What inflation measures
Inflation is the rate at which prices across the economy are rising. It matters because it directly determines what central banks do — and central bank policy is the single biggest driver of asset prices in the short to medium term.
The Consumer Price Index (CPI) measures what a basket of consumer goods and services costs. It's the most widely watched inflation measure. Core CPI strips out food and energy (which are volatile) to show the underlying trend. When CPI comes in above expectations, the market typically reprices rate hikes higher and equities sell off.
Producer Price Index (PPI) measures what producers are paying for inputs. It leads CPI because cost increases at the production level eventually flow through to consumer prices. Watching PPI gives you advance notice of where CPI is likely to go.
CPI is released monthly by the BLS, usually in the second week. It's one of the highest-volatility scheduled events in the calendar — indices can gap significantly on a surprise print. PCE (Personal Consumption Expenditures) is the Fed's preferred measure, released monthly by the BEA.
How inflation affects markets
Moderate inflation (around 2%) is considered healthy and typically accompanies economic expansion. Equity markets usually perform fine. High inflation forces the Fed to hike aggressively, which compresses P/E multiples, hurts bonds, and often causes recessions as credit conditions tighten.
Inflation also determines the real return on assets. A 5% stock gain means nothing if inflation is 6% — you're losing real purchasing power. In high-inflation regimes, commodities, real assets, TIPS (inflation-protected bonds), and energy stocks historically outperform.
Deflation — falling prices — sounds good but signals economic distress. It causes consumers to delay purchases (why buy today if it's cheaper tomorrow?), which crushes corporate revenues. Japan's "lost decades" are the classic deflation case study.
Trading inflation data
CPI release days are high-volatility events. The market has an expectation priced in (from the consensus estimate). If CPI prints above consensus, the market prices in more rate hikes — equities typically fall, yields rise, the dollar strengthens. Below consensus does the opposite.
The setup is in the surprise, not the number itself. A 4.0% CPI print is bullish if the market expected 4.5% and bearish if the market expected 3.5%. Watch the consensus estimate heading into the release and think in terms of deviation from expectation.
Sticky inflation (services, shelter) is treated differently than transient inflation (goods, energy). A spike in energy prices is likely to reverse; a persistent rise in shelter costs and wages signals structural inflation that requires more aggressive Fed action.