Inflation, Interest Rates, and Investments all affect one another.
Things cost more than they did yesterday. To a certain degree, that’s always true, but lately it’s been too obvious to miss. Consumer prices, which include everything from a gallon of milk to a tankful of gas, have gone up so high and so rapidly that we’ve been able to see the numbers on price tags counting up week after week. The thing with consumer prices is that they’re something everyone sees, and when inflation forces them upward, everyone feels things getting that much tighter.
And it’s when the same feeling strikes everyone at the same time that emotional states start translating into economic realities.
How can a prudent investor get through those times when irrationality takes the wheel? Even with an experienced financial advisor offering insights, any kind of cool-headed analysis might seem practically impossible. However, experience breeds familiarity with the cycles that underlie these changes. Once you know how the three I’s of Inflation, Interest Rates, and Investment each affect one another, you can craft a successful investment strategy amid what can sometimes seem like a sea of chaos.
Tricky Problems and Indirect Solutions
There are a lot of reasons why prices have jumped up lately. And they have: the USDA Food Price Outlook has found that food prices are 11.4 percent higher in August 2022 than August 2021 (13.5 percent higher if you don’t count restaurant meals), and the overall Consumer Price Index shows an 8.3 percent jump over the same period. In 2021, many of those prices had already reached record highs.
Why did this happen? The COVID-19 pandemic disrupted workplaces and the way goods move around the world. Then, Russia – a major petroleum supplier – invaded Ukraine, and the war drove fuel prices through the roof. (Fuel oil in August 2022 was a whopping 68.8 percent higher than in August 2021!) At the same time – and for some of the same reasons – most people, on average, had less money to spend due to layoffs and company closures.
In the US, the Federal Reserve has started to use the main tool it has at its disposal. It began fighting inflation with interest rates. The central bank announced in September 2022 that it was raising its funds rate (meaning, the interest rate at which banks lend to each other) to a target range of 3 to 3-1/4 percent because it wants “to achieve maximum employment and inflation at the rate of 2 percent over the longer run.” That was the fifth rate hike in 2022, and the third hike in a row of .75 percent.
Higher interest rates can be good for an investor – for instance, if you expect rates to drop, it could be a good time to buy bonds because they’ll grow in value. But in general, higher interest rates means it’s a little harder for banks to loan money to businesses, which means companies grow more slowly. Prices will also drop, or at least rise less … but that’s because unemployment tends to rise. (On the other hand, a stronger economy leads to higher prices, because more people are willing to spend more for the same stuff.)
The balancing act the Fed is playing right now is to increase the cost of borrowing money, which leads to less investment, thus less business growth, thus fewer jobs and lower pay, thus lower costs all around. In terms of the three I’s, higher interest should mean less traditional investment and lower inflation.
But as you can see, it’s not a one-to-one correspondence. And this complexity can lead to opportunity. As interest rates rise, your credit card bill will likely rise, and if you don’t have a fixed-rate mortgage, then that payment might rise as well – as will the rate on refinancing or home loans if you’ve been considering doing that. But the value of savings vehicles like certificates of deposit will rise too. High-yield savings accounts will also be more profitable than they have been in more than a decade. Now would be the time to start hunting for the banks and credit unions that offer the most rewarding interest rates.
And now, more than ever, consulting with a financial advisor can point you toward strategies for protecting your nest egg by diversifying your portfolio and identifying new possible sources of profit, whether it’s a fund that focuses on a rising-rate environment, or some other investment vehicle.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
If there’s anything else you’d like to know, ask us! We’d be happy to talk with you about your questions and review your portfolio.
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Sept. Interest Rate Hike: https://www.fool.com/the-ascent/federal-reserve-interest-rates/
Consumer Price Index, Food Price Outlook: https://www.ers.usda.gov/data-products/food-price-outlook/summary-findings/
CPI, fuel oil: https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category.htm
Fed quotes: https://www.federalreserve.gov/newsevents/pressreleases/monetary20220921a.htm
More on the Fed’s moves from NY Times: https://messaging-custom-newsletters.nytimes.com/template/oakv2?campaign_id=9&emc=edit_nn_20221005&instance_id=73753&nl=the-morning&productCode=NN®i_id=111991619&segment_id=109039&te=1&uri=nyt%3A%2F%2Fnewsletter%2Fbd9f5ba2-ab83-5741-a332-7f93004fb775&user_id=1efd0996e60ab5cf182a8ca90701dfdd