Is the Current High Rate of Inflation Temporary?

Back in April 2021, U.S. Federal Reserve Chair Jerome Powell was widely quoted as saying the high rate of inflation was "transitory." He said his expectation was inflation would be temporary. This was despite the fact the U.S. government had pumped $4.5 trillion into the economy in pandemic relief funds. Indeed, the economy was already showing signs of overheating. Still, Powell felt the Fed could reasonably target an annual inflation rate of around 2 percent.

Fast forward a year later and any suggestion that the rate of inflation is a temporary blip has long receded. The U.S. inflation rate is 8.6 percent—a 40-year high—easily crushing Powell's optimistic expectations.

Takeaways

• What is contributing to the high rate of inflation

• Understand the influence of the central banks

• Ideas for inflation-hedging strategies

What's causing the high rate of inflation?

Economists blame a variety of culprits causing the current bout of high inflation. Many agree the main culprit is the huge expansion of the money supply. In the United States, the Federal Reserve employed aggressive fiscal and monetary policies in response to the pandemic. The Fed deliberately kept interest rates low to spur growth.

Meanwhile, the Trump and Biden administrations showered the economy with trillions of dollars in relief funds. Inflation ramped up as the supply of currency grew faster than the nation's economic growth.

But let's not forget ongoing supply chain problems, increased demand, surging production costs, spiking gas prices, and the war in Ukraine. All of this combined to make the perfect storm for accelerating inflation. The Consumer Price Index has shown consistent increases for 2022. Over the last year, the cost of food is up 10.1 percent, while energy costs have rocketed up almost 35 percent.

Source: US bureau of labor statistics

Inflation shocks consumers and stymies investors

One easy way to visualize how detrimental inflation has been to the average consumer is to consider it in context of wages earned. Simply put, high inflation erodes a consumer's purchasing power.

This is particularly harmful when inflation outpaces wage growth, as we see in the below Statista infographic. Yearly inflation in the UK is almost double that of salary growth, meaning workers' larger paychecks are not enough to keep up with higher prices.

You will find more infographics at Statista

Investors are feeling inflation's impact as well. Inflation worries—combined with a fear of an upcoming recession—have set the markets into a tailspin.

Since the beginning of the year, the Dow has plummeted 15.4 percent and the Nasdaq has fallen over 20 percent. The S&P 500 is also down about 20 percent. You will have to go back to 1970 to find a year where the S&P 500 had a worst first half of the year.

When will inflation come down? What the experts say…

Bank of England

With prices already rising by 9 percent over the last year, UK governor of the Bank of England Andrew Bailey warned he cannot prevent inflation from climbing to 10 percent. Bailey says global food prices could reach "apocalyptic" levels.

The Bank of England predicts energy prices will spike higher this autumn. This will push the overall inflation rate to 10 percent. While not specifying a time, the Bank expects the current high prices are not likely to last.

Some economists are doubtful of this prediction, however. In the past, it has taken years (not months) for inflation to come down once it has climbed over 9 percent. At the very least, these economists predict inflation will be high through 2023.

A critical factor is the war in Ukraine and its impact on energy prices. Previously, the UK government said Russian gas imports represent less than 4 percent of the nation's total gas supply. Still, the growing geopolitical uncertainty has spurred the UK to bolster its gas stockpile by entering into agreements with Norway to buy additional supplies.

Federal Reserve

Federal Reserve Chair Jerome Powell doesn't mince words when talking about the extent to which he's willing to hike interest rates to bring inflation down. His mission is to ensure inflation does not control the economy over the long haul.

Says Powell, "There's a clock running here, where we have inflation running now for more than a year." He says it would be "bad risk management" to succumb to the expectation of indefinite high inflation.

Thus, he indicates he will continue to act swiftly by raising interest rates and reducing the Fed's $9 trillion balance sheet until prices fall back to healthy levels. Of course, as we already mentioned, the real concern is if this plan will provide the U.S. economy with a soft landing or a plunge into recession.

How to protect your investments from long-term high inflation

It is open for debate whether the U.S. and UK are headed for recession. However, what is clear is that high rates of inflation can severely impact an investor's returns. Here we list some strategies you can use to shield your investments from long-term inflation.

Think like a contrarian

You could argue that Warren Buffett is one of the world's greatest contrarian investors. Contrarians typically buy assets that other investors ignore or refuse to buy. Indeed, Buffett sees opportunities when the market is bearish and doesn't hesitate to buy stocks in companies he believes are undervalued.

And herein lies the key to Buffett's contrarian strategy. He buys equities in companies that are fundamentally sound and are selling at a bargain price. He focuses on companies with valuable products or services, strong management, and long-term potential. When the price is low, he loads up.

As an investor, you can use the basics of fundamental analysis to do what Buffett does. As inflation continues and the markets trend downwards, hone your skills in spotting companies that are unfairly taking a beating.

Take a tip from this billionaire

Buffett isn't the only billionaire with advice about investing during inflationary times. American billionaire Ray Dalio is the founder of Bridgewater Associates, the world's largest hedge fund. He cautions investors against holding too much of their assets in cash as inflation spikes. Many investors believe cash is a safe haven, something Dalio argues against.

That's because fiat money loses value as inflation ramps up. As prices accelerate over time, your purchasing power declines. The money you hold today won't buy as much in the future. Even cash that you hold in interest-bearing accounts (such as savings accounts and certificates of deposit) will lose value as inflation outpaces the yield you earn.

According to Dalio, a better option for investors is to underweight cash. He suggests investors change their mindset and look at real returns—what an asset earns after subtracting inflation. If the real return is negative, investors should look for assets with returns that at the very least offset inflation.

Dalio sees the world as undergoing major political and economic uncertainty in the years to come. For this reason, he recommends investors keep a highly diversified stock portfolio in a wide range of stocks that are not tied too heavily to one geographic location.

Invest in real estate as a hedge

Stocks, gold, silver, and commodities all have their fans as inflation hedges. Real estate has become a popular hedge as well. This is mainly because of its historical long-term appreciation in value.

Still, some investors are hesitant to invest in physical real estate because of the time, expertise, and capital required to get started and generate a profit. Not everyone wants to become a landlord or take such a hands-on approach to their investing.

Because of alternative real estate investments now available, you can bypass these limitations. You can buy shares of companies that specialize in managing real estate. This gives you exposure to the sector without taking on the responsibilities of managing property yourself.

Some of these companies offer the opportunity for investment growth along with reliable dividends. Examples of these alternative investments include real estate investment trusts, exchange traded funds (ETFs), and mutual funds. Investors can get started with a small investment. Buying is often as easy as purchasing a stock.

Conclusion

Whatever strategy you decide is right for you, it's critical you have a plan and maintain a calm approach in your investing. As the markets become volatile, investors without a plan often fall prey to panic buying and selling. This rarely results in gains.

Also, be on the lookout for asset bubbles. While it might be tempting to invest in what everyone says is the "next big thing," make sure you're not jumping into a bubble that is about to pop. Look at the fundamentals of any investment you are considering. Be willing to take a pass on any investment that doesn't measure up, no matter how emotionally appealing.