If you've been following markets for long enough, you will quickly come to find that inflation apparently has more than one answer.
One week, everyone is waiting for the CPI release. A few days later, the PPI report becomes the focus instead. Then, the PCE arrives and we are reminded that this is the inflation measure the Fed actually targets.
And so the question is, which one should traders care about? The short answer is all three, but for very different reasons.
Let's try to break it all down by imagining the journey of a cup of coffee.
To start, PPI looks further up the chain. It measures the changes in selling prices received by domestic producers. So if coffee beans, packaging or transportation become more expensive, PPI is what can give us an early look at whether price pressures are building before they reach consumers.
Meanwhile, CPI is much closer to your wallet. It tracks the prices consumers pay for a basket of items, covering food, housing, and transport among other things. In our coffee example, this is the price that you actually see on the menu.
And typically, this is where markets tend to get the most excited. That is because in practice, CPI tends to generate the sharpest immediate market reaction.
A hotter-than-expected reading can push Treasury yields and the dollar higher if traders think that the Fed may need to raise or keep interest rates higher for longer. Meanwhile, the likes of stocks and gold can come under pressure as higher yields tighten financial conditions. On the flip side, a softer reading can produce the opposite reaction.
Then, we have the PCE - which is just another measure of consumer inflation. However, it is built differently from the CPI as it adjusts more readily when people change what they buy. As an example, if coffee becomes more expensive and consumers shift to tea instead, PCE is better able to capture that shift in spending behaviour.
More importantly, the PCE is the measure that the Fed uses for its 2% long-run inflation goal.
Now, that doesn't mean that the PCE is what will always generate the biggest market move. That is because by the time it arrives, traders have already seen the CPI, PPI and other data that provide clues about inflation. So, part of the story may already be priced in.
As such, I would argue that there is a useful distinction to be observed. CPI often matters most for the immediate market reaction, while PCE matters most when thinking about the Fed's inflation framework.
But what about PPI then? Well, think of it as a supporting character that can occasionally steal the scene. A big surprise here can change inflation expectations further down the pipeline. But in a normal month, CPI and PCE tend to command more attention.
Besides that, there is one more differentiation worth knowing. And that is headline versus core inflation.
Headline inflation basically includes everything, including volatile items such as food and energy prices. Meanwhile, core inflation strips out those categories to give traders and policymakers a cleaner look at underlying price pressures. And that's precisely why policymakers pay particularly close attention to core PCE when trying to judge the underlying inflation trend.
To sum up, there is no single inflation report that always matters most.
PPI tells us what may be happening earlier in the price pipeline. CPI tells us what consumers are experiencing and often produces the biggest immediate market reaction. And PCE is what sits closest to the Fed's policy framework.
For traders, that means it isn't so much about asking whether inflation rose or fell. It is more important to think about whether the latest numbers change what markets think the Fed will do next.
This article was written by Justin Low at investinglive.com.from Investinglive RSS Breaking education Feed https://ift.tt/JQGau2R
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