Yesterday we talked about interest rates — the steering wheel of global markets. But here’s the question: what actually forces central banks to turn that wheel?
The answer: inflation.
1. Inflation, More Than Rising Prices
Most people think of inflation as “stuff getting more expensive.” True, but for traders, inflation is a signal. It tells us how much central banks will have to tighten or loosen policy.
• High inflation? Central banks panic → rate hikes.
• Low inflation? Central banks breathe easy → rate cuts or QE.
So, inflation isn’t just an economic stat. It’s the trigger that sets off interest rate moves.
2. The Different Flavors of Inflation
Not all inflation is created equal, and this is where pros separate from rookies:
• CPI (Consumer Price Index): The headline number everyone sees.
• Core CPI: Excludes food & energy (too volatile). Central banks watch this closely.
• PCE (Personal Consumption Expenditures): The Fed’s preferred gauge — smoother, more reflective of consumer behavior.
👉 Pro Tip: The market impact often comes when the number diverges from expectations. Example: if CPI comes in “hot” (higher than forecast), USD can spike immediately.
3. Why Inflation Hits Your Charts
• Forex: If U.S. inflation is sticky while Japan’s remains low, USD/JPY climbs.
• Bonds: Inflation erodes fixed returns → bond prices fall, yields rise.
• Equities: Growth stocks bleed when inflation spikes (cost of capital rises).
• Commodities: Oil and gold often serve as inflation hedges, but gold only wins if real yields lag behind inflation.
4. A Real Market Story
Remember June 2022? U.S. CPI printed 9.1% YoY, the highest in 40 years. The market instantly priced in more aggressive Fed hikes, the USD exploded higher, and equities tanked.
Traders who weren’t just watching the CPI headline — but the Fed reaction function — had the edge.
5. The Trading Edge
Here’s how seasoned traders use inflation:
• Watch the spread between headline and core — it signals stickiness.
• Track expectations vs. actual print — surprise = volatility.
• Always think two steps ahead: “What will this force the central bank to do?”
Where we’re heading next: if inflation is the fuel tank and interest rates are the steering wheel, then central bank policy is the driver. Tomorrow, we’ll put it all together — and decode how to read a central bank like a trader, not an economist.
