Yesterday the US CPI inflation figures were released. There was, predictably, much talk about the figures on CNBC and in many other media sources. Inflation, of course, is something very important as an influence on the financial markets. It particularly influences interest rates, which then feed in to the relative value of currencies and in both the profitability of companies (interest expense)Â and the valuation of stocks (discount rates).
Here’s the thing, though. The CPI and other measures such as price deflators are measures of historical inflation. They tell us (with questionable accuracy) what prices have done. That, though, doesn’t really matter to the markets. Interest rates, stock prices, and currency exchange rates in the present are influenced by the expectations of inflation in the future. The same is true of central banks, like the Federal Reserve, in determining interest rate policy.
So as a trader, what do you do with the CPI release?
Well, if you are a news trader you can certainly play the market reaction to the figure. That aside, what you really want to be looking at is what, if anything, you can take from the data which points to future inflation. Does is give you a hint as to where prices might be rising more or less in certain areas? More specifically, you want to understand what traders are going to read in to the figures to determine the expectations for future inflation they develop. And of course no data release can be viewed in isolation. You need to be viewing it in conjunction with others to understand (to the exent possible) the full picture.
This probably sounds a bit convoluted. After all, if everyone is trying to read expectations from everyone else, you have a market based on the expectation of expectations. And there you have the reason why market sentiment and psychology are so important.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
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