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4 Effects Of Inflation On Your Personal Finances

4 Effects Of Inflation On Your Personal Finances

Inflation is a general increase in the price of goods and services, and decrease in the purchasing value of a currency – essentially, it is measuring the temperature of the economy of a country. In addition to the broader implications of inflation on the economy of a country, it also affects one’s personal finances. Inflation is measured by the consumer price index (CPI). The CPI reflects the value changes in a basket of consumer goods and services, which are often adjusted to factor consumption patterns of the average consumer. Yet many people don’t consider the impact of inflation on future financial planning, seeing as the average American doesn’t keep up with inflation. It is something that should always be taken into account, especially when it comes to investments that will provide retirement income. Here are the 4 effects of inflation on your personal finances.

(Source: The Bureau of Labor Statistics)

The Effects Of Inflation On Your Savings

 Inflation affects specific aspects of one’s personal finances differently. One area that is perhaps most susceptible to inflation are cash investments like a savings account. Because money is readily accessible, some people prefer to keep it in a savings account rather than invest it. Yet, as time passes, the value of money kept in a savings account can lose its value, considering that prices generally increase in the future. What you could purchase with $20,000 25 years ago, isn’t the same as the value of $20,000 today in 2019. In essence, the purchasing power of money may decrease while it sits in a savings account at a bank.

 For instance, if a savings account contains $1,000 with an interest rate of 1%, by year’s end the account will have $1,010. If the rate of inflation is running at 2%, then there must be $1,020 in the account to have the same purchasing power that was started with. It’s important to remember, that interest gained in a savings account never keeps pace with the rate of inflation.

In essence, inflation will eat away at one’s purchasing power, because not only will the money lose value, it won’t gain anything either. This can be a cause for concern during retirement when you have less earning power. To protect the purchasing power of your savings from the rate of inflation, it would have to grow at or beyond the inflation rate. An effectual way to beat the effects of inflation on your savings is to invest some of those savings in the stock market.

The Impact Of Inflation On Stocks

 Investing money in the stock market inevitably comes with a higher level of risk than simply keeping money in a savings account. Yet, as time passes, the stock market is expected to be able to handle or exceed the rate of inflation. Because of this fact, some investors prefer to invest their money in potentially higher growth investments like stocks. For those who prefer to avoid the volatility of individual stocks, another option is mutual funds, which usually provide good returns and are professionally managed. Furthermore, index funds might be an even better alternative for some, as they aren’t reliant on a fund manager, and follow their benchmark financial market index.

However, apropos of stocks, inflation still affects the value of the investment. The value of a stock is dependent on the performance of a company. When the economy is strong, inflation is usually high. During these periods, a company may have increased revenue and earnings, which would help their share price. However, as inflation rises, the company would have a larger expenditure for things like wages or raw materials – thus, affecting the company’s value. Additionally, akin to any other return, the stock’s return value will decrease as purchasing power decreases over time.

1979 $10,000 Treasury Bond (Photo: Wikipedia)

The Effects Of Inflation On Bonds And Treasury Bills

 Debt securities like bonds and Treasury bills are fixed-income assets that payout the same amount each year. These assets are not as affected by inflation as money in a savings account. However, when the rate of inflation increases faster than the return on debt securities, their value depreciates. Earnings diminish as purchasing power declines with the rate of inflation.

One option, especially for those in their retirement years, is Treasury Inflation-Protected Securities (also referred to as TIPS). These forms of inflation-protected bonds are indexed to inflation, therefore protecting investors from the adverse effects of increased prices.

Property Ownership And Inflation

 Property ownership is perhaps the most beneficial during periods of high inflation. As inflation increases, so does the value of the property. If you have a fixed-rate mortgage on a property, then the cost of the monthly mortgage payments will decrease as time passes.

However, because most people purchase properties with mortgages, higher interest rates could dissuade people from increasing their debt-load. Therefore, the demand for property decreases, making it more difficult to resell.

(Photo: REUTERS/Carlo Allegri)

Warren Buffet And The Matter Of Inflation

 Preeminent investor Warren Buffet has long been a leading authority on inflation, as he is both focused on and fearful of it. In fact, lest it be forgotten, that prior to the financial crisis of 2008, Buffet, the CEO and chairman of Berkshire Hathaway warned that inflation would cause a collective upset – which it did.

In 2010, after the world was wrestling with the effects of the financial crisis, Buffet wrote a “tongue in cheek” thank you note to the US government.

“We are following policies that unless changed will eventually lead to lots of inflation down the road,” Buffet stated on an op-ed.

In his classic piece for Fortune in 1977, aptly titled How Inflation Swindles the Equity Investor Buffet succinctly outlined his views about the effects of inflation on investors.

 It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment. We have been in such an environment for most of the past decade, and it has indeed been a time of troubles for stocks. But the reasons for the stock market’s problems in this period are still imperfectly understood.

There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.

It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.”

Despite the fact that Buffet wrote this 42 years ago, certainly words of wisdom from an individual who is legendary for his investing prowess and sagacity pertaining to finance.

Planning For Inflation

 Inflation is a financial component of life that cannot be avoided. However, there are things that can be done. Keep abreast of monthly inflation rates and CPI, via the Bureau of Labor Statistics release schedule. If inflation goes above the 3% level, it could be an indicator of worse things on the horizon. Factor in inflation when investment planning, especially with regards to fixed-income investments. Lastly, when planning for retirement, expect that the rate of inflation will be exponentially higher in the coming decades, rather than decreasing. All are good ways to protect your personal finances from the possibility that the rate of inflation increases.

 

New Survey Highlights The Average Americans Feelings Towards Inflation

We conducted a survey asking 1,500 US respondents whether or not they kept abreast of inflation. We used Google Surveys and targeted males and females between the ages of 18 to 65+ from coast to coast. We asked the following question with three possible responses:

Do you keep up with inflation?

  • No
  • Yes
  • I don’t even know what inflation is

The Average American Woman Does Not Keep Up With Inflation, Especially 18 to 24-year-olds

The overwhelming response of Americans, who took part in the survey, indicated that they did not keep up with inflation. A full 56.1% chose this response.

When demographic filters were applied to the survey results factoring females, very compelling insight was discovered. The percentage leaped to 63.6% and skyrocketed to an astounding 75.1% of females between 18-and 24-years-old.

 Conversely, when demographic filters targeted specifically males, 48% stated that they did not keep abreast of inflation. Of the males between 18 and 24 who responded to the survey, 59.8% chose this option.

One possible explanation for the drastic variance of the percentage between genders could be the finance sector. Although blessedly changing, positions across the spectrum of finance and business have typically been held by males – thus, making a larger percentage of males more inclined to keep up with inflation.

Males Are More inclined To Keep Abreast Of Inflation, Especially Middle-Aged Males

 The second most popular response to the survey was 30.9% of respondents indicated that they did, in fact, keep up with inflation.

Yet, when demographic filters were applied focusing specifically on gender, 38.9% of male respondents stated that they kept up with inflation, while conversely, 23.5% of female respondents selected the same option.

When the demographic filters targeted middle-aged males between 45 and 64-years-old, the results soared to 42%. Because almost half of this cohort indicated that they kept up with inflation, they have the highest percentage of respondents who answered “yes” to the survey question.

These results could further be demonstrative of the fact that males, especially middle-aged males, populate a higher percentage of positions across the spectrum of finance and business, which would warrant them keeping up with inflation.

American Women Between 25 and 34-years-Old Indicate That They Don’t Know What Inflation Is

 Of the American respondents who participated in the survey, 13% indicated that they didn’t even know what inflation was.

Yet, interesting insight was discovered when demographic filters were applied to the results, targeting specifically gender. 13.1% of male respondents indicated that they did not know the definition of inflation, while 12.9% of female respondents chose the same response.

However, when demographic filters focused specifically on females between 25 and 34-years-old, 18.6% of this age bracket indicated that they didn’t know what inflation was. Thus, it was the second most popular response to the survey question for this demographic.

Conclusion

Based upon the results of this survey, more than half of all Americans who responded did not keep abreast of inflation. Although a higher percentage of males who participated indicated that they did not know the definition of inflation, the highest percentage of respondents who did not know what it was were females aged 25 to 34. Yet, males, especially middle-aged males, were more inclined to keep up with it. This could be explained by the fact that as a generalization, jobs within areas of finance and business which would necessitate keeping abreast of inflation, are typically dominated by males.

Details About The Study And RMS Score

Sampling
Audience: Users on websites in the Google Surveys Publisher Network
Method: Representative
Age: All Ages
Gender: All Genders
Location: United States
Language: English
Frequency: Once

Root mean square error (RMSE) is a weighted average of the difference between the predicted population sample (CPS) and the actual sample (Google). The lower the number, the smaller the overall sample bias.

 

Are Annuities a Good Investment for Inflation Protection?-9 Experts Weigh In

Are Annuities a Good Investment for Inflation Protection?-9 Experts Weigh In

Annuities are a popular insurance contract that provides guaranteed returns for a set period or for a lifetime. In this article, financial experts discuss whether or not annuities represent a good investment for inflation protection.

Carefully Evaluate Any Annuity And Pay Special Attention To The Inflation Riders And How It is Calculated

“Single-Premium Annuities are not designed to be inflation protection, they are insurance product designed so that you don’t run out of money. Annuities are simply a promise to pay you and income for the rest of your life how long or short that may be. Annuity companies usually offer the opportunity to purchase or not purchase an inflation rider when you purchase one of these contracts. An annuity is not really an investment to protect against inflation because your actual return, that is how many and long you receive payments- is primarily delivered by how long you live!

An inflation rider might be purchased and in this case, inflation might outpace the contract terms and your payment would be adjusted upwards to keep up with the rising costs of goods and you would see your real income keep up with the rising costs. Inflation may be similar to historical averages and your income would be similar throughout the term of the contract.

Currently, we are at near-historic low rates of in inflation and if an example consumer purchased an SPIA and then saw a run-up in inflation, the real income of the annuitant could be significantly reduced. Inflation may be very low and you may have paid a premium for inflation protection, but if the inflation rate was very low you may have been better off not purchasing the option.

This only covers single-premium annuities, there are also period certain annuities, return of premium annuities and many more. The main point is to carefully evaluate any annuity and pay special attention to the inflation riders and how it is calculated, as well as understand the pros and cons of
the contract you are evaluating.”

Jason B. Ball, CFP®, ChFC®, CLU®, Ball Comprehensive Planning, LLC

When Setup Properly Annuities Can Provide A Lifetime Income Stream

“I am an independent insurance broker specializing in annuities – and yes – I believe annuities are a good investment.

When setup properly, annuities can provide a lifetime income stream for individuals and couples. That income stream can also increase each year based on moves in the CPI index. And once the income stream increases, it can’t go back down.

A guaranteed lifetime income annuity that increases payments based on moves in the CPI (or other inflation indexes) can be a valuable piece to any retirement plan. It acts as a pension plan and can reduce the financial strain that comes along with the overall market volatility we’ve experienced the last decade and a half.”

Adam M. Hyers, President, Hyers and Associates, Inc.

Annuities Are A Great Way To Make Sure Your Money Grows

“Annuities are a great way to make sure your money grows at a rate that outpaces inflation. Annuities are also often guaranteed not to go down when the market goes down. This means they are protecting you against losing everything in a crash as well, making them ideal for people who need to have a certain amount of money each month to live on when they are no longer working.”

Stacy Caprio, Financial Blogger, Fiscal Nerd 

They Come With Several Costly Caveats That Do Not Make Them Worthwhile For Most Investors

“Annuities are not a great buffer against inflation. They provide guaranteed returns, but they come with several costly caveats that do not make them worthwhile for most investors.

Annuities typically have several fees (including administrative or death benefit costs) associated with them above the cost of investment fund management fees. Inflation-protected annuities have additional fees for this benefit as well.

Annuities payments are not guaranteed. If the insurance company an investor purchased from goes bankrupt, it is possible that the individual might lose their payments.

If the investor decides they no longer want to the annuity, there is usually a penalty fee to cancel it and withdraw the money.

In general, a better strategy would be to invest in low-fee options that return healthy dividends. Over time the stock market historically outperforms what an annuity can offer, so investors with many years to go will do much better putting their available funds into 401K and IRA options than to purchase annuities now.”

Isaiah Goodman, Becoming Financial

Good Investment For Inflation Protection But Should Not Be Used As Pure Inflation Protection Vehicles

“Annuities can be a good investment for inflation protection but should not be used as pure inflation protection vehicles. They should only be used as inflation protection vehicle if the investor has an additional concern such as running out of money too quickly, having a stable income for peace of mind, or having some form of downside protection. Most annuities offer a cost of living adjustment rider which allows the income to scale based on one of the economic inflation metrics. However, annuities are primarily insurance for running out of money too fast. The way this happens is that you either live too long, you can’t budget to save your life, or you panic every time the market gets volatile.

If you don’t think you experience one of these core problems than there are a variety of better investments, you can make to protect your self from inflation concerns. If you are conservative in nature you can buy Treasury Inflated Protection Securities. Not only are they guaranteed by the federal government, but they are very stable investment. Their payments adjust directly based on inflation, so it is a direct hedge for inflation. However, if you want the best inflation-adjusted investments then look no further than the stock market. Equities are the best available investment when it comes to inflation. The cost of your day to day goods will directly be represented in the cost of goods these companies sell.”

Alex Caswell, CFA CFP, Wealth Planner, RHS Financial

Annuities Are A Very Misunderstood Product

“Annuities are a very misunderstood product. Annuities are a popular choice for investors who want to receive a steady income stream in retirement. There are different types of annuities that can play a beneficial part in anyone’s holistic strategy. As an industry professional, I believe that annuities serve a purpose for anyone, and can’t fall into a lump-sum of good or bad.”

Danita M. Harris, Managing Member, Guice Wealth Management

Fixed And Indexed Annuities Will Almost Certainly Beat Inflation With No Risk Of Loss

“Most long-term instruments will likely beat inflation, and therefore are good for inflation protection; however, most individuals who are looking for inflation protection are also just as concerned with the safety of principal and long-term liquidity. Fixed and indexed annuities will almost certainly beat inflation with no risk of loss, offering significantly higher interest rates than most fixed instruments. Additionally, annuities are tax-deferred, resulting in an even higher effective rate of interest. Once the surrender period has expired (usually between about five and ten years), most annuities are completely liquid provided the account owner is age 59.5 or older, unless of course, the account is annuitized (set to pay out a guaranteed income stream, usually for life or beyond).”

Rob Drury, Executive Director, Association of Christian Financial Advisors

It Depends What Type Of Annuity You Choose To Invest In

“I think it depends on what type of annuity you choose to invest in. Inflation can be unpredictable, and since annuities tend to be long-term investments, they may not be the best way to protect your finances from inflation. Even in a fixed annuity, you would guarantee the same amount of capital in return, but inflation could potentially negate any capital gains from this type of investment.

However, you could take out an immediate annuity that would start paying out in the short-term, making it a very viable option. This way you could start receiving your investment in small parts over the course of time, which is better than receiving a lump sum in the distant future. Smaller short-term capital gains will help you hedge against rising inflation, and you can always halt your annuity in the event inflation rises unexpectedly in the future.”

Igor Mitic, Co-Founder, Fortunly.com

It Is Generally Not The Top Of Mind Reason One Would Purchase An Annuity

“Annuities CAN have a place in someone’s overall financial planning for part of someone’s overall assets. Inflation protection could be a component of the reason why one would purchase an annuity, although the more common reasons found involve potential guarantees of income for life and the death benefit…always for additional fees. There are step-up features whereby the income benefit base steps up each year, or where the death benefit base steps up annually…or both. The increasing income base can mitigate the effects of inflation, depending on the specifics of the particular feature. There is not a one-size-fits-all, in that annuities can be tied to the stock market [variable annuity], a fixed rate of return [fixed annuity], or tied to an index [indexed annuity]. The fees can vary depending on the insurance carrier and the ancillary benefits purchased. The distribution options can vary as well, depending on the income need. All of that said, while inflation protection can be a component of the features of an annuity, it is generally not the top of mind reason one would purchase an annuity.”

Jimmy Masters, AIF(r), CRPS(r), Vice President – Investments, The Alcaraz Fisher Justis Wealth Management Group of Wells Fargo Advisors

Although annuities provide guaranteed payments to investors, there is no overall consensus as to whether or not they provide good inflation protection. If you are thinking about investing in annuities, take into account what the financial experts have discussed in this article, and always do your due diligence.

Things To Know About Inflation Protected Bonds-5 Experts Weigh In

Things To Know About Inflation Protected Bonds-5 Experts Weigh In

Inflation protected bonds, or more specifically, Treasury inflation protected securities (TIPS) are Treasury bonds designed to protect against inflation. The principle of TIPS rises with inflation, and pays interest twice a year, at a fixed rate. In this article, industry experts discuss specific things investors should know about inflation protected bonds.

Best For Savings Not Investment

“Treasury inflation protected securities are meant to help protect your principal amount from the effects of inflation. Your invested amounts are adjusted regularly in accordance to changes in the consumer price index – the official inflation indicator in the country. And the inflation-adjusted principal amounts will be used to determine your possible interest earnings. Some important things to note about TIPS include:

It pays less than ordinary government securities: You can expect the interest rate for TIPS to be a few points below that of ordinary bills and bonds. But a TIPS holder stands to benefit in two ways; one is through regular principal amount adjustments in accordance with CPI changes and the second in form of the agreed interest.

Inflation is currently not an issue: TIPs is supposed to caution you against volatile changes in inflation like in the case of 2007/8 economic downturn when the purchasing power decreased by 3.84%.

The Treasury Direct account can be cumbersome: Unlike stocks, you can buy
TIPS directly from the government through a Treasury direct account. But I believe you are better off using a TIPS fund for two reasons. The managers are more experienced and therefore able to tell the best buys and also because it is more effective than using the sluggish Treasury Direct website.

Best for savings not investment: You are better off using TIPs for savings and not for investments because they post lower returns and are essentially designed to protect the principal amount from depreciating at the expense of earning solid incomes.”

Edith Muthoni, Chief Editor, Leanbonds.com

The Current Fed Policy On Interest Rates

“There is no doubt of an accelerating attraction to inflation-protected U.S. government bonds. The key to answering why this is occurring rests with the current Fed policy on interest rates. The facts are that the nominal and inflation-adjusted bond yields have dropped over the past 12 months (i.e., taking the 10-year U.S. government bond yields as an interest rate yardstick.) The economy is still chugging along in full-growth mode, thus exerting pressure on future yields and boosting bond prices still more. At the same time, the Fed’s go-to inflation gauge (measuring inflation over five years starting today) indicates an expected rate of just over 1.8%. We don’t expect the Fed to resume increasing interest rates until we see a small excess over the expectation. The scenario painted above points to inflation-protected bonds outperforming the categories with zero protection (i.e., nominal rate bonds). Even if reality overtakes expectations and the Fed pushes interest rates earlier than expected, inflation-protected bonds like TIPS (Treasury Inflation-Protected Securities) should continue to head the pack. The reasoning is that inflation will be back in play to spur the Fed’s change of direction, and therefore TIPS (indexed to the inflation rate) will continue to thrive. Either way, you are a winner in our view.”

Gordon Polovin, Finance Expert, Serves on the Advisory Board, Wealthy Living Today

These Types Of Investments Are Best Suited For Individuals Who Are In Or Approaching Retirement

“Treasury inflation protected bonds (TIPS) are designed to help investors protect against the effects of rising prices. These types of investments are best suited for individuals who are in or approaching retirement as they are a hedge against inflation and they provide the strongest bond hedge against default risk. TIPS also provide income in the form of coupon payments. These payments are generally paid semiannually and are based as a fixed percentage of the face value of the bond. The fixed-rate is applied to the principal, and like the interest payments, it can rise with inflation and fall with deflation. A couple of important things to note are that once TIPS mature, the investor will receive the greater of their original investment or the adjusted higher principal amount. Meaning the investor can’t lose money during a deflationary period. TIPS are best used in non-taxable accounts (Traditional or Roth IRA, etc.) because the increase in the bond’s value will cause a taxable event each year there is an increase.”

Jordan Sester, Founder/Investment Advisor Rep, J.S Financial Group

(Photo: Wikipedia)

You’re Better Off Owning Them In IRAs

“They’re not spectacular. Treasury inflation protected bonds TIPS are government bonds so there’s no default risk. The coupons are small. You run the risk of losing value if you sell prior to maturity. You will lose value in times of deflation. When the face value adjusts each year due to inflation it creates a taxable event. You’re better off owning them in IRAs where you won’t have to report taxes. They do hedge a risk.”

Chane Steiner, CEO, Crediful 

Pay investors A Fixed Interest Rate As The Bond’s Par Value Adjusts With The Inflation Rate

“Treasury Inflation-Protected Securities (TIPS) are a form of U.S. Treasury bond designed to help investors hedge against inflation. These types of bonds are indexed to inflation, they have full faith and credit backing of the U.S. government. They pay investors a fixed interest rate as the bond’s par value adjusts with the inflation rate. TIPS pay interest at a rate that is fixed when the bond is purchased. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. The actual coupon payment (the amount of interest you receive), then, will fluctuate every six months, because it is calculated based on the new inflation-adjusted full value of the bond for the following year. One has to consider whether the variable income is a factor that fits their lifestyle, goals, and needs before purchasing.”

Jimmy Masters, AIF(r) CRPS(r), Vice President-Investments, The Alcaraz Fisher Justis Wealth Management Group of Wells Fargo Advisors 

Inflation protected bonds protect investors from the negative effects of rising prices. As with any investment vehicle, there are advantages and disadvantages to investing in Treasury inflation protected securities. If you are interested in TIPS, factor in what these industry experts have discussed, and remember to do your due diligence.

 

Where Is US Inflation Heading In The Next 5 Years? – 5 Experts Weigh In

Where Is US Inflation Heading In The Next 5 Years? – 5 Experts Weigh In

The general consensus amongst economists is that US inflation is low. This was corroborated by favorable reports by the Department of Labor at the beginning of May. Yet, what trajectory will inflation take in the next half-decade? In this article, 5 experts weigh in on where US inflation is heading in the next 5 years.

The Fed Does Not Expect Inflation To Rise Significantly

“Inflation management is one of the primary roles of the Federal Reserve, so you can look to them for indications of inflation expectations.

The Fed will raise interest rates when it expects inflation to get above the 2% target. By raising interest rates, the Fed makes borrowing less attractive so spending and inflation will fall. Most recently, the Fed has announced that they do not plan to raise interest rates through 2021. This means that they do not expect inflation to rise significantly.

The Fed has also said they expect for unemployment to increase slightly. Again, this indicates low inflation. If less people are employed, then less people will have money to spend and create that upward pressure on prices that causes inflation.”

Brandon Renfro, Professor, Financial Planner

Not Much Organic Inflation

“Speaking as a consumer I do not believe there will be much ‘organic inflation’ in the next five years. A lot of people never fully recovered from the Great Recession. They’re saving a little bit more and do not fully trust the recovery. In addition the baby boomers are all approaching retirement age and will be living on fixed incomes. Healthcare costs are a major concern. According to statistics the economy is booming and yet a lot of people do not feel that is the case in their personal life.

Many people are working in Gig Economy jobs, which are in essence temporary assignments with no health benefits. Examples include driving for Uber, Lyft, Grub Hub, Door Dash, or Amazon delivery. These are not the type of positions, which fueled the economy in past generations.

Inflation is generally caused by consumers pumping a lot of money into the economy and taking on large amounts of debt. The wounds of the Great Recession have yet to heal. People are not automatically assuming they will be better off a year from now. Whenever one feels uncertain about the future they are reluctant to spend lavishly. Any spending they do is usually measured.

Having said that world affairs such as tariff wars and instability in the Middle East could cause inflation without any assistance from consumers. A major rise in oil costs could ripple through the economy causing prices to rise in other sectors of the economy. However, fear has a way of causing people to spend even less which leads to higher unemployment and recession. That would eliminate any inflation bubble.

We’re not likely to see any real inflation until the average working person believes the backbone of the economy is solid with good paying jobs. Right now adults are taking jobs from teenagers such as delivering newspapers, cutting lawns, snow removal, and working in fast food restaurants. This explains why there is a sudden push to make the minimum wage $15. We may not see historically high inflation for another 10 years!”

Kevin Darné, Author, Continuing Education Instructor

Rates Must Creep Back Up To Historic Levels

“Where’s US inflation heading in the next 5 years? – This is impossible to pin down precisely, but I believe that short of a recession, rates must creep back up to historic levels.

In spite of trade wars, government shutdowns and the resultant delay in statistics, the business cycle goes on. That said, corporations have used all the cost-cutting tricks in the world. Now is the time for increasing prices on the ground level as well as at the Fed Open Market Committee.

Complicating matters is that persistently low inflation and low rates hamstring the options that central banks have historically used to address crises. Again, in order to relieve this psychological pressure rates and inflation must creep up.”

Robin Lee Allen, Managing Partner, Esperance PE

A Modest Stagnation Of Growth Rates Can Be Expected

“Considering the latest development in trade and monetary policy, it can be expected that the U.S. inflation rate will remain at modest levels.

Given the uncertain outcome of the ongoing trade war, as well as highly leveraged corporate debt levels, which weigh on the outlook of the world economy, a modest stagnation of growth rates can be expected.

Another point to consider is the Fed’s shift in interest rate expectations. The expected monetary easing is an indication of concerns about low growth and geopolitical tensions.

Since the conundrum about the missing effect of the last quantitative easing programs still prevails, especially the question why full employment did not yield to higher inflation, it remains at least questionable if another round of quantitative easing would lead to higher inflation. The Federal Reserve Bank of St. Louis 5-Year Forward Inflation Expectation Rate (T5YIFR) dropped in the last year from 2.16% to 1.94% and from 2.47% to 1.94% within the last 5 years, even though the Fed deployed massive quantitative easing programs.”

Dr. Stephan Unger, Assistant Professor of Economics, Saint Anselm College

A Recession Within The Next 5 Years

“I predict inflation will stay around 2% for the next 3 years unless a recession hits sooner in which case I think the government will print more money and drive up inflation at a drastic rate. I think there will be a
recession within the next 5 years, so when that hits inflation may be as high as 10% in just one year.”

Stacy Caprio, Financial Blogger, Fiscal Nerd

Given economic indicators, the Fed has projected that there will be no real threat of skyrocketing inflation in the coming years. However, there are numerous variables that can shift which would alter that forecast. Ultimately, only time will provide the definitive answer.

 

Investing During Inflation And Deflation – What Do Investors Need To Know?

Investing During Inflation And Deflation – What Do Investors Need To Know?

Inflation and deflation can have a significant impact on the performance of a portfolio. It is crucial for investors to understand investment strategies to weather these two economic factors. In this article, experts provide valuable tips and insight into what investors need to know when investing during inflation and deflation.

Avoid Having High Cash Balances

“A top rule for investing during inflation is to avoid having high cash balances. Since money loses it’s purchasing power during such phases, investors should aim at investing into assets which are immune against devaluation, such as physical goods, e.g. gold, silver, other commodities, real estates, etc.

But also an investment into stocks would be good advice since stock prices tend to increase in times of inflation. The reason is that investors flee out of cash and are looking for any types of investment.

In times of deflation, investors should consider to hold cash and to invest in bonds, especially long-term bonds, since interest rates are likely to decline and therefore bond prices.”

Stephan Unger, assistant professor of economics, Saint Anselm College

Utilize The Power Of Diversification

(Credit: Richmond Quantitative Advisors)

“The above illustration details global asset classes that tend to outperform during rising inflation and falling inflation. You can further delineate if the economy is in a declining stage or growth stage to provide four full quadrants of global asset performance.

The four quadrants include:

* Inflation with Growth – Inflationary Boom

* Inflation with declining Growth – Inflationary Stagnation

* Deflation with Growth – Deflationary Boom

* Deflation with declining Growth – Deflationary Bust

Based on the illustration, there are ways to position one’s portfolio for certain environments the US encounters. The main focus for investors should be to utilize the only free lunch in investing which is the power of diversification. By diversifying across assets within these four quadrants, one has the highest likelihood of weathering the storm (even if it is not clear where it may occur across the quadrants). Investors need to know those asset classes that have the ability to outperform in each quadrant and then assess their personal asset allocation decisions accordingly.”

Andrew S. Holpe, Managing Member, Richmond Quantitative Advisors

Investors Need To Generate After-Tax Returns

“Most people create investment portfolios to invest their assets to outpace the rate of inflation. The financial markets and governments prefer an environment with low, controllable inflation growth. These conditions allow for expansion while enabling governments to repay current debt with future-value currency.

According to Morningstar, a consensus of financial analysts predict that long-term inflation will grow at 2.48% per annum. Simply put, an investor needs to generate an after-tax return above this inflation rate to stand still and protect the purchasing power of their money.

The most prudent way to ensure success is to build a highly diversified portfolio of stocks, bonds, real estate, commodities, and cash-like liquidity. Limit your single-name stock concentration per issue to not more than 5%. Construct a bond portfolio focusing on credit-quality and that the current yield of your bond portfolio exceeds the effective duration of your portfolio. Effective duration is the sensitivity to a change in interest rates. The combination of these factors allow for growth and provide additional protection during a recession and deflationary environments.

During deflationary environments, consumers defer purchases because they expect lower prices in the future. That reality convinces more people that prices are falling and induces more deferral of purchases, etc. This virulent feedback loop is difficult to change and often requires extraordinary policy measures by central banks. During the credit crisis, the Federal Reserve (FED), Bank of Japan (BOJ) and the European Central Bank (ECB) all implemented radical policy measures to fight deflation. A flight to safety…underweight stocks, overweight cash, foreign exchange (FX), insured CDs, and sovereign bonds are prudent positioning during deflation of asset values. Your cash is worth more in terms of purchasing power as time goes on so there is some inherent return to cash even if there is little or no interest income.”

Paul Bowers, Managing Director, Compass Family Offices

Invest in Commodities And Real Estate

“Typically, assets that an investor would invest during inflationary times would be hard assets such as commodities and real estate. Commodities would include energy such as oil and gas as well as industrial and precious metals (not necessarily gold), You would NOT want to invest in bonds since interest rates rise during inflation and would result in declining bond prices. Many investment advisors recommend gold but I view it as more of a crisis manager rather than an inflationary hedge. In fact, one could argue that gold might be better used as a hedge during deflationary times since deflation tends to occur in a rapidly deteriorating economy when investors flock to protect their assets.

Stocks tend not to do well in deflationary environments. One reason often provided is that revenue and earnings are under duress as prices decline, which would eventually translate into lower stock prices.”

Cliff Caplan, CFP(r), AIF(r), Neponset Valley Financial Partners

Two Sides Of The Same Coin

“Economic factors such as inflation and deflation have a direct bearing to investors’ portfolio. Both are two sides of the same coin. Inflation is the rate at which general prices for goods or services are increasing while deflation is the decline in prices.

Investors need to know how these two factors can affect their investment portfolio. In certain situations, both inflation and deflation can occur at the same time, and this poses a more difficult prospect of protecting your investment. But whether it’s deflation or inflation, there are steps you can take to avert this threat.

If it’s inflation, investors can use the stock market to protect their portfolio. Normally, rising prices are good for equities. International bonds can also provide a solution in this case. Investors can buy international bonds in countries that are not experiencing inflation and hence reduce the impact of razing inflation.

In times of deflation, the most appropriate way to deal with it is to acquire high-quality bonds rather than stocks. Bonds tend to perform well during these times. Government-issued bonds and foreign bonds provide excellent options.”

Edith Muthoni, Chief Editor, Leanbonds.com

Investments Need To Beat The Rate Of Inflation

“It’s important to consider your real rate of return when you expect inflationary markets. Your investments need to beat the rate of inflation in order to make any real progress.  If inflation is 8%, you need to make at least 8% on your investments just to break even. If your investments only earn 5% during an 8% inflation period, your real rate of return is roughly -3%. You made money, but not enough to keep up.

There are ways to invest specifically in anticipation of inflation. The simplest is to invest more aggressively in stocks. Since equity investments do better over longer horizons they are often a good inflation hedge. One drawback though is you do need to plan to hold the stocks for a long time. Since stocks tend to be more volatile, you’ll need to plan for a longer investment term. In the short-term, your stock values could fall.

A direct way to invest for inflation is to purchase securities that have explicit inflation terms. The most common of these is the Treasury Inflation Protected Security, or TIPS. These are government bonds whose par value, and therefore interest you receive, adjusts with changes in the consumer price index. You can get these in terms as short as five years.

Another way to invest for inflation is to buy rental real estate. The reason rental real estate is an inflation hedge is because of the rent payments. You can adjust those for inflation when your tenant’s lease expires. If your terms on an annual basis, you would be able to make the adjustment every year.”

Brandon Renfro, Professor, Financial Planner

Regardless of the economic climate, a diversified portfolio is essential. Diversification is crucial when factoring both periods of inflation and deflation. When making investment decisions, take into account these expert tips and always do your due diligence.

Is the CPI (Consumer Price Index) A Valid Metric For Inflation?

Is the CPI (Consumer Price Index) A Valid Metric For Inflation?

The Consumer Price Index (CPI) is one of the most oft used techniques for measuring inflation the world over. Specific countries scrutinize different sets of data, but all employ a similar method. In the US, there has been contention surrounding the CPI for many years now. Initially, it was calculated by contrasting a market basket of goods from two periods – effectively operating as a cost of goods index (COGI). Yet, under the auspices of the US Congress, the CPI eventually developed into a cost of living index (COLI). In addition, as time passed methodological changes occurred which often resulted in a lower CPI. In this article, experts weigh in and provide compelling insight into whether the Consumer Price Index is a valid metric for inflation.

A Better Measure Would Be “Chained CPI”

“The Consumer Price Index (CPI) has long served as the foundational inflation measure for economic activity. In fact, it underpins the health of an economy because a stable CPI measure indicates the opportunity for economic prosperity. Absent predictable CPI readings, consumers will not have an accurate signal about price expectations and may change their behavior in detriment to the economy as a whole.

One major limitation to the current CPI measure is its inability to incorporate decisions consumers might actually make when evaluating a fixed basket of goods. For example, when a price increases for one consumer product included in the selection of goods used to measure CPI, many consumers would choose to switch to a substitute. CPI doesn’t account for this reality. Instead, CPI assumes the consumer would simply pay more for the same product. Reality usually shows a different response in the form of choosing a substitute product.

Instead, a better measure which accounts for this substitution effect would be “chained CPI.” This more closely resembles the substitution decisions consumers would make in response to rising prices of certain items as opposed to simply paying more for the same good. This metric will capture the switching dynamic.”

Riley Adams, CPA, Youngandinvested.com

Not An Exact Reflection, But Gives A Good Feel For It

“The CPI isn’t an exact reflection of the inflation rate, but it gives us a good feel for it. For the consumer, it shows them the increase in the price of the most common items that people buy, so if this is what they want to know when it is perfect.

However, for anyone interested in a deeper look at the current inflation rate there are other factors to take into account. For example, the CPI is based on a fixed basket of goods rather than taking into account every single product available. So, it really comes down to the reason for wanting to understand this subject.”

Phillip Konchar, Head Tutor, My Trading Skills

CPI Is Likely The Best Measure

“The CPI is one of a few common economic indicators that attempts to measure the magnitude of price changes (inflation) in the economy. The CPI, as the name indicates focuses on the price changes experienced by consumers. There are better indicators if one is looking at price changes for producers
(Purchaser Price Index – PPI), imports and exports (Import/Export Price Indexes – MXP), or employment costs (Employment Cost Index – ECI).

One drawback of the CPI is the time lag associated with the basket of goods included within the CPI. The basket of goods is determined by surveys the Bureau of Labor Statistics conducts to understand what products consumers are purchasing. There is generally a lag of about three years from the survey to when the basket of goods used in the Index is updated. This can be meaningful as the items consumers are purchasing can change quickly, particularly with rapid change in technology or substituting one good for another.

One other consideration is that the CPI can be volatile as it includes volatile products such as the price of energy (gasoline and natural gas prices can be quite volatile) and food. The Federal Reserve prefers to use a core inflation metric that excludes these volatile goods. The core inflation index the Federal Reserve prefers is the Personal Consumption Expenditures Price Index published by the Bureau of Economic Analysis.

Overall, the CPI is likely the best measure of the change in prices that consumers actually experience within an economy.”

John Linton, Managing Member and Portfolio Manager, Elbert Capital Management

Conclusion

There are both benefits and issues surrounding the use of the CPI as an accurate measure for inflation. For instance, the basket of goods used for the CPI is based upon purchases from a “typical household”, which is not a representative sample of all households. Thus, it is not an exact science, as it were. Likewise, the CPI can overstate inflation if it factors goods and services that consumers are using less of due to price increases. Substitution influences the weighting on the market basket, consequently resulting in a lower CPI. In addition, the basket of goods does not always factor the expenditure of new products that people regularly use. Consumption trends take time to be accounted for.

In essence, we are faced with a decision: accept the official CPI numbers provided by the Bureau of Labor Statistics (BLS), or choose alternate measures of inflation, thereby embracing the argument that official figures are inaccurate. Ultimately, whether or not the Consumer Price Index is a valid metric for inflation remains to be seen.

8 Inflation-Proof Investments to Hedge Against the Dollar Devaluation and Inflation Risk

8 Inflation-Proof Investments to Hedge Against the Dollar Devaluation and Inflation Risk

More and more investors are growing alarmed at what they see as the steady attack on the value and stability of the dollar. Between rising annual federal deficits and the over $21 trillion total U.S. federal debt time bomb, the future of the dollar and dependably low inflation is no longer a sure and certain ultimate outcome. This is why sensible investors are hedging their portfolios against both dollar devaluation and risks of significantly higher inflation. Here we look at seven solid choices to accomplish both of these goals.

Gold and Silver Bullion

It often comes as a shock to many investors to learn that studies on investments outperforming inflation show gold only outpaces the inflation genie some 54 percent of the time. This is not a fair result though. In cases where hyperinflation or substantial currency devaluation becomes the order of the day, gold (and silver too) massively outdoes inflation. In environments with high and continuous inflation, you need a prolonged depth of exposure to gold.

The surest way to reliably own gold is in the physical bullion form of it. The key is to obtain and store it in the least expensive way possible. What you need when you opt for this most secure form of gold and silver are the most broadly minted, traded, and liquid forms of bullion. This means that your top choices should nearly always be American Eagles, Canadian Maple Leafs, Vienna Philharmonics, or the British Britannia. All are popular, easy to sell in nearly all countries around the world, and come with low premiums (and discounts) over spot bullion prices.

When you are looking to make some of the smartest investments in gold, you should consider a Gold IRA. It is critically important to use a reputable Gold IRA company. These three companies will steer you in the right direction and help you to pick out the best tax-advantaged gold products possible for your situation.

Gold and Silver ETFs

Some people are more concerned about low entry and exit fees, highest liquidity, instant saleability, and split-second diversification. In these cases, Gold and Silver ETFs may be your best option for hedging against devaluing dollars and inflation. The truth about these various ETFs is that not all of them were created equal.

The best performing ETFs are those that are most closely correlated to the underlying price of gold. The least desirable ETFs have baskets of gold miner stocks, which consistently do not closely match up in performance to the underlying price of gold (or silver). Individual gold company stocks introduce a variety of risks to the equation, such as possible corporate quarterly losses, financial bankruptcy potential, and strikes at or seizure of mines and other valuable assets around the globe. All of these risks can lead to a wide divergence between the performance of gold and the price of a Gold ETF made up of gold mining stocks.

Analysts generally recommend one of two Gold ETFs that deliver the goods. These are the SPDR Gold Trust ETF trading under the appropriate symbol of GLD and the ETF iShares Gold Trust trading as IAU. These two ETFs are not dealing in any shady derivatives or even futures contracts on the underlying metals. They actually purchase the appropriate physical quantities of their commodities to match the trading price of underlying gold (and silver) as precisely and safely as possible. Since the two funds own their physical gold outright, their performances nearly mirror gold and silver price movements. The two companies boast nearly the same risk to return profiles and ratios. Their ten year betas amount to .47 and .49 respectively.

Commodities

As inflation rises and accelerates, commodities’ prices tend to rise apace. This makes them an ideal protection from the inflationary effects. There are not that many assets which gain from higher inflation, especially inflation that is unexpected. Commodities are a notable exception. As demand for services and goods rise, this typically pushes the costs of the services and goods higher, along with their underlying commodities prices for those goods utilized within them. It is the commodities futures markets that serve the role as ongoing clearing houses and auction markets for latest supply and demand information.

One thing to keep in mind with commodities is that they remain among the most volatile asset classes on the markets. They do provide higher returns in inflationary and devaluation environments, but this comes at the cost of a higher risk (in the form of standard deviation) than with standard equity investments (stocks). The key in most cases is to include commodities in an asset portfolio that is already significantly less volatile. This would decrease the all around risk to portfolio from negative correlation while often boosting the overall anticipated return.

Investing in commodities futures requires a great deal of background, some expertise, and ultimately nerves of steel. Generally only accredited or sophisticated investors meet the tests of this harder form of investing. Mutual funds provide a more suitable means of getting involved in them for the majority of investors. Alternatively, natural resources funds purchase firms that are involved with the production or mining of commodities. There are also raw commodities funds that buy into derivatives based upon commodities and back them up with fixed income investments.

The key is to be careful that you are not simply buying into mutual funds full of resource producing companies, which does not give you the real diversification you are seeking away from equities. Two solid ideas for direct commodity investments are the PIMCO Commodity Real Return Strategy Fund and the Oppenheimer Real Assets Fund that trades based upon the GSCI commodities index. There are also a range of new ETFs using the commodities indices as their underlying instruments which will be launched in the future or are imminent to be launched.

Remember that commodities have beaten inflation in an impressive 66 percent of instances. This is especially the case with the iShares S&P GSCI Commodity Index Trust.

Cryptocurrencies

The newest way to hedge against inflation and especially against dollar devaluation is using the cryptocurrencies like Bitcoin and Ethereum. The cryptos are a technologically cutting edged way for retaining your purchasing power. They have become particularly popular in two jurisdictions: ones with astronomical or runaway inflation like Venezuela and Argentina, and those that have capital controls like North Korea, South Africa, and China. In countries such as these with prolonged bleak outlooks, cryptocurrencies are an idea that could not come along soon enough.

This is especially the case because cryptocurrency wallets provide 24 hours per day, 7 days per week access to this electronic form of money that knows no borders. Back in Cyprus in 2013, the Cypriot Central Bank announced 100 euros per day ATM withdrawal limits. Greece went harsher with 60 euros per day in 2015. No matter how great your personal savings may have been, without access to your funds, it is irrelevant. You could lie helpless in a hospital room unable to be discharged for not paying a bill as you can not gain access to your own money.

The dawn of cryptocurrencies changed this. Citizens of crisis-stricken national economies finally found a credible and viable means of escaping from their national borders that had served as financial prisons. Farmers in Cuba may not be able to pack up and leave, nor factory workers in Iran or North Korea, but thanks to cryptocurrencies they can at least rest easy knowing that their money is continuously stored outside of the reach of their country’s central bank and regulatory agencies.

Real Estate

In this case, we use Real Estate to speak specifically about vehicles for holding commercial properties. This one of a kind investment class is both a hard asset that holds its intrinsic value well in inflationary and devaluation periods as well as an income-producing asset in the form of office spaces being leased out to tenants. The income-producing element pays out regularly in the form of dividends to the investors. This is why real estate has a long-term historical appeal to investors who are seeking a credible means of hedging their holdings against prolonged periods and bouts of inflation.

Real Estate equity and real estate investment trusts beat out inflation in an impressive 69 to 71 percent of real-world scenarios. Gaining a well-diversified exposure to such real estate with a reasonable expense ratio is imminently possible even for smaller retail investors, thanks to the Vanguard REIT ETF. For a comparable mortgage property residential REIT, you might opt for the Market Vectors Mortgage REIT Income ETF.

Barclays Aggregate Bond Index

Bonds may not be a vehicle that most investors think of for beating out inflation and currency devaluation, but their track record is impressive. A great barometer of this category is the bell weather Barclays Aggregate Bond Index. It beats out inflation in an impressive 75 percent of cases. You can track the index with an investment in the iShares Core U.S. Aggregate Bond ETF.

TIPS

Americans have a unique Treasury option in the TIPS. These are Treasury Inflation Protected Securities. Specifically indexed to the American CPI inflation index, these Treasury instruments provide a way to protect your portfolio from inflation and its ravages. TIPS are so effective that they outperform inflation in 80 percent of scenarios. It makes the TIPS the leading out-performing category of investments.

You have three different Exchange Traded Funds to choose from to get involved in these TIPS on a highly liquid scale. Two of them track the Barclays U.S. Treasury Inflation Protected Securities Index. The third follows the iBoxx Three Year Target Duration TIPS Index.

Leveraged Loans

A non-traditional investment that fares very well in periods of inflation is the category of leveraged loans. They provide low duration risk as well as a lower correlation to investment grade bonds.

There are other advantages to leveraged loans, such as comparatively attractive yields, improved diversification, lesser volatility versus equities, and the possibility of producing powerful risk-adjusted returns. Thanks to improved credit conditions, defaults should remain under average for the leveraged loan market for the foreseeable future at least.

These leveraged loans outperform inflation in an incredible 79 percent of cases. A way to invest in them with safety and liquidity is through the PowerShares Senior Loan ETF.

In Conclusion

There is no good reason to be a prisoner of either excessive inflation or ruinous currency devaluation. Thanks to these seven credible inflation busting investments, you can both realize gains and sleep easier at night, knowing that your portfolio is effectively hedged. The additional advantage of gaining more effective and comprehensive diversification is only additional icing on your investment cake.

Consumer Prices Slump in March

Inflation seemingly took a breath in March. According to Friday’s report from the Bureau of Labor Statistics, prices climbed 2.4% over the 12-months ending in March. Markets had expected an annual rate of 2.6% after February’s five-year peak at 2.7%. For the month, consumer prices inched up 0.1% in March. However, with seasonal adjustments the CPI-U posted a 0.3% decline, the largest one month drop since January 2015, when the all items index fell 0.6% with seasonal adjustments. Only two month ago, monthly inflation was at its highest level since February 2013.

Whether the decline in March represents a temporary blip on the radar or true underlying economic weakness remains to be seen. It is worth noting that when energy is excluded, the CPI-U has grown at a relatively stable rate over the past decade (represented by the blue line in the chart above). Gasoline represents roughly 3.3% of the CPI-U and half of the energy index; it has increased in price by nearly 20% over the past year, despite a 6.2% decline in March. Extreme volatility in the energy index, has been, and continues to be the dominant force impacting headline monthly inflation. Interestingly, March’s monthly decline (excluding energy) is the sharpest in the past 10 years.

March Monthly Prices

Core prices (excluding food and energy) dropped 0.1% with seasonal adjustments in March, after increasing 0.2% in February. March was the first month that seasonally adjusted core inflation dropped below zero since January 2010. Outside of the core index, food prices climbed 0.3% to more than offset a larger decline in the energy index, which fell 3.2%. Food accounts for around 14% of the all-items index, nearly twice the weight of energy.

Grocery store prices were up 0.5% in March. Prices were higher in four of the six major grocery store components; the index for other food at home slipped 0.1% and the index for dairy and related products fell 0.6%. The chart below illustrates the volatility of food prices since 2007; even with seasonal adjustments this index fluctuates drastically each month. Since 2014, the index for food at home has posted more months of declines than growth. In recent months, grocery store prices have clearly spiked.

 

Within the core index, shelter is by far the largest component of consumer spending. The index for shelter added 0.1% in March and 0.3% in February with seasonal adjustments. The price of medical care services was also up 0.1% in March; higher costs for hospital services (up 0.3%) were offset by lower costs for physician services (down 0.4%). The seasonally adjusted price of new vehicles fell for the second month in March, down 0.3% compared to 0.2% in February. Similarly, the index for used cars and trucks fell 0.9% in February adding to declines in both January and February.

Annual Inflation

Core prices climbed 2.0% year-over-year in March, slightly less than the all items index. Meanwhile, energy prices shot up 10.9% as energy commodities (mostly gasoline) surged 19.8% and energy services were up a more modest 3.4% annually. The food index inched up 0.5% over the 12-months ending in March. Grocery store prices fell 0.9% over the year, but this was offset by higher prices for food away from home; that index climbed an annual 2.4%.

 

 

 

Core commodity prices (commodities less food and energy commodities) slumped over the year ending in March, down 0.6%. This includes a 4.7% decline in the index for used cars and trucks. Apparel prices were up just 0.6% year-over-year. On the other hand, the medical care commodities index posted a 3.9% increase.

Over the year, the price of shelter rose 3.5%. Shelter is categorized as a service and service prices were up overall on an annual basis in March. The transportation and medical care service indexes were both higher, up 3.8% and 3.4% respectively. Within the transportation services index, motor vehicle insurance prices jumped 8.0% compared to a year earlier. However, declines in the price of wireless telephone services were the largest on record. That index fell 11.4% year-over-year.

Economic Outlook

The Fed has increasingly expressed their intention to continue raising interest rates, citing positive economic news and burgeoning inflation. The Fed aims to maintain an annual inflation rate close to 2% and they are generally more interested in the core index. When prices are rising faster than their target, higher interest rates prevent the economy from overheating. On the other hand, sluggish inflation is a sign of weak consumer demand and discourages current investment. Friday’s negative report may force the fed to reconsider the pace of rate hikes going forward. Inflation is not the Fed’s only mandate, they also aim to maintain stable and full employment.

Inflation Runs Out of Steam in February

According to today’s report from the Bureau of Labor Statistics, consumer prices grew a modest 0.3% in February, down considerably from 0.6% in January. On an annual basis, the all-items index (CPI-U) was up 2.7% in February and 2.5% in January. These are the highest annual rates in nearly five years (see graph below). Excluding food and energy, consumer prices were up 0.4% in February and 2.2% over the 12-months ending in February. These were the numbers analysts had expected.

Annual Inflation

Year-over-year, the price of food was flat in February despite plenty of volatility in grocery store prices. The price of meat declined significantly, including uncooked ground beef, down 6% and ham, down 3.9%. The price of eggs reportedly dropped 23.6% over the same 12-month period. The index for fresh vegetables fell 7.2% and fruit prices were down 4.3%. These declines were somewhat offset by higher prices for fish and seafood, up 3.4% for the year. Overall, the grocery store index fell 1.7% on an annual basis, while the index for food away from home added 2.4%.

For the year ending in February, the energy index advanced 15.2%. The soaring price of energy commodities was tempered by more modest growth in the price of energy services. Energy commodities, which account for roughly half of the energy index, were 29.8% more expensive in February compared to a year earlier. This is largely the result of higher prices at the pump; the gasoline index grew 30.7% year-over-year. Over the same period, the index for energy services (which includes electricity and utility piped gas) was up 3.5%.

There was a downward trend in the price of many retail commodities over the relevant year. The index for household furnishing and supplies fell 1.7%, while the apparel index inched up just 0.4% and prices for recreational commodities dropped 3.3%. Transportation commodities, which do not include motor fuel, posted a 1.2% annual decline in prices. While the price of new vehicles was up 0.5%, the index for used vehicles dropped 4.3%.

The index for transportation services grew 3.6% annually despite declines in the cost of car and truck rentals, reportedly down 1.7%. Over the same period, the index for motor vehicle maintence and repairs added 2.5%. The major reason for higher transportation service costs was a 7.6% spike in motor vehicle insurance rates. Intercity train fairs also jumped a notable 5.4%.

The price of medical care commodities appreciated significantly over the year. That index was up 4.1%, mostly the result of a 5.2% annual increase in prices for prescription drugs. Similarly, medical care services recorded a 3.4% year-over-year increase. The price for physician services was 3.6% higher compared to a year earlier while the index for hospital services was up 4.3%.

Shelter is the largest component of the all-items index, accounting for over a third of its total. The shelter index, up 3.5% over the year ending in February, is mostly comprised of rental costs including owners equivalent of rent, which is a reflection of home values. The index measuring owners equivalent of rent climbed 3.5% while those renting their primary residence saw costs rise 3.9%.

Inflation in February

In February, the price of food gained 0.2% with both the index for food at home and food away from home rising at that same rate. Three of the six components of grocery store consumption increased by 0.2% over the month; cereals and bakery products, meats poultry fish and eggs and fruits and vegetables.

The energy index declined on a monthly basis, down 0.7% in February. Although energy service prices added 0.5%, a 2.0% decline in the the energy commodity index more than offset the rise. Volitile gas prices were once again responsible for changes in the energy index. Prices at the pump dropped 2.1% in February. Gasoline accounts for roughly 3.4% of the all-items index and nearly half the energy index. The graph below illustrates the average price of regular unleaded gasoline per gallon over the past decade.

The apparel index, which includes clothing, footwear and accessories, jumped 2.4% in February. However, with seasonal adjustments, the apparel index was up 0.6%, following a 1.4% seasonally adjusted increase in February. The index for transportation commodities increased 0.2% in February, including 0.4% growth in the price of used vehicles. The transportation services index added a more significant 0.8% in February. The price to lease a car or truck was 2.0% higher for the month and the index measuring the cost of public transportation increased by 2.3%. Medical care was more expensive in February. Medical care commodity prices grew 0.5% as prescription drug costs were 0.6% higher. The medical care service index was also up 0.6% as the price of hospital outpatient services shot up 1.3% in February.

Economic Outlook

Inflation appears to have rebounded despite February’s low monthly rate. The CPI-U has surpassed the Fed’s annual 2% target after remainingy stubbornly low throughout 2015 and most of 2016. Along with higher inflation, employment and economic growth numbers support today’s decision by the Federal Reserve to raise interest rates. The optimism reflected in the stock market also indicates the economy may need to be reigned in. Today, interest rates were increased by 0.25% to a range of 0.75% to 1.0%. Higher rates make borrowing harder for business and consumers but also keep prices from growing to quickly, which is good for the consumer. The Fed did not alter their outlook for 2017, two more rate hikes are expected this year.