Are Signs of Inflation a Temporary Worry or Long-Term Threat?

You aren’t imagining it. It feels as if we’re playing an endless game of Whac-A-Mole with pandemic-related supply shortages—knocking down one (toilet paper), then another (meat), only to have several more pop up (lumber, microchips, rental cars, and even chicken wings).

There’s no telling how long demand will outpace supply, even as production begins to pick up, or what it will mean for the long-term. But for now, at least, prices for some in-demand goods and services are spiking.

In our last article, we talked about whether the government’s Covid-19 stimulus relief programs could create short- or long-term inflation, and what that might mean for your purchasing power—and your portfolio. Now it’s happening: The recovery is in full swing. Consumers have cash to spend, and there’s a pent-up desire for everything from big-ticket items, like housing and cars, to smaller spends, such as dinners out, clothing, and plane tickets.

Consumer prices in May rose by 5% from a year ago; and that’s stoking fears of an economic threat we haven’t seen in years: out-of-control inflation.

Should You Be Worried?

The answer to that question can vary greatly depending on who you ask. If you read the headlines, you’ll find views are split about what all this means moving forward. Certainly, inflation concerns are growing among businesses, consumers and investors. At this point, however, few economists are sounding dire warnings about uncontrollable or chronic inflation.

For years, inflation has remained below the 2% annual target set by the Federal Reserve. The Fed’s Chairman Jerome Powell seems confident they can keep it in check even as the recovery kicks into high gear.

Testifying before a congressional oversight panel on June 22, Powell restated his opinion that the recent jump in inflation would be temporary, and blamed the rise in costs on several factors. Sharp price declines in 2020, at the start of the pandemic, are making current numbers look much larger, Powell said. He also noted higher gas prices, supply bottlenecks and increased consumer spending as the economy reopens also are contributing to price increases.

We cautiously agree. At Octavia Wealth Advisors, we believe that in the short term, the price spikes we’re seeing will subside. After that, we expect a more moderate form of inflation will set in for the next year or two. A moderate inflation rate is normal and even healthy for a growing economy.

So…What’s Next?

Of course, the economy is predictably unpredictable. And because the situation we’re currently in is unprecedented, it’s especially difficult to say what will happen next.

Financial experts—including the team at Octavia—will be keeping an eye on a few factors, including:

• The Federal Funds Rate: The Fed has a dual mandate: to keep prices stable and support sustainable employment. When necessary, it may attempt to keep a lid on inflation by raising interest rates. In mid-June, the Fed’s Federal Open Market Committee (FOMC) unanimously left its benchmark short-term borrowing rate at near zero. However, committee members signaled there could be a sooner-than-expected rate increase in 2023, instead of 2024 as the group indicated in March. A rate hike can affect borrowers, savers and investors, so it’s definitely something to watch.
• Personal Savings and Consumer Demand: Yes, some U.S. consumers are flush with cash, thanks to stimulus checks and other relief programs. Will they spend it? Now that the economy is opening up, it sure looks like it. But surveys suggest many plan to save at least a portion of that money. And higher prices may cause cautious consumers to think twice before throwing their money at expensive goods and services.
• The Workforce: Will the current labor shortage continue and force employers to raise wages? Or will businesses that struggled to survive during the pandemic be more restrained when it comes to pay increases? It could be difficult to determine what employment and wage pressures will look like until federal unemployment benefits expire, schools reopen in the fall, and companies and their workers resume normal operations. But wages and inflation can feed off each other, so this is something we will continue to monitor.
• Inflation Expectations: You’ve likely heard of a “self-fulfilling prophecy,” or when a belief influences a behavior. “Inflation expectations”—the rate at which people expect prices to rise in the future—can work the same way. If inflation expectations rise, actual inflation tends to rise to meet it. Businesses may end up raising their prices, and workers may ask for higher wages. Which is why it’s important to stick to the data when determining the true risk that inflation will rise, and keep rising, beyond the Fed’s target rate of 2%.

How Can You Prepare for Inflation?

Inflation risk will always be an important factor to consider. We believe that’s something everyone—retirees and soon-to-be retirees, in particular—should keep in mind when creating their short- and long-term budget, income and investment plans.

Understanding inflation is a crucial part of financial planning, because it can give you an idea of how well your investments need to perform to maintain your standard of living. We’re prepared to discuss that at any time.

If inflation predictions have you feeling especially anxious about what’s coming, and what it could mean for your pocketbook and portfolio, talking with your Octavia wealth advisor could help. Please feel free to reach out to discuss your ideas or concerns. We can review the potential risks and opportunities in your portfolio and overall financial plan, and we can make adjustments if necessary.

Rest assured that the Octavia team will be watching this situation closely, and we’ll keep you informed of any developments that are pertinent to you and your family.