US Consumer Price Index/Inflation (CPI): A New Market Opportunity.
Hello dear, welcome to my little space. Is this your first time or are you a regular reader? In either case, I wish you a warm welcome.
A new market opportunity was presented to us by CPI; but first, I believe I have talked about this CPI subject before. It measures the price US citizens pay for goods and services. And from the name itself, you can see that it's an index, meaning it comprises many things. These many things are a basket of goods to put it simply; from fuel to bread and automobiles. All these goods are measured for each month, averaged, and released early the next month. Here, we'll be talking about the just-released figure. Though released in July, it represents the measurement for June 2023. We all saw that US consumers are beginning to see the prices of their goods and services drop. Indeed it's been tough past months beginning in early 2022, when CPI/inflation hit 9.1%. This meant an economy that was growing too fast and was going to get out of control for everyone. So the "central bank" of the United States known as the Federal Reserve (FED) embarked on using one of their crucial tool in the name of interest rate hikes to cool down the economy. This means they embarked on making sure inflation/CPI dropped to their preferred target of 2%. They do this by making some not-so-good choices like making it difficult (cost) for businesses to operate and thus resulting in high unemployment and a decrease in salaries/wages. A lot more is done but for now, let us proceed with these basic ones.
I say a new market opportunity because for currency speculators and investors, knowing what the FED will do in light of data releases like CPI is crucial to making money in financial markets. When the FED or any central bank of a major economy engages in hiking interest rates to cool down inflation, the value of their currency appreciates and in the case of the US, we witnessed a very strong dollar all through 2022 and the first quarter of 2023. It's normal that a currency widely used in international trade like the US dollar will greatly appreciate when the FED begins to make it scarce in the market. Simply put, they hike interest rates so that US government securities like bonds become extremely good investment assets to own. To own them, you need US dollars and lots of them. So other countries, banks, hedge funds, and, individual investors start channeling their resources to owning some of these US-issued securities and as a result, suck out US dollars from the market. This is simply what happened and capital flows so fast in this technology-driven world and markets that we can see the dollar appreciating within seconds of data like CPI releases. To make it clearer, most participants in financial markets monitor these data releases and anticipate them based on the laws of economics and what the central bank decision-makers have been saying. So as the data is released, they know whether the US dollar will appreciate or depreciate.
Given that the FED's preferred target is 2%, we recently saw the headline figure standing at 3%, and given that the FED had paused hiking interest rates in June, plus the fact that other major economic releases have been deflationary (showing fewer inflationary pressures), and lastly because the FED decision-makers had said further hiking will be data-driven going forward, it was no surprise to see the dollar depreciate. Markets are forward-looking in the sense that, when something is bound to happen, market participants already start acting on it. Let me demonstrate with an example; if you know that Tesla has been selling many of its cars and making profits beginning January 2023, will it not make sense to start buying Tesla stocks before they even declare their quarterly earnings? that's just because the demand is high and hence the company is bound to do well. This is a short-term scenario for a market speculator. So the market reaction to CPI printing 3% was highly anticipated and you can see from the chart below how the dollar (DXY) dropped like never before erasing the majority of its gains in 2022.
Don't be fooled by big economic terms and jargon, at the core of many so-called complex stuff lies very simple explanations, and it's as simple as I have laid out above. Market participants are now anticipating no more or at least a few if any rate hikes and are positioning to let go of some of their US dollar holdings. We could all see this as major currencies have been appreciating against the USD and the stock market has rallied. The S&P 500, Dow Jones, and NASDAQ are all up on the release of the June CPI. Now, all participants will be monitoring incoming data to also see for themselves that indeed the aggressive rate hikes of 2022 will do the remainder of the job and bring inflation to the FED's 2% target without warranting another hiking cycle. Yes, it's all about market cycles, even the world itself operates in cycles from seasons to whatever else you might think of. We study past cycles and prepare for the next for the variances are usually not that wide.
On this note, I rest my case and until next time, stay safe.
Comments
Post a Comment