Trading CPI Release: How Inflation Moves Currency Pairs

One especially impactful report released each month is known as the CPI report and is likely to cause waves in the forex market. A key principle of trading forex is understanding tradinCPI is, its implications, and ways you can better your trades using this information.

What Is the CPI and Why Do People Care About It?

The Consumer Price Index (CPI) tracks the costs associated with everyday expenses such as groceries, rent, gas, and clothing. When the average cost of these items increases, this is referred to as inflation, and the opposite is deflation.

You can think of the CPI as being akin to a shopping basket. If every month, you filled up a shopping basket with the same items and the cost of that basket went up, then inflation went up. If the cost went down, then inflation went down. These data sets are released by the US Bureau of Labor Statistics on a monthly basis.

There are two CPI reports released each month by the US. The first is the headline CPI, which covers everything, including food and energy. The second is the core CPI (or the core inflation report). Since energy and food are volatile, core CPI excludes them. Since core CPI is less volatile, forex traders tend to focus on this.

How Does Inflation Affect Forex Markets?

The relationship that inflation and forex trading derives down to is interest rates. When inflation is on the rise, the US Federal Reserve is likely to increase interest rates to combat inflation.

This would make the USA forex more appealing to investors. People want to park their money where they earn a better return. That demand pushes the dollar’s value up.

When inflation falls, the Fed often cuts interest rates. Lower rates make the dollar less attractive. People move their money elsewhere, and the dollar’s value drops.

Simple Chain You Need to Remember

You do not need to memorize complex formulas. Just keep this chain in your head:

• CPI comes in higher than expected → Inflation is rising → Fed may raise rates → Dollar gets stronger
• CPI comes in lower than expected → Inflation is falling → Fed may cut rates → Dollar gets weaker
• CPI matches expectations → Market already priced it in → Dollar reaction is usually small

What moves prices is the surprise. The market already prices in the forecast number before the report even drops. When the actual number is very different from the forecast, that is when you see the big moves.

How the CPI Moves Major Currency Pairs

When a CPI report is released, currency pairs can change enormously and rapidly, sometimes within a matter of seconds. Here are the reactions for the most popular pairs.

EUR/USD

This is the most popular pair in forex. If the US CPI results are higher than expected, the EUR/USD falls. If the results are lower than expected, the USD weakens, and the EUR/USD rises. This pair is heavily influenced every month by the CPI release.

GBP/USD

This pair behaves almost the same as the EUR/USD. If the CPI is strong and the USD is strong, then the GBP/USD is falling. If the CPI is weak and the USD is weak, then the GBP/USD is rising.

USD/JPY

This pair is somewhat the opposite of EUR/USD. If the CPI is strong, the USD/JPY rises. If the CPI is weak, then the USD/JPY falls.

AUD/USD and USD/CAD

AUD/USD behaves almost the same as EUR/USD. If the USD CPI results are strong, then AUD/USD falls. If the results are weak, then AUD/USD rises. The opposite applies to USD/CAD. This pair rises when the CPI results come in strong because the US dollar comes first in the pair.

A Simple CPI Forex Strategy for Beginners

Trading CPI releases can be risky because the market moves in both directions. Experienced traders follow a plan. Here is a strategy you can start practicing today.

Step 1: Understand the Forecast

Before the release of the CPI report, it’s important to understand what economists are predicting. Economic calendars, such as Forex Factory and Investing.com, will provide this estimate.

Be sure to note the estimates for both the headline CPI and core CPI. Generally, the greater the difference between the expected and the actual number, the greater the market reaction.

Step 2: Wait for the First Candle to Close

Many of those new to trading CPI releases will attempt to make trades the moment the CPI report is released. This is very dangerous to your account. Spreads widen significantly and price can whip in both directions. This can stop you out in the process.

A safer approach is to wait for the first one-minute or five-minute candle to close. This gives a much clearer view of the market.

Step 3: Risk Management

The majority of accounts that lose money on CPI trading lose money because they didn’t manage their risk as opposed to a poor reading of the data. Identify a stop-loss before entering a trade.

A common technique is to place a stop-loss beyond the spike that occurred as a result of the news. Always keep your position size small.

Step 4: When to Not Trade

The old adage of “no trade is the best trade” can often be correct when the CPI report closely matches the economist predictions. In these cases, the market reaction is very unpredictable and can whip your trades back and forth very quickly.

You may see the price shoot up, then shoot down, then settle with no clear direction. In those cases, smart traders wait on the sidelines and let the dust settle before looking for the next setup.

Common Mistakes People Make When Trading CPI Release

Even seasoned traders make errors dealing with high-impact news events. Here are some mistakes you should look to avoid.

Trading Before The Number Is Released

Don’t guess; you don’t know what the CPI number is going to be, and neither does anybody else. Those who trade just before the number is released are making a guess, not a trade. Always wait for the data before making a trade.

Not Considering The Updates

The BLS typically updates the previous month’s CPI number with the following month’s release. If the update contradicts the new number, this can cause the market to move in an unpredictable way. You should read the full report instead of relying on the headline number.

Ignoring The Current Situation Of The Fed

Identical CPI numbers can move the market in totally different ways depending on what the Fed is currently dealing with. If the Fed is in a rate-hiking cycle and the CPI is hot, this confirms a hike and the dollar will strengthen.

If the Fed is in a rate-cutting cycle and the CPI is hot, the dollar will move in an unpredictable way. You need to have all the information available to you in order to understand the reaction.

Closing Remarks

The CPI release is a very good tool that you should have in your arsenal as a forex trader. You’ve learned what the CPI is, how it affects currency pairs, and how to formulate a trading strategy based on it. The most important aspect is being patient, comparing the real number to the forecast, and exercising risk management. Remember, don’t feel the need to trade during every single CPI release. You just need to be ready when the setup is right.