FI Pillar: Inflation
Inflation tracks the pace of price changes across the economy—impacting purchasing power, monetary policy, and valuation frameworks. This pillar analyzes both realized and expected inflation pressures to gauge cost trends and policy responses.
Why Inflation Matters
Inflation influences interest rates, consumer confidence, and corporate margins. Persistent inflation pressures central banks to tighten policy, while disinflation supports easing and growth recovery. Understanding its drivers helps investors anticipate rate changes, sector rotation, and asset allocation shifts.
Key Metrics and Their Importance
1. CPI & PCE (Headline Inflation)
Why it’s important: The Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) measure changes in overall consumer prices. They guide monetary policy and reflect real household cost pressures.
Factors involved: Energy and food volatility, shelter and medical costs, and substitution effects. Core PCE—excluding food and energy—is the Fed’s preferred inflation measure.
2. Core & Services Inflation
Why it’s important: Core inflation removes volatile categories to show underlying price trends. Services inflation, especially in housing and wages, reveals stickier, demand-driven pressures.
Factors involved: Shelter (rents and owners’ equivalent rent), labor costs, and healthcare prices. Core services often lead inflation persistence during tight labor markets.
3. Producer Prices (PPI)
Why it’s important: The Producer Price Index tracks input costs faced by producers. Rising producer prices often pass through to consumers, affecting profit margins and CPI trends.
Factors involved: Commodity inputs, freight costs, global supply-chain pressures, and energy prices. Goods vs. services PPI trends indicate pipeline inflation risk.
4. Inflation Expectations (Breakevens)
Why it’s important: Market-based inflation expectations (breakevens) guide long-term yields and asset valuations. Anchored expectations signal credibility in monetary policy; unanchored expectations increase volatility.
Factors involved: 5-year and 10-year TIPS breakevens, UMich expectations survey, and the Fed’s 5y/5y forward inflation gauge. Movements influence rate path assumptions and real yield valuations.