Is Inflation Here to Stay?

Let’s jump back to 2019. You enter your local McDonald’s drive-thru listening to the newly-released “Lover” by Taylor Swift and purchase a Big Mac for $4.39. Fast forward to today, that same Big Mac costs $5.29 (and you’re still listening to “Lover” by Taylor Swift because while the price of fast food has changed, your taste in music likely hasn’t). The 21% Big Mac price increase tracks well with the CPI (Consumer Price Index), which was up 23% in the same period.

Introduced by The Economist magazine, the Big Mac Index is a tool used to measure purchasing power parity between nations. McDonald's is everywhere, and the Big Mac is the same, which allows for easy price comparison of an identical good across different economies. According to this theory, exchange rates should adjust over time to equalize the cost of an identical basket of goods across different nations. In this case, the basket of goods is represented by the price of a Big Mac.

Big Mac vs. Inflation

Percentage Increase from 2019-2024

Why should you care about Bic Mac prices and the CPI?

The Federal Reserve Bank, commonly addressed as the “Fed”, just released monthly CPI numbers, reporting consumer prices up 3.3% from a year ago, coming in cooler than the expected 3.4%. The ever so slight easing of the change in prices of all goods and services, including housing, food, clothing, transportation, medical care, etc., is a move in the right direction, however, Jerome Powell, chairman of the US Federal Reserve Bank, remains committed to returning the inflation rate to the Fed’s 2% long-term goal, awaiting greater confidence that inflation is moving sustainably to 2% before initiating rate cuts. 

Taking a step back, any action the Fed takes is with the goal of maintaining the purchasing power of the dollar and ensuring jobs are plentiful. The lever they pull is interest rates. With lower interest rates, consumers are incentivized to borrow more and with that comes an influx of capital into the economy. With a high-interest rate environment, people spend less, demand decreases for goods and services, and prices stabilize.

You may feel consumer prices have not fully stabilized and do not properly reflect the inflationary pressures experienced on everyday items. Within every category, there are nuances between headline inflation and the true effects everyday consumers are feeling. For example, housing, rent, and restaurant meals jumped 4.6%, 5.3%, and 4.0% respectively over the last year. Keep in mind, these reported numbers are year-over-year comparisons. While prices are growing more slowly, that doesn’t mean things are costing less. Cumulative inflation shows a 23% increase over the last 5 years, and 33% increase over the last 10 years.

Decoding inflation

Even as the Fed works to curb inflation through high interest rates, inflation remains persistent. Historically, the CPI has shown relatively stable inflation rates of around 2% annually from 2014 to 2019. However, the COVID-19 pandemic disrupted this stability, causing inflation to surge above 7% in 2022 due to supply chain issues, increased energy prices, labor shortages, high consumer demand, and other economic impacts. This led to the series of interest rate hikes. Understanding the causes and continuance of inflation is essential for both consumers and investors.

Several key factors contribute to the ongoing inflationary pressures we experience. Here’s just a few:

-Supply Chain Disruptions: The COVID-19 pandemic severely disrupted global supply chains, causing ongoing delays and shortages that have driven up manufacturing and shipping costs, ultimately increasing consumer prices.

-Geopolitical Tensions: Events such as the Russia-Ukraine conflict have further strained global supply chains, particularly in energy and food sectors. Sanctions and trade restrictions have led to higher prices for oil, gas, and wheat.

-Deglobalization: A combination of supply chain failures and geopolitical tensions have spurred major powers like the U.S. to prioritize secure access to food, energy, and tech, shifting from global efficiency to localized, higher-cost production.

-Labor Market Dynamics: Labor shortages and higher wage demands have significantly contributed to inflation, as businesses raise wages to attract employees, resulting in higher operational costs passed on to consumers.

-Monetary Policy: While the Federal Reserve has increased interest rates to curb inflation, the effects take time to materialize.

-Current Debt Crisis: Higher interest rates increase government debt payments, requiring more money printing and exacerbating inflation.

Is your portfolio well poised to fight inflation?

In addition to increasing the price of everyday goods, inflation also erodes the real value of savings, retirement funds, and investments. When considering how to combat inflation, a well-diversified portfolio is essential. If you are packing for a backpacking trip across Europe, instead on just relying on one type of clothing, you pack a variety: a raincoat, a sweater, a hat. Each item serves a specific purpose and provides unique comfort and protection to changes in weather. Similarly, diversification in investments during periods of high inflation is like packing for that journey. Asset classes behave differently in inflationary environments. Just as you don’t want to get caught without a raincoat in a storm, you diversify your investments to weather the impact of inflation on your portfolio, each asset providing a unique offering such as stability, growth, or income. Together, a balanced strategy that safeguards your financial journey is created. 

Protecting the wealth of a portfolio in an inflationary environment requires strategic portfolio construction, ensuring the portfolio maintains its purchasing power over time. By continuously monitoring, diversifying, and adjusting asset class strategy in response to economic indicators, one can safeguard against the effects of inflation, thereby preserving and enhancing wealth.