Should We Be Worried About a Rise in Inflation?
In May of 2021, according to the US consumer price index, a variety of common household goods rose 5% compared to May of 2020. That gain was larger than anticipated by the US federal reserve and economists, and is the largest increase in prices since the summer of 2008. This unexpected rise has wall street and retail investors buzzing about what this level of inflation can mean for the markets and the economy.
To understand the effects of inflation, it is important to know what it is and where it comes from. Inflation is the rise in prices that a consumer pays for goods and services. For example if a carton of eggs cost $1.00 and inflation was 5% then the new price would be $1.05 for the same carton of eggs. Economists say that a 2% inflation rate is normal, and shows that the economy is in a healthy state since there is increasing demand for goods and services.
So does this mean a 5% rise is bad or something consumers should worry about? Well not necessarily. The present rise in inflation can be attributed to a few factors mainly pent up demand for goods and services as well as low interest rates. Basic economics tells us that if there is not enough supply to meet demand then the price of those goods will go up.
During the COVID-19 pandemic, people were sheltered at home and not able to buy goods from stores as they normally would, but were still earning similar wages as they were before the pandemic. Now that reopening is happening in the US, all of the built up demand to buy new clothes, go out to eat, or take a trip is happening at once. The problem is that manufacturers and service providers just do not have enough inventory and staff to handle all of this demand, which is where the price increases come in. This is why we see shortages in industries like computer chips, cars, and lumber.
Low interest rates also contribute to higher inflation since the cost of a loan over time is lower. For example, The interest paid on a $300,000 30-year fixed mortgage at a 4% interest rate is $215,242. If the interest rate is lowered to 2.5% with all other variables staying the same, the interest paid is only $126,540 which is a difference of over $88,000. This is a main factor of why demand for homes is so high, and why prices are seeing levels near the pre-2008 financial crisis across the US.
With an understanding of what inflation is and where it comes from, is it good or bad for a consumer's wallet?
For those holding cash, bonds, bank cds, and other investments alike, inflation is not the friendliest. If an individual is holding $1,000 in the bank, a 5% inflation hike means that cash is really only worth $995. The same goes for bank CDs and bonds, where say the fixed yield on the investment is 3% annually, a 5% inflation rate eats away at the full return and then some.
For investors holding stocks or owning a home, inflation is typically beneficial. Since stocks are equity in a company, and not an IOU like a bond, they will adjust upward with inflation as the revenues generated from the business’s goods and services will increase as well. Homeowners with a fixed mortgage rate will benefit since inflation will increase the value of their home, but the interest rate on the loan will stay the same.
In more recent news, according to the Fed, These high levels of inflation are not expected to last long, as supply chains are picking up and people are going back to work and consumer demand should normalize in the coming months.
Hardy Capital Investments is a registered investment advisor. Information provided on these sites is for informational and/or educational purposes only and is not, in any way, to be considered investment advice nor a recommendation of any investment product. Advice may only be provided by Hardy Capital Investments's advisory persons after entering into an advisory agreement and providing Hardy Capital Investments with all requested background and account information.
If you have any questions regarding our policies, please Contact Us at contact@hardycap.com