Trying to understand the effects of CPI

Trading Discussion News and Economy
1

Hi everyone, I’m interested in trading CPI reports that are released for the pairs I trade. However before doing so I would like to have a better understanding of the effects that inflation has on a currency.

This is my understanding, please anyone correct me If I’m wrong, and explain why. I have two ideas on how to interpret it in my head, I have labeled them option 1 & option 2. Option 1 seems to consider future repercussions of low CPI, option 2 seems to consider past/present.

Option 1:

If the CPI comes in lower than expected ----> this means there is low economic growth ----> so central banks try to increase economic growth by decreasing interest rates —> lower interest rates tend to make consumers and businesses borrow and spend more stimulating economic growth ----> which then increases inflation due to demand -----> due to higher inflation the currency becomes weaker

Option 2:

If the CPI comes in lower than expected ----> this means currency is stronger because things are worth less and you could buy more

any insight would be helpful.

Thanks

1 Like
2

Option 1 is the correct line of thinking… Most central banks have an inflation target of around 2%… So if inflation is coming in lower they will want to increase the inflation which is usually accomplished by lowering rates, and in some extreme cases will inject monetary stimulus into the economy … Both action de-value the country’s currency.

If inflation is coming in higher… then interest rate increases are used to cool it off. This increases a currencies value…

An example of how CPI can effect forex would be too look at New Zealand’s last CPI release (last week) … It came in low and the kiwi lost about 80 in the two minutes following the release.

Australia’s CPI release tonight should also make a significant. impact because the RBA is on the fence in regards to another rate cut… The CPI tonight, could make their decision either way.

3

Hi,

The problem with trading the news is that you must understand the general market sentiment to calibrate how the market is going to react. Its not as easy as better than expected --> will go up, worse than expected --> will go down. You must have a feeling beforehand of which direction the currency is vulnerable to take.

Consumer Price Index is a leading indicator of how inflation is going to be.

Basically inflation is the increase in average of goods and services, meaning a decrease in purchasing power of the currency.

The main premise is: If inflation goes over target countries need to raise interest rates to cooldown the economy (which is bullish for the currency). Also if inflation threatens to go negative (deflaction), country are forced to be more agressive in monetary policy to boost economy (Bear for currency).

Hope it helps.

1 Like
4

Thank you very much banker! very informative reply.

I was planning to trade the CPI for Australia tonight although wanted to make sure my thinking was correct, so thanks for clarifying that.

You mentioned that NZD moved 80 pips in 2 minutes, it would be quite hard to trade that unless you could access the CPI data almost instantly.

Either way I will keep a keen eye on the release of Australia’s CPI, I am thinking to short if YoY is 2.2% or lower, and go long if 2.6% or higher, as most economists are forecasting 2.4%. Of course this will all depend on how price is moving and momentum it is moving with.

5

Thanks Alph, I appreciate the reply. you explained it in very simple terms. I will keep in mind what you have mentioned.

6

Just remember that inflation is not directly related to economic growth, but to interest rates!!!

You can have a country growing with low inflation and a country in recession with high inflation. Look at Argentina!!!

7

I got 50 of those 80 :slight_smile: I entered the trade a few minutes prior to the release so as to catch the whole move… I spend a great deal of time reading through economic reports and forecasts to get a good idea of which way the release is likely to go.

8

Hi, a lot depends on the expectation of the report. If inflation comes in higher than expected it could mean that the demand for goods is high, so the economy is hungry, the currency will therefore be worth more. In an economy when you are trying to stimulate growth and the inflationary pressures that go alongside it, should CPI come in lower, it can potentially show that demand is cooling, and there may be grumbles surrounding its economy.

9

Hey Banker, can you give a heads up/lesson on how to dig out this info and make a judgement call on where it can go?

10

Condensed story -

I look at consumer related reports that are released prior to the CPI… Retail sales, credit card transaction volume, auto purchases etc. these are directly related to CPI and are predictive… If credit card transaction volume and new car purchases are trending higher… There’s a good chance these will boost CPI.

Investment banks release their reports and forecasts organized by their senior economists… You can find these with google searches… Jpmorgan chase, Wells Fargo, Barclays, Goldman sacs provide good reports for American and European economic news… Westpac and NAB provide good reports for Asia economic news…

Here’s this weeks report by westpac

There are another handful of forex specific analysts that I follow that provide good information… Basically I find whatever I can get my hands on, and have developed a nice portfolio of information sources over the years.

And then when I get a feel for where I think the direction is likely to go, I make sure the profitability factor justifies the risk of the trade…

Example: if the kiwi has been appreciating up to the CPI release… And I expect the CPI to come in high… I probably will not trade it because the market has priced in the release already… And if I was wrong, there would be a sharp move down… The risk reward is skewed against me.

However… If its in the middle of a range or even better at the low end… Then I will place a buy trade before the release as the positive CPI hasn’t been fully priced in and the reaction will be much stronger if I am right… And my downside is more limited since it is already on the low end anyways.

I usually spend about 4 hours researching the bigger releases beforehand to determine my game plan… If it is one that I’m not getting a strong signal one way or the other I sit out… And ill wait until the initial move retraces before entering… Sometimes can take quite a few hours.

The worst thing you can do is to try and enter while its making its first move during the minutes following the release… If I’m not in the trade before the release… I don’t try and chase the initial move

Also… Not all CPI events are equal… Some come at times where inflation is of no concern… If a central bank has stated concern over inflation in their last rate statement or in a speech by the central banks figurehead… Or if the central bank is expected to make a rate cut or increase… Then CPI releases can be more impactfull

11

You have it figured out under Option 1.

Just a note, lower than expected CPI number does not equate to stronger currency. It just means price of good and services did not rise as quickly as expected.

12

Long term, they only give indications to what the GDP is and interest rate. Only something markedly out is notable. I would not try to trade CPI numbers on an intraday basis.

13

The consumer price index is obtained by dividing the expenditure on a set of consumer goods in one year (the current year) by the expenditure on that same set of goods in the base year. For example, let’s assume that consumer expenditure on a specific set of goods in the base year (1996) was $20,500 and, in 2004, consumer expenditure on that same set of goods was $25,000. We put these numbers together as $25,000/$20,500, which is 1.22. It is common to then multiply this result by 100, giving us a CPI of 122. Other CPI values are calculated in exactly the same manner, always dividing a given year’s expenditure by that of the base year. Note that we’ll always be dividing the current year expenditure for any given year (or period) by the same number. This implies that if we calculate the CPI for the base year we divide base year expenditure by base year expenditure, making the base year CPI always equal to 100.