Inflation is everywhere: Cars and groceries cost more, your home heating/cooling bill is bigger, restaurant prices are up, and gasoline prices are at record highs. When will there be relief?
Ameriprise Financial Chief Economist Russell Price answers the inflation questions clients are asking.
What is inflation?
Inflation is an increase in prices as measured across a broad range of goods and services. In the years prior to the pandemic1, the U.S. inflation rate averaged 1.8%, according to the Labor Department. The impact of high inflation is what economists call a loss of purchasing power, meaning you pay more for the things you normally buy, which can reduce the quantity of things purchased.
What has caused higher inflation during the pandemic?
Surging COVID-19 cases over the past two years impacted the workers who produce, ship and store all the goods we buy (i.e., the supply chain). Simultaneously, demand for goods increased as more consumers were at home not spending as they normally would on services such as vacations. Recently, food and energy prices have also been pushed even higher due to shortages created by Russia’s invasion of Ukraine.
What are examples of goods and services?
Goods range from everyday items such as food and gasoline to durable items such as clothing, furniture, household appliances and cars. Examples of services are restaurants, doctor visits, airline fares and hair stylists.
Why is inflation still so high?
It is a combination of factors. But most of the recent higher prices have come from goods, rather than services. Some items, such as automobiles, have experienced parts shortages, limiting their availability. More broadly, fewer workers handling the jump in demand led to expensive bottlenecks at shipping ports, limited trucking transportation and overpacked warehouses. It will take some time, but demand should slowly ease, and supply chains should slowly increase the volume of goods being transported to retailers.
Energy prices, however, are likely to remain high and could go even higher. Global production has not kept pace with rising demand and refinery capacity has become a constraint. It could take a few years for the market to rebalance.
When will we get some relief?
Inflation could begin to ease over the summer. We currently project inflation, as measured by the Consumer Price Index, to end 2022 in a range of about 6.0% to 7.0%. Such rates would still be much higher than pre-pandemic averages of just below 2% but they would represent a noticeable deceleration from current levels.
As virus conditions ease, some consumer spending is likely to shift back to services such as vacations, movies and concerts. This should allow the supply chain to further recover and reduce the pressure on prices for goods.
Is this a repeat of 1970s inflation?
The current U.S. inflation is not a repeat of 1970s inflation, in our view. Both periods have their own unique circumstances.
In the 1970s, the excessive inflation situation was allowed to linger much too long, and over several years inflation became deeply ingrained. Today, the Federal Reserve has committed to aggressively containing inflation’s surge and we believe they have ample tools to achieve this over the course of several quarters.
Are certain products or services seeing more price hikes than others?
Automobiles, energy and food have experienced some of the largest price increases. In May, new-vehicle prices were 13% higher year-over-year, according to the Consumer Price Index. Used-car prices were up even more, rising 16% from the prior year. Food prices, meanwhile, were a difficult 10% higher than their year-ago levels and gasoline was a dramatic 49% higher.
What’s the outlook for energy and food prices?
Energy and food prices have seen added upside in recent months because Russia and Ukraine are normally large global suppliers.
Unfortunately, we believe higher energy prices are likely to linger, and could go even higher. Globally, energy production needs to increase, and refinery capacity needs to expand. Both take time under the best of conditions. Drillers have been reluctant to invest in such activities given broad efforts to slowly transition away from fossil fuels.
Does inflation affect my investments?
The burden of higher prices and rising interest rates is slowing economic activity, and we could yet see a mild recession. Financial markets have also come under pressure due to the uncertainty of how high interest rates will have to rise to contain inflation. Higher interest rates mean lower bond prices. But as interest rates rise, it creates better re-investment opportunities.
Additionally, long-term investors should avoid making major portfolio changes based solely on today’s conditions. Historically, market pull-backs have proven to be opportunities for investors to purchase assets at lower prices.
What could help lessen the impact of inflation on my investment portfolio?
If it supports your financial goals, risk tolerance and time horizon, you could consider allocating more to stocks with a history of solid dividend growth. That may provide a hedge against inflation for some investors. Dividends are a cash return on your investment in a stock, but dividends are not guaranteed and can be impacted by taxes and inflation.
If you have questions or concerns, your Ameriprise financial advisor is ready to help. Offering personalized advice based on your financial goals and needs, they can help you navigate market and economic cycles over time.