Inflation is the 2022 Song of the Summer. But is it a One-Hit Wonder?

My younger son made his Little League All-Star team, which is a fantastic accomplishment and something he’s worked hard towards these last few years. Unfortunately, he did so in a year when the All-Star tournament involves daily trips to Winston-Salem during a time when gas is approaching $4.70/gallon.

While there are many factors that are contributing to rising gas prices – such as pent-up travel demand from the pandemic and limited supply stemming from the ongoing war in Ukraine – knowing that doesn’t necessarily heal the immediate sting. And while we’ve seen the largest year-over-year increase in gas and other fuel prices, inflation has impact folks’ attempts to purchase anything from used cars to slabs of bacon.

After seeing headlines trumpeting inflation numbers that haven’t been seen in over 40 years, it’s understandable to start feeling a little beaten up at the cash register, and maybe even a little worried. I have no idea where inflation is going this month, next month or the next 12 months. But like with most things, a little bit of perspective may help re-frame what’s happening.  

Headline inflation isn’t necessarily your inflation. If you’re not driving a whole bunch, you might not necessarily be feeling the pain of higher gas prices. Alternatively, if you’re taking a road trip from North Carolina to the Grand Canyon…ouch.  It takes some effort, but if you can figure out how much you spent on things last June and compare it to now, you might see a personal inflation number below what the headlines are saying.

While not a perfect gauge, markets are not expecting high levels of inflation to persist. You can get a sense of the market’s ideas about inflation by comparing the rates of regular Treasury bonds and Treasury Inflation-Protected Securities (TIPS) of the same duration. (TIPS are special types of government bonds with fixed interest payments, but where the principal value can adjust based on inflation.). The point where the yields on these two different types of bonds is at equilibrium (meaning that one bond isn’t a better or worse choice than the other) is called the “breakeven point”, and it is often used as the best reflection of the market’s expectation of where inflation is headed.

As of now, the 5-year breakeven point is around 3.13% and the 10-year breakeven point is around 2.76%. Both are higher than they’ve been in a while, though lower than they were a month ago and certainly much lower than the ~8% inflation numbers we’ve seen on year-over-year data. That suggests that markets think that higher rates of inflation, while unpleasant, may be short-lived. (This article by Wes Crill of Dimensional Fund Advisors does a good job discussing the potential light at the end of the inflation tunnel.)

Your portfolio has inflation hedges in it. Historically, stocks have provided the best long-term consistent inflation hedges. Despite current volatility, it’s important to remember that the real returns of stocks (which is returns after the impact of inflation) far outpace any other asset class, and it’s not even close. While some assets are marketed as being inflation hedges – such as commodities – those asset classes don’t necessarily perform well over long periods of time and can lead to prolonged stretches of portfolio drag. And as for the claim that bitcoin can protect against inflation…well, that doesn’t seem to be holding up very well.

Don’t sleep on your cash. While stocks can be volatile in the short-term, their long-term return potential makes them a desired asset to hold. But cash? In an inflationary world where cash pays next to nothing, that’s a guaranteed loss. There’s just not enough return to offset the negative impacts of inflation. Instead of holding excess cash, consider these options:

• Make sure you’re keeping only as much cash you need. After an emergency fund and anything needed for planned expenses (including one-offs like a car, vacation, home improvement, etc.), move cash to accounts with higher expected returns, like your portfolio.
• Be smart with the cash you do keep. While savings account interest rates haven’t moved as high as we’d like, there are now some online accounts earning about 1%. That’s still not great, but it’s better than the almost 0% rate offered by most traditional banks.
• Consider Series I Savings bonds for cash you won’t need for 12 months. I-bonds are government bonds that pay a variable rate of interest based on inflation. As of now, I-bonds issued in May are paying 9.62%, which is far above anything else. But there are a few caveats:
  • There’s $10,000 limit on how much each person can buy per year, though there are some workarounds for folks with trusts and/or people who use tax refunds to purchase I-bonds.  
  • You need to hold I-bonds for 12 months before redeeming them.  
  • I-bonds redeemed before 5 years lose the previous 3 months’ worth of interest.
  • I-Bonds can only be purchased and held through the Treasury Direct website

Of course, there’s no guarantees about if/when inflation will return to more moderate levels. But hopefully this helps provide a little breather from the “sky is falling” stories we’re all seeing.