For the past 16 months, the inflation headline has dominated economic news and become the most widely discussed topic in financial circles. Wall Street analysts and investors alike have been closely monitoring each inflation report, trying to decipher what it means for the economy and financial markets. As the Federal Reserve grapples with rising inflation and its impact on interest rates, the eyes of the financial world are fixed on how this will shape the future of the economy.
Inflation is a persistent increase in the general price level of goods and services in an economy over time. It is a crucial economic indicator that policymakers and investors monitor closely. Put simply, inflation means that the same amount of money will buy fewer goods and services than before. Understanding inflation and its different measures is crucial for investors to make informed investment decisions, particularly in fixed-income securities like bonds.
Key Inflation Indicators
The key measures of inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the Personal Consumption Expenditures (PCE) price index.
Producer Price Index (PPI): PPI measures the average change in prices received by producers of goods and services at all stages of production. The PPI provides an early indication of inflationary pressures in the supply chain, which can ultimately lead to higher consumer prices. The PPI is calculated by comparing the price of goods and services at different stages of production in the current period with the price of the same goods and services in the base period.
For example, if the price of raw materials in the base period was $100, and the price of the same raw materials in the current period was $110, the PPI for the current period would be 110. This means that prices for raw materials have increased by 10% over the base period.
The latest PPI report was released yesterday as you can see this is still trending in the right direction.
Producer Price Index Chart 5.10.2023
(Source: FactSet)
Consumer Price Index (CPI): CPI is a measure of the average change in prices of a basket of goods and services consumed by households, including food, housing, healthcare, and transportation. The CPI is widely used by policymakers and investors to track inflation and adjust economic policies accordingly. The CPI is calculated by comparing the price of a basket of goods and services in the current period with the price of the same basket of goods and services in the base period.
For example, if the price of the basket of goods and services in the base period was $100, and the price of the same basket of goods and services in the current period was $110, the CPI for the current period would be 110. This means that prices have increased by 10% over the base period.
The next CPI report is going to be released next week, which we will see if it follows the trend of the latest PPI report. Below is the most recent data which shows the areas that have been stickier to decrease such as costs of food. Housing is the other metric that has left this number elevated compared to the other reports.
(Source: U.S. Bureau of Labor Statistics)
Personal Consumption Expenditures (PCE): PCE price index measures the average change in prices of goods and services purchased by households for personal consumption. Unlike the CPI, the PCE includes all personal consumption expenditures, including durable goods, nondurable goods, and services. The PCE is also weighted differently than the CPI, with a higher weight assigned to healthcare and services.
For example, if the price of healthcare services in the base period was $100, and the price of the same healthcare services in the current period was $110, the PCE for the current period would be 110. This means that prices for healthcare services have increased by 10% over the base period.
The differences between these measures of inflation are primarily due to the differences in the goods and services included and the weights assigned to them in the calculation of the index. For example, the CPI assigns a higher weight to housing, while the PCE assigns a higher weight to healthcare and services.
The next PCE report is going to be released on May 26th. Below is the most recent chart showing inflations decreasing here as well.
(Source: Bureau of Economic Analysis)
Investors can gain a better understanding of inflation by monitoring the various inflation measures and analyzing the underlying drivers of inflation in each of these reports. By keeping a close eye on inflation data and understanding the factors that contribute to rising prices, investors can make more informed decisions about how to allocate their investments and protect their portfolios. While inflation can be a complex and often unpredictable economic phenomenon, staying informed and being proactive in response to changing market conditions can help investors stay ahead of the curve.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
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