Inflation is a measure of the change in prices for goods and services over a given time period. It is an important number because it informs us how much more we are paying for everyday expenses, which has a direct impact on retirement planning as well as investment management. March 2022 inflation of 8.5% was the highest since 1981. In other words, the amount we pay for everyday stuff jumped higher than it has in the last 40 years.
This wasn't a surprise number - inflation has been rising at an increased rate since the COVID crisis. This is because of a combination of government imposed lockdowns, housing migrations, and more recently Russia's war in Ukraine, among other factors like tax breaks and government cash infusions.
Lockdowns in major manufacturing hubs like China have caused disruptions in what is referred to as the global supply chain. It's the reason you see empty store shelves far more often than happens in a normal environment. With fewer goods arriving, people are willing to pay more for the goods that do, which stores indulge by raising their prices.
Home prices and rents have also jumped dramatically since the COVID crisis, driven by a migration of people away from cities into more rural communities. Adding fuel to this fire is the buildup of cash in households over the past several years, and many companies quickly transitioning to work-from-home policies, allowing households more flexibility in choosing where to live.
With food and goods prices increasing from supply chain disruptions, housing costs rising, and gas prices surging due in major part to the uncertainty stemming from the war in Ukraine, we have a perfect storm for accelerating inflation. We are at the point now where the U.S. Federal Reserve (The Fed) is being forced to address it.
The Fed's job is to strike a healthy balance for both inflation and jobs. Its main path to slow the increases we have seen in inflation is to raise interest rates. The rationale is that higher rates should increase the cost of doing business, since it becomes more expensive to borrow money to invest. Higher rates also incentivize savings, taking money out of the economy that would otherwise be spent and perhaps contribute to further inflation, although rates would have to move fairly substantially for most consumers to view savings accounts as an attractive place to stash money.
However, the Fed has become more creative since the housing crisis in 2007-2008. It learned then that participating in bond markets can be an effective way to impact interest rates. It went through a massive bond-buying program known as quantitative easing, or QE, whereby it purchased bonds as a way to inject cash into markets and also reduce longer-term interest rates, to keep borrowing costs low. When COVID hit, the Fed again engaged in QE to help boost the economy. The reversal of QE (Quantitative Tightening) could lead to the opposite - sopping-up cash from investors by selling bonds, which also would have the intended effect of raising longer-term rates and slowing-down inflation, although that effect is disputed from even within the Fed, and thus far untested.
Whenever money is flowing in amounts individuals can barely even comprehend, it is best not to try to fight the trend. Whether the Fed will engage in Quantitative Tightening or not doesn't change the fact that it will, without question, address the inflation surge with whatever means it has and deems necessary for the betterment of our economy. The risk with any strategy like this is the unintended consequences. It is not clear whether rising rates may slow economic growth enough to cause a recession, or whether rising rates will even work at all in the near term. And, because these strategies take time to fully work-through our economy, it is difficult to know when the Fed should back off. Too soon and inflation could continue rising, negating any positive momentum. Too late and the economy could fall into a deeper recession than necessary (many experts believe risk of a recession is now higher but hope for any to be small and short-lived, AKA a "soft-landing").
Where does this leave people curious how to invest in such times? With a properly structured portfolio, focused on appropriate levels of risk based on retirement planning considerations, there may not be much to change. One strategy would be to sell any equity (stocks) you own back to your long-term target, assuming they are above target with the stock market surge we have experienced since COVID. Within bond allocations, staying "short-term" tends to result in lower losses as interest rates move higher, and taking a cash position with some previous bond holdings may also be prudent.
My best advice: pull up a chart of the stock market and zoom out. Think about all the different, difficult times we have endured through the decades. The trend is still up! If you believe in our free markets and way of life, there is no reason to assume this should change over longer time periods, regardless of what happens with inflation over the next several years.