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Inflation may be coming?

November 29, 2021
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          Rising inflation is talk on the street these days. For the past 30 years, inflation has run at a modest 2.4% average annualized rate. At least that's what our financial planning software estimates when we are considering the long-term impacts of rising costs in a retirement analysis. The definition on inflation is a measure of the rate of increase in prices over a given period of time. The CPI (Consumer Price Index) is a common barometer that measures the price of a "basket of goods" over time. Things such as transportation, food, and medical care. If you don't consider inflation in your planning, what you spend today could easily cost you double in 30 years! 

          But why is inflation rearing its ugly head now? Well, for the past two years, Covid has wreaked havoc on many parts of the economy. Some business supply chains reduced capacity and now that things are reopening, the demand for these goods and services are booming and consumers have stockpiled massive amounts of cash to spend. You can see it with fleets of shipping containers, lined up off the ports of California. Just like in economics 101, when supply goes down and demand increases, prices must rise. Interest rates have stayed so low for so long and the Federal Reserve has continued to stimulate the economy by buying bonds at a rate of $120 billion per month. It's important to understand the Fed has been given three key objectives by Congress. The first is to keep prices stable. The second is to maximize employment. The last objective is to moderate long term interest rates. 

          The consequences of rising inflation mean the most vulnerable people in our society are at the highest risk. Those on fixed incomes, such as the elderly or low wage earners that spend all of their money on just the basic necessities to live. Therefore, if higher levels of inflation persist, the Fed may be forced to raise interest rates more aggressively to slow down economic activity, which could certainly derail the stock market, the bond market and even the real estate market as well. This may then lead to a recession. Some ways portfolio managers address this potential threat are by focusing their investments on companies that can more readily pass along their rising costs to consumers. Bond managers, on the other hand, will shift their holdings to give up higher yielding longer term investments, to shorter term maturities, protecting the principal from rising rates. TIPS (Treasury Inflation Protected Securities) are also another hybrid government bond, that pays a very low coupon rate, but the principal gets adjusted with inflation each year. 

          As this economy continues to reopen and if congress gets this spending deal passed, I believe it's highly likely that we will continue to see a surging demand and inflation will persist. The question and the danger is, just how much? If it becomes seriously threatening and the Fed is forced to move abruptly, it could shock the financial system, sending asset prices down. Of course, I don't have a crystal ball, so only time will tell. If you would like to discuss the possible impact to your investments, give us a call.