Breaking Down the New Inflation

  |   December 23, 2021

A follow up to the November 3, 2021, REDW Wealth Management Update webinar series

If you’re following the news, you may have noticed that inflation has been creeping up recently. Should you be worried? REDW Wealth examines the new era of inflation and its effects on your investments.


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Historical Inflation Rates Rising

First, let’s start with a little bit of background on inflation. The charts below show two measures of inflation. The bottom chart (green series) is typically what we call headline inflation, or the consumer price index (CPI). This is the one most often mentioned in the news, but there are multiple layers of CPI. 

Historical Inflation Rates Rising - US Core PCE Price Index YoY, US Consumer Price Index YoY, 2021

For example, we can see on the top chart (blue series) that inflation has been really low over the last 30 years. This chart represents how the Federal Reserve measures inflation, which is similar to the core Consumer Price Index, as it excludes food and energy price movements. Both measurements are higher than they’ve been in a long time.

In a nutshell, inflation is now the highest it’s ever been in the range shown the top chart. Referencing the bottom chart, you can see that, in the last 30 years, there’s a similar spike in inflation back in 2007-2008. Back in 2007, oil was hitting between $140 and $150 a barrel, so that really contributed to high inflation, followed by a crash in oil prices.  

With the green series, the drop looks significant, but when you smooth it out over the long run, the peaks and valleys look more shallow—that’s where the blue series comes into play. Any way that you look at it, inflation, by at least two measures, is between 3 percent and 6 percent right now. 

U.S. Monetary Supply Increases Inflationary Pressure

Below is another chart that the REDW Wealth Investment Committee reviews periodically, showing the Gross Domestic Product (GDP) growth over the last five or six years (the bottom, gray series below) 

Gross Domestic Product (GDP) growth trend from 2017 to 2021You can see the trend in GDP growth was pretty positive, even though we had a drop last year. Now look at the top, blue series, which represents the U.S. money supply growth. It used to go hand in hand with the GDP, or economic growth, until about a year and a half ago. The big difference here is that we hit a recession, but more importantly, the Federal Reserve increased the money supply significantly. And when there’s more money in the system, it’s got to go somewhere and that generally contributes to inflation. 

Relationship Between Purchasing Power and Inflation

What does that all mean for you? The below CPI chart breaks down typical expenses for American families 

Consumer Price Index (CPI) Weights for American families

In this chart, you can see that most of the Consumer Price Index is attributed to housing, which makes sense – for a lot of us that’s the biggest bill we have to pay. Housing includes some mortgage numbers, but essentially it equates to the cost of rentals. Food and beverage also makes up a big portion of CPI, followed by transportation. Smaller shares of CPI come from medical, recreation, education, apparel, and other expenses. Housing, energy and food comprise three quarters of the Consumer Price Index. 

Why is inflation a big deal? Inflation erodes the purchasing power of cash savings.  

The chart below can be challenging to read, but essentially the gray bars indicate the interest you would get from holding $100,000 in your savings account. The short blue lines on top of the gray bars show the savings income needed for you to beat inflation. Going back to the mid-90s, when interest rates were much higher, you would get roughly $5,000 (or almost $6,000 in some cases) on a $100,000 savings account or about 5 percent interest. Later on, the savings interest income falls below the blue lines – that’s the inflation number. If the gray bar of your savings interest income passes the blue line, that means you’re doing better than inflation. 

Cash Account Returns - Income Earned on $100,000 in a savings account and income needed to beat inflation

That was the good news back in the ’90s, but there’s been a real disconnect in the 2000s. Over the last 10 years, our savings interest hasn’t kept up with inflation, even though inflation was low, around 2 percent. With inflation at almost 4 percent, a savings account earns only $70 on a $100,000 account.

You lose purchasing power by staying in cash, which is why we’re seeing a lot of growth on the investment side from real estate, stock market, bond markets, and other non-cash assets. 

Staying Ahead of Inflation

Because we encourage diversification at REDW Wealth, a lot of our clients already have good stock exposure and tend to do pretty well in an inflationary environment. More conservative clients may hold more bonds, so we’ve been adding Treasury inflationprotected securities to their portfolios and replacing lower interest rate bonds with higher interest rate bonds. See the next graphic for a list of inflation-sensitive investments. 

Inflation Sensitive Investments: TIPS, Commodities, REITs, Equities, Infrastructure, Cash, Some Bonds

Key takeaway:

We all need some portion of our portfolios in cash. But if you have an overwhelming amount of cash, consider investing more in financial vehicles designed to combat inflation.  

Update:

Shortly after our webinar, the Federal Reserve announced that they would slow down the purchases of government securities, which slows down their stimulus. More recently, Federal Reserve Chairman, Jerome Powell, mentioned that inflation isn’t as transitory as initially expected and they will be monitoring it more closely. This means that the Federal Reserve may stop their stimulus and start to raise interest rates sooner than expected. 

If you’d like to discuss your investments with an REDW Wealth advisor, please contact us.