Navigating Inflation: A Guide for Consumers

Surviving a challenging economic environment

In like a lion, out like a lamb, as the saying goes. In March of 2022, however, the Federal Reserve is flipping that script as it raised the Federal Fund Rate by 25 basis points (0.25%) and, by the end of 2022, potentially raising it an additional seven times, according to recent reports.

After years of pumping government money into the economy via stimulus checks, coupled with ongoing issues tied to the global supply chain, inflation – or the rate prices of goods and services increase over time – is now at its worst in 40 years.

To put it into perspective, the average annual inflation rate traditionally hovers between 2 and 3 percent per year. This means one U.S. dollar buys 2 to 3 percent fewer goods and services per year, a mostly manageable rate that typically paces with annual wage increases.

Today, spurred by the COVID-19 pandemic driving prices in the labor and sales markets, inflation is hovering around 7 percent and potentially trending higher.

Many consumers will not be able to keep pace with this level and will be forced to curtail spending as the dollar loses its value and purchasing power continues to diminish. As consumers stop buying goods and services, some of the companies that make those products might need to make cuts to an already challenging labor market, resulting in a further decrease in consumer spending that could drive the economy into recession.

The Federal Reserve needs to act now to help slow the economy, decrease demand, and get inflation back to more stable, sustainable levels.

What is the role of the Federal Reserve?  
The primary role of the Federal Reserve Bank, or the Central Bank of United States, is to manage the country’s money supply and make interest rate decisions that help keep the cost of goods and services stable to ensure the economy grows at a steady pace.

It accomplishes this by targeting and controlling the nation’s money supply to ensure adequate liquidity or removing excess liquidity through open market operations.

During times of high inflation, which is monitored via the Consumer Price Index (CPI), the Federal Reserve increases the sale of government bonds to banks, which helps decrease the money supply, and drives interest rates up.

As commercial banks purchase such securities, there is less money to lend the general public, which reduces credit creation capacity and the supply of credit available to consumers and small businesses. Together, these efforts curtail consumption due to limited supply and overall demand, helping to bring inflation levels down.

On the opposite side, when the Federal Reserve starts buying such securities, the cycle is reversed and money is pumped back into the economy, spending increases, and interest rates decrease. This drives economic growth as consumers are able to do more with each dollar they spend.

How Does the Federal Reserve Set Interest Rates?
The Federal Open Market Committee (FOMC) is the Federal Reserve’s policymaking body. It consists of 12 members from the Federal Reserve System, the 12 Federal Reserve Banks that provide financial services to other banks and government entities. These are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, and St. Louis.

The FOMC holds eight regularly scheduled meetings per year to review economic and financial conditions, determine monetary policy and assess the risks to long-run goals of price stability and sustainable economic growth. Additional meetings can be added as needed throughout any given year.

During these meetings, the committee discusses developments in the financial and foreign exchange markets, activities of the New York Fed’s Trading Desk, which is where U.S. government securities are bought and sold, and reviews economic and financial forecasts, including the state of the Federal Funds Rate.

The meetings conclude with a decision on the stance of the fund rate policy and whether to leave it where it is, to raise it, or to lower it. In short, the Federal Fund Rate establishes the interest rates commercial banks then need to charge on the credit and loans they provide to their customers.

At this time, there is a great deal of speculation on what the FOMC will decide for the remainder of 2022. Although increasing interest rates is a helpful market correction over the long term, that decision will not come without a significant cost to consumers and small businesses as the cost of goods and services continue to rise and interest rates on borrowed cash and credit increases.

Consumers who are currently carrying high-interest consumer debt, those without a fixed loan or mortgage, or those who hold a majority of savings in cash are particularly susceptible to potential market fluctuations driven by increased interest rates. These individuals should take immediate steps to mitigate potential near-term losses, particularly for those who are close to retirement.

Planning for inflation is a challenging endeavor and advice and guidance from a professional financial advisor is highly recommended. Charles Claver, Senior Vice President and Director of the Private Wealth Advisor team for First Bank Wealth Management, is offering his thoughts on how consumers and small businesses can best navigate the rocky landscape ahead, while protecting assets and maintaining cash flow.

According to Claver, these seven key areas should be top of mind:

1. Refinance to Lock in Rates  

Home values continue to go up and interest rates are currently still relatively low. That is why now is the time for everyone with a mortgage to investigate refinancing to secure a better rate. Those with an Adjustable Rate Mortgage (ARM) should take steps now to shift into a fixed-rate mortgage as inflation remains high and interest rates are poised to spike.

Refinancing is also a good option for those who want cash on hand in case of an emergency. However, the window on refinancing is closing, so it is important to take action now.

2. Shop the Job Market   

Wage increases cannot keep pace with current inflation levels. For those considering making a change, or concerned about inflation and maintaining current wage levels, now is the right time to consider shopping the job market.

Today, it seems nearly every company is looking for qualified employees and most employers are willing to pay a premium to staff up. Now is the time to seek out a new position or consider leveraging a new offer to secure a raise from a current employer to help offset the ongoing rising cost of living.

3. Cash is Not King  

During times of inflation, cash in the bank quickly loses its value. With inflation on a significant rise, cash in the bank is essentially losing significant value every year going forward. If there is more than one month’s budget of cash in a checking or savings account, consider investment options.

One option is to take cash out and invest it in the market. Although the markets tend to be more volatile during periods of high inflation, those with significant cash in savings could also consider investing in Treasury Inflation Protected Securities (TIPS). These appreciate with inflation, which can serve as a big help in protecting against value loss.

4. Diversification is Key

A diversified portfolio is generally a good hedge against most negative economic conditions. For instance, when stocks go up, bonds tend to go down. But, when stocks go down, bonds go up. Owning both assets helps insure that whatever the economy is doing, an investor is relatively protected from a significant loss.

The best way to diversify amongst all of these asset classes is to purchase indexed funds. These funds have low fees and offer broad exposure to the market. With several different indexed funds across market sectors, investors can find themselves in a low-cost, relatively low-risk position. Learn more about investment options.

5. Lower High-Interest Debt

It is critical to begin shifting away from high-interest consumer debt. Those with high credit card balances, for example, could consider a Home Equity Line of Credit (HELOC). A HELOC is also a good option for those in the midst of starting a major home renovation project.

6. Explore Life Insurance Investment

Explore some life insurance investment options. While most people think of life insurance as providing a death benefit if someone dies, life insurance has also grown to include lifetime investment components in more recent years.

Permanent life insurance, like whole life or universal life, can provide alternative forms of relatively low-risk investing. Moreover, life insurance returns are strongly-tax preferred and there is often substantial flexibility for changing investment strategies, covering future needs, like long term care, and accessing returns all without incurring a tax bill. 

Some life insurance products, like indexed universal life, offer market growth opportunities while strongly limiting down-side risk. Learn more about life insurance options.

7. Retire Smart for Portfolio Growth

Retirees who are living off savings should also take caution. Inflation will have a significant impact on those who keep savings in cash, particularly if retirement plans are poorly planned.

A well-diversified portfolio, which includes a healthy mix of stocks, bonds, and alternative investments, can often grow faster than the rate of inflation.

For more information on these topics, or for professional perspectives on any other aspect of financial planning, contact a trusted advisor at First Bank.