The Real Reason This Week's CPI Will Shake the Stock Market: Oil Price Volatility Makes Inflation Prediction Difficult

This Wednesday at 9:30 PM (U.S. time), the CPI (Consumer Price Index) will be released, followed exactly 24 hours later by the PPI (Producer Price Index). These two indicators are considered so important that they typically quiet the market before their release, then cause immediate movement in futures charts and international market charts. Investors are paying close attention to these numbers, watching for market reactions.

While many investors are aware of the impact CPI and PPI have on the market, they often don't accurately distinguish between the two or understand their meaning and calculation methods. Therefore, today, we will take time to explain to beginner investors how CPI and PPI differ, what each signifies, related terminology, and the meaning behind this upcoming CPI index.

Both CPI and PPI fall under the broad category of price indices. The basic concept of a price index starts with a 'basket of goods.' Statistical agencies survey households to understand what and how much they purchase on average each month, then construct a hypothetical basket based on this data. By tracking the price changes of the items in this basket, the price index is calculated. It is important to consider not only price changes for each item but also the proportion each item occupies in the basket.

The proportion of each item in the price index calculation is crucial. For example, even if the price of snacks rises significantly, its impact on the overall price index will be minimal if it accounts for a small portion of the basket. Conversely, items such as food, energy, and especially housing-related costs, occupy a large share of total living expenses and thus have a huge impact on price indicators. In the U.S., housing-related costs (rent, home maintenance, etc.) account for about one-third of total living expenses, making them a decisive factor in price indicators.

A price index is interpreted as a relative value, comparing current prices to a specific base period set at 100. For reference, the U.S. price index sets the average from 1982 to 1984 as 100. If a basket of goods that cost $100 then now costs $333, it suggests that prices have more than tripled. What's important is not the absolute value of the price index but rather understanding the trend through relative rates of change, such as month-over-month (MoM) or year-over-year (YoY).

The CPI (Consumer Price Index) measures prices directly paid by consumers at places like supermarkets, gas stations, and hospitals. This makes it more directly relatable as it reflects the inflation level consumers experience in their daily lives. The U.S. CPI focuses on urban consumers, covering over 90% of the total population, making it significant and meaningful data. CPI news typically uses terms like 'MoM (Month-over-Month)' and 'YoY (Year-over-Year)' to analyze inflation rates. MoM indicates changes compared to the previous month, while YoY indicates changes compared to the same month a year ago.

MoM (Month-over-Month) is the change rate compared to the previous month, useful for understanding the most recent pace of price fluctuations. YoY (Year-over-Year), on the other hand, is the change rate compared to the same month a year ago, showing the cumulative inflation trend over a longer period. For example, if the U.S. CPI in June recorded -0.4% MoM but +3.5% YoY, it means that while prices slightly decreased in one month, they remained at a high level on a yearly basis. These two indicators should be analyzed together to understand inflation trends more accurately.

CPI is broadly divided into headline CPI and core CPI. Headline CPI reflects price changes for all items in the basket, while core CPI excludes volatile food and energy items. Food prices are heavily influenced by weather or natural disasters, and energy prices by geopolitical issues such as the situation in the Middle East. Since these highly volatile items are difficult for the Federal Reserve (Fed) to control through monetary policy, core CPI is often referenced to filter out market 'noise' and grasp the underlying trend of inflation.

When interpreting price indices, 'base effect' must be considered. The base effect is a phenomenon where the situation at the comparison point in time causes a statistical error in the current indicator. For example, if oil prices surged this time last year, causing the CPI to hit a record high, the year-over-year (YoY) inflation rate might appear low this year even if oil prices haven't risen significantly. This is because an excessively high benchmark was set last year. Therefore, when a price index is released, it is necessary to understand what happened in the previous month or the same month a year ago to accurately interpret the indicator's meaning. News typically provides such additional analysis after the initial release.

The concept of 'Seasonally Adjusted (SA)' is applied to price indices. This is to remove price fluctuations caused by recurring seasonal factors each year to understand the underlying inflation trend. For example, heating costs rise in winter, airfare increases during summer vacation, and consumer spending grows due to large sales at year-end—these patterns are due to seasonal characteristics. Figures with these seasonal fluctuations filtered out are called Seasonally Adjusted (SA), and those without are called Not Seasonally Adjusted (NSA). Generally, month-over-month (MoM) indicators use seasonally adjusted figures, while year-over-year (YoY) indicators typically use unadjusted figures.

The PPI (Producer Price Index) measures the prices received by factories, farms, refineries, and wholesalers when they sell their goods. Because this index is formed before consumer prices, it can sometimes serve as a leading indicator for the CPI, but this is not always the case and can vary depending on the situation. To understand PPI, three key terms are important. First, 'Final Demand' refers to prices at the stage just before sale to the final consumer. Second, 'Intermediate Demand' includes prices of goods and services traded at intermediate stages of production. Third, 'Trade Services' reflects the costs of services incurred during the distribution process of goods. These three indicators allow for a more detailed analysis of producer price trends.

The reason PPI can be a leading indicator for CPI is due to the 'pipeline' structure where price increases at each production stage are passed on to final consumer prices. That is, if a cost increase begins at production stage 1, this increase can transfer through stages 2 and 3 to the price of the final product, ultimately being passed on to consumers. The market interprets that if final PPI rises, CPI may also follow suit after a certain period. Because of this chain reaction, PPI is sometimes used as an important indicator to predict future consumer price trends. However, it is also important to consider that it may not be passed on due to other factors such as companies absorbing profit margins.

Rising costs do not necessarily mean consumer prices will increase. In situations where consumer prices have already reached a significant level and further increases could burden consumption and actually dampen it, companies may choose to absorb cost increases by reducing their own margins or seek other ways to lower costs. In such cases, PPI may rise while CPI does not. This leads to a decline in corporate operating profit margins, ultimately suggesting that the market might move towards a slowdown in demand for raw materials.

The gap between PPI and CPI must ultimately be resolved in one of two ways. First, companies pass on increased costs to final consumer prices. Second, companies bear the burden, reducing margins or cutting other expenses. Either way, inflationary pressure impacts the market, serving as a crucial variable for future economic trends and corporate performance.

Last June's CPI and PPI both recorded negative month-over-month figures, primarily due to falling oil prices. In June CPI, the energy sector dropped 5.7% in a single month, with gasoline prices specifically falling by 9.7%. In PPI, final demand goods declined by 1.4%, with gasoline's 12% plunge accounting for most of the monthly decrease. This illustrates how significant energy price volatility directly influenced the inflation indicators.

Although June's inflation figures recorded a negative due to falling oil prices, oil prices are highly likely to rebound. The market is currently seeing oil prices rise again through July and August, leading to growing concerns about whether this upcoming inflation report will be low. Particular attention is being paid to whether core CPI, excluding energy items, will remain stable without secondary ripple effects. The impact of oil price fluctuations on future inflation indicators is noteworthy.

Looking at the June inflation figures, CPI was 3.5% year-over-year, and PPI was 5.5%, creating a difference of about 2 percentage points. If the general rule that PPI increases can be passed on to CPI applies, then the July CPI could potentially hit 5%. This gap indicates that the cost-push pressure at the producer stage has not yet been fully passed on to the consumer stage, implying potential upward pressure on future CPI. The market is closely watching this potential upward pressure.

The market consensus for July's headline CPI is a 3.4% year-over-year increase, and for core CPI, a 0.2% month-over-month increase. What's crucial is not the absolute value itself, but whether the actual announced figures exceed or fall short of market expectations (consensus). If the figures fall short of consensus, the stock market is likely to react positively, but since market expectations are often not set unrealistically high, the results should be watched carefully. Investors will focus on the interpretation relative to consensus to predict market direction.

This July CPI is proving exceptionally difficult to predict due to the significant volatility in oil prices. Various media outlets and institutions are forecasting different outcomes, with some anticipating inflation and others expressing concerns. These differences in expectations are predicted to greatly amplify volatility in the bond and stock markets after the announcement. Investors will need to closely analyze the impact of the upcoming CPI figures, alongside oil price movements, on the market.