.
PPI is a leading indicator of cost pressures. If producers are facing rising costs, they might pass these on to consumers, leading to CPI increases down the road. Investors might use PPI to anticipate future inflationary pressures.
PCE is preferred by some economists and the Federal Reserve as a measure of inflation. It encompasses a broader range of expenses and adjusts more dynamically to changes in consumer behavior. PCE also offers longer-term consistency in its calculation methodology and thus facilitates historical comparisons more readily than other inflation measures. High PCE growth can suggest strong consumer demand, which might be good for consumer-driven businesses.
The GDP deflator gives an overview of inflation across the entire economy, including investment goods, government spending and exports, rather than just consumer goods. A rising GDP deflator can signal broad inflationary pressures and might affect investment decisions across various sectors, not just consumer-driven ones.
The “Big Six” inflation indicators provide various lenses to assess inflationary pressures in the economy and financial markets. Investors use this information to anticipate policy changes, evaluate sector prospects, and adjust portfolios in anticipation of future economic conditions. Understanding inflation can make for better portfolio performance.
Investors have rediscovered inflation-sensitive investments as a key allocation for their portfolios. Want to learn more about hedging against and benefiting from inflation?
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