Inflation Is Raising Interest Rates, but Investors Stand To Benefit

This year has been economically challenging largely due to soaring inflation and mounting uncertainty. Since February, the Consumer Price Index (CPI) has persistently demonstrated the highest year-over-year readings we’ve seen in over 40 years. Inflation rates reached as high as 9.1% as of June 30, 2022 — and have remained above 8% ever since.

Several factors have contributed to the price pressure, including COVID-induced supply chain disruptions, surging consumer demand, tight labor markets and geopolitical distress due to the war in Ukraine.

Ultimately, we’re experiencing a technical imbalance, where the demand for goods and services outpaces its supply. The bigger the gap between demand and supply, the higher the rate of inflation. Unfortunately, prices will continue to rise as long as the gap exists.

What Is Being Done To Fight Inflation?

The U.S. Federal Reserve, which is responsible for maintaining price stability and maximizing employment, has been working to close the inflationary gap. It does so by implementing restrictive monetary policies designed to weaken consumer demand and slow the rate at which money changes hands.

The Fed’s most prominent move has been raising the federal funds rate, which is the overnight lending rate for depository institutions, such as banks, as well as the foundation for all longer-term lending arrangements. Over the past nine months, the rate has soared from a target range of 0% – 0.25% to 3.% – 3.25%, the highest level since early 2008.

The dramatic increase has had a noticeable ripple effect on loans of all types and tenures. For example, the average weekly rate for a 30-year, fixed-rate residential mortgage has jumped from about 3.25% at the start of 2022 to 6.75% in late September.

This has had a huge impact on home affordability for the average consumer. According to Zillow, in January, an individual with good credit could buy a $300,000 home (with 20% down) for a monthly payment of about $1,650, inclusive of taxes, fees and insurance. Today, the payment has skyrocketed to around $2,150 — an alarming 30% increase.

Have the Restrictive Monetary Actions Worked?

Higher interest rates are significantly impacting borrowers and lowering the demand for loans, but the Fed’s efforts have yet to make a definitive impact on inflation. Many economists attribute this to the fact the Fed’s toolkit is designed to curb inflation caused by demand shocks but has little-to-no impact on supply-side pressure. Moreover, they argue that we are simultaneously experiencing both types of inflation, with the demand shocks being predominant.

Whether or not you have confidence in the Fed, the delayed effect between rate hikes and inflation requires more time to gauge the impact. At this stage, a very cautious stance is critical. If the Fed continues to move aggressively before understanding the effect of its actions to date, it could tip the economy into a painful recession.

Higher Interest Rates Are Good for Investors

It’s clear that rising rates are a burden for borrowers, and if rates rise too fast, it could throw the economy into a tailspin. That said, high inflation can be a good thing for some investors, especially those struggling to meet their spending needs.

Conservative investors have been crippled with ultra-low yields for nearly 15 years — ever since the Great Financial Recession. Fortunately, an assortment of secure savings vehicles and high-quality, fixed-income investments are finally starting to throw off some attractive yields. A couple of the most prominent investment vehicles during inflation are described below.

Best Savings Vehicles During Inflation