Americans are starting to look over their shoulders for an economic boogeyman: out-of-control inflation.
Consumer prices in April soared by the most since 2009, while firms saw the highest price jump in 11 years during the month. Federal Reserve officials in their most recent economic projections even see their preferred measure of inflation rising to 2.4 percent, which would be the highest in decades.
The fear is that massive government spending to blunt the blow of the crisis, easy monetary conditions for years to come from the Federal Reserve and a post-vaccine boom that gets consumers out traveling, dining and shopping again are creating the perfect inflationary storm. Investors are worried that too-rapid price gains could force the Fed’s hand, prompting it to raise interest rates before the economy has fully recovered.
Yet, the orchestrators of the world’s largest economy are betting that increases will only be temporary, reflecting supply bottlenecks as the U.S. economy opens back up as the coronavirus crisis lessens and data swings from last year’s below-average readings. Even the Fed’s projections show inflation balancing back out at their typical 2 percent objective next year.
Still, the jump was eye-catching, with inflation being a dirty word for those who remember the economic havoc it wreaked while running rampant in the mid-1970s and early ‘80s.
Experts say consumers and investors should really only shudder at the mention of inflation when it becomes more sustained and pronounced. That hasn’t happened in decades and economists believe that’s unlikely to happen unless the U.S. labor market gets back on track. That’s a long ways away, with 3.5 million fewer people working today than in February 2020 and the U.S. economy short of more than 8 million jobs since the start of the pandemic.
“It would likely take years for that situation to develop,” says Greg McBride, CFA, Bankrate chief financial analyst. “But in hindsight, we’ll look back and see that the seeds were planted in 2019 to 2020 and 2021.”
Still, accounting for inflation is an important part of any consumer and investor’s financial plan. Here are three steps you can take to better protect your finances from a post-pandemic inflation boom, regardless of whether it’s temporary or sustained.
From an investing perspective, you might not want to adjust your strategy all that much, particularly if you’re someone who’s in it for the long haul. But if a perfect inflation-safe strategy existed, someone would’ve figured it out by now. A diversified portfolio is your best bet.
“It’s hard to find a perfect inflation hedge: It doesn’t exist,” says Kristina Hooper, chief global market strategist at Invesco. “Investors have to recognize that, if they have a long enough time horizon, they typically are going to live through lower and higher levels of inflation over time, so to have components of a portfolio that typically perform well in inflationary environments is enough.”
What makes higher inflation particularly challenging is that “there’s not a whole lot of places to hide,” McBride says. “That’s why inflation can become a real stranglehold on growth.”
Those living on a fixed income, primarily retirees, might want to take greater care than others when crafting an inflation-friendly gameplan. Price pressures would erode your wallet if you have too much exposure to cash and fixed-rate return investments such as bonds.
“I’m not in favor of people changing their investment mix based on the direction of the wind, but the key ingredient is to save and invest and consistently build a well-rounded portfolio,” McBride says. “The reality of it is, not everybody does that.”
Longer-dated bonds take a bigger inflation hit, meaning you’d probably be better off incorporating some with a shorter maturity into your portfolio to offset the damage.
Another beneficial strategy can be incorporating inflation-indexed bonds, the most common being Treasury-Inflation Protected Securities (TIPS). TIPS protect you from inflation by design. They pay a fixed interest rate every six months and an inflation adjustment on a semiannual basis, which applies to the bond’s face value, rather than its yield.
“Inflation-adjusted, inflation-indexed or floating-rate bonds would provide a little bit more cushion than traditional bonds,” McBride says.
Stockholders tend to have a better chance at beating inflation. Companies generally pass along higher inflation in the form of higher prices, and the same market forces that increase inflation are also what tend to increase the value of companies.
But investors taking a longer-term view might also want to incorporate some specific equities in their portfolio, one of them being a dividend-paying stock. Annualized dividend increases over time have outpaced inflation, Hooper says. “That doesn’t mean every year you’re going to outpace inflation, but if you’re taking a long view, that’s an interesting asset class to consider.”
You should also consider investing in stocks that have a high growth potential, according to Jordan Jackson, global market strategist at J.P. Morgan Asset Management. Those willing to look beyond the U.S. might find that emerging-market equities can also be a strong bet.
As always, however, keep your risk tolerance in mind and don’t make too many gambles. Think about which companies still have strong underlying fundamentals. Translation: You might not see many meteoric rises like the GameStop phenomenon when inflation is high.
“Stable, dividend-paying consumer staples could have their day in the sun” with higher inflation, McBride says. “High-growth companies that are long on expectations but short on current-day profits, those prices would be significantly undercut in a higher-inflation environment.”
Physical assets to some extent might also benefit your portfolio. Property values tend to rise and fall in line with inflation, increasing the value of your investments. Having a broad basket of commodities could also help, as could some amount of precious metals — both tending to be a safe haven from inflation.
But lots of external factors influence those prices. They tend to be volatile, and they don’t pay a dividend or yield.
A clear loser during high inflation is simply the U.S. economy. The Fed historically had to manufacture a recession to stifle rampant inflation in the ‘70s and ‘80s. Higher inflation can also choke innovation, making it harder for companies to find funds for new investments and projects.
Many Americans know the drill: During recessions, it’s important to prioritize building up an emergency fund. But bouts of high inflation are generally a bad time to park a cushion of cash in a savings account.
American consumers might look fondly on the days when certificates of deposit (CDs) came with a record 18.3 percent annual percentage yield (APY). But inflation was also around those levels, and the average cost of a 30-year mortgage wasn’t far behind, according to data from the Federal Reserve Bank of St. Louis.
“Some people would look at their savings and bonds and rejoice at a number that’s at 5 or 6 percent,” McBride says. “But it’s 5 or 6 percent when inflation is 5 or 6 percent. You’re no further ahead.”
It’s always important to have an emergency fund worth at least six months of your expenses regardless of where savings yields or inflation stand. But after that, higher inflationary environments are a particularly important time to make sure that you start searching for a better return — especially for consumers, who are losing purchasing power.
“With the same $100, we’re able to buy fewer amounts of goods throughout the economy,” Jackson says. “You don’t want to have too much cash on the sidelines as we talk about losing your purchasing power, but you don’t want to have too little in the sense that things go wrong and you don’t have that safety net.”
Inflation hasn’t technically disappeared. Prices tend to rise every year — and for good reason. Too little inflation could lead to the devastating economic downward spiral of deflation. Too much might mean consumers can’t afford their everyday goods and services with what they’re currently being paid.
The goldilocks not-too-hot, not-too-cold rate is accepted to be around 2 percent annually. A healthy level makes paying debts easier, while also giving the U.S. central bank more room to cut interest rates during downturns.
With 2 percent inflation, firms and consumers “can borrow and spend and do everything they’d like to do without overheating the economy,” Jackson says.
Threatening inflation hasn’t shown its face for decades — at least in the index that the Fed closely follows. Annual price increases have averaged out to about 1.9 percent since the early 1990s, the last time inflation eclipsed 4 percent and seemed like it risked running out of control. Those gains were held down even more in later years by a slow recovery from the Great Recession of 2007-2009.
A separate gauge from the World Bank shows that consumer prices in 2019 rose 1.8 percent from a year ago. That was before the pandemic, when inflation took another tumble.
But one month of higher inflation shouldn’t be vexing to consumers. What matters is where inflation reaches over time. There’s a difference between a one-time bump versus a sustained pick up — the latter of which would be the most devastating for consumers.
“A kid who brings home one ‘D’ on his report card, not a problem, but when he consistently brings home D’s and F’s, then that’s a problem,” McBride says. “[When it comes to] Inflation, we have to view it in the same way.”
Firms from McDonald’s to Chipotle are already announcing that they’re raising wages and wooing workers with sign-on bonuses in an increasingly tight post-pandemic labor market. But experts aren’t convinced that’s the kind of wage pick up that could lead to a sustained build up in prices. More so, it reflects a struggle to get people back to work while the virus is still present, childcare issues are ongoing and unemployment benefits are still enhanced.
Along the way, displaced workers had relationships with their employers severed when the crisis forced firms coast-to-coast to shut down.
An environment with more than 8 million jobs missing would naturally keep a lid on demand and take away firms’ wherewithal to hike prices, with wages also being restrained as extra workers remain on the sidelines.
“The greatest indicator of inflation in recent decades has been unit labor costs, and we’re looking at a labor market that has a lot of slack,” Hooper says. “When you have decades of disinflationary pressure, it’s very unlikely to see a rapid change.”
A pick-up in inflation might be welcomed news for Fed officials and possibly even American workers, if it means wages are climbing. But what’s clear about inflation is, once that plane takes off on the runway, it’s pretty hard to turn it around. Fed Vice Chairman Richard Clarida said in a Wednesday appearance that the consumer price jump caught him by “surprise.”
“The risk is definitely there, but it’s not a foregone conclusion,” McBride says. “For those that are too heavily weighted in cash and fixed-income investments for their age and risk tolerance, they would want to revisit that before inflation becomes a problem.”