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All Eyes on Inflation Thumbnail

All Eyes on Inflation

As demand recovers and both foreign and domestic economies alike continue to ease their restrictions, an inflation increase – if not an inflation scare – seems to be arriving.

Recent data has indicated that inflation is starting to creep higher. In March, the U.S. Consumer Price Index exceeded the Fed's mandated 2% inflation target for the first time in more than a year, when year‐over‐year inflation reached 2.6%. Commodity prices across the board are up, which will tend to show up down the line in higher consumer prices.

Energy‐related commodities were up about 30% in the first quarter of the year, which will ultimately mean consumers will be paying higher prices at the pump. Agriculture‐related commodities have also been trending higher, which may result in higher food costs for the consumer.

WHAT HAPPENS NEXT

One of the key ways that government has historically dealt with inflation is for the Federal Reserve to begin raising interest rates. But remember, the Fed has a twin mandate of countering inflation and pursuing full employment, and the jobs numbers are still a good deal lower than they were in the pre‐pandemic era. The Fed's view seems to be that the U.S. remains a long way from full employment, so it is committed to allowing inflation to run hotter than its traditional 2% goal in order to pursue full and inclusive employment.

Given this, and given that we expect these inflationary trends to continue for at least the remainder of the year, the back half of 2021 is likely to be a key period for countering inflation. With that in mind, it's helpful to take a look at some of the strategies you can use to help protect yourself against the effects of inflation.

REVISIT YOUR RETIREMENT PLANS

Inflation means, of course, that the things you plan to spend your money on will cost more in the future. Expenditures that can be expected to eat up a sizable portion of your cash flow, such as healthcare, can be subject to tremendous inflationary pressures. At the same time, some of your investments, such as fixed‐income instruments, suffer if inflation outpaces your expected return.

That makes this an ideal time to revisit your retirement strategy with your Baird Financial Advisor team. A robust, well‐constructed retirement plan is designed to withstand changes like a bout of inflation but it never hurts to double‐check and make sure your plan doesn't need any tweaks.

REVIEW DEBT BALANCES

Debt can be a double‐edged sword when inflation is rising. On one hand, you are repaying existing debts with money that's worth less than the money you borrowed, so it's advantageous to be paying off debt now. But if you're planning to take out a new mortgage, those rates could be moving higher, and if you have a variable‐rate credit card, expect to pay more for that as well.

There may still be time to make moves before rates rise significantly. It's a good opportunity to review what you owe and see if there are any chances to refinance or consolidate your debts into fixed‐rate loans. Your Baird Financial Advisor team can help with this.

LOOK TO INVESTMENTS THAT CAN COUNTER INFLATION

Traditionally, broad market stocks have been a hedge against rising inflation, but not a particularly strong one. Plain vanilla fixed‐rate bonds won't help, given that their returns don't change in response to the wider economy.

But there are some asset classes that may provide a bit of a hedge:

Financial Stocks ‐ Rising inflation expectations tend to coincide with steepening rate curves and easing credit conditions, both of which support bank stock prices.

Energy Stocks ‐ Energy should have little correlation to interest rates that are driven by volatile, rising inflation. Energy stocks also tend to provide dividends, which serve as another hedge against inflation.

Small‐Cap Stocks ‐ Small‐cap stocks are the only asset class that has outperformed inflation every decade since the 1930s. They have less exposure to foreign economies than large‐caps do, so they're less sensitive to trade wars.

Short‐Term Corporate Bonds ‐ Short duration investment‐grade corporate bonds provide a positive real yield and minimal sensitivity to both rising inflation expectations and rising real yields.

TIPS ‐ Treasury Inflation‐Protected Securities can provide the best protection against rising inflation expectations, as long as real rates don't rise.

None of these asset classes are a pure hedge against inflation, but you may want to consider combining them with other inflation‐fighting strategies in order to safeguard your financial future. Talk to your Baird Financial Advisor team about how you can stay protected against inflation.

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