What to Make of Rising Inflation and the Current State of the Economy

Written by: Jared T. Tanimoto

Prices have been skyrocketing everywhere we turn, and it may take a while for things to start cooling off. With the recent Bureau of Labor Statistics release on the Consumer Price Index (CPI), inflation just reached a new 40-year high of 9.1%. We also see rising recession fears, as real GDP growth in the U.S. has been contracting; a second quarter print of negative growth qualifies as a technical recession.

Taking a peek under the hood, most of the slowdown in growth is concentrated within a subset of the economy and with the largest drivers of inflation. With respect to GDP, the primary drivers are residential investment, inventory, and net exports. On the inflation front, food and energy prices (which are in part tied to larger global supply issues) continue to drive over half of the recent gains. Regardless, prices across the board continue to rise—which seems to counter the narrative that inflation is starting to cool down. 

With the recent print, it’s highly likely that the Federal Reserve (“Fed”) will raise interest rates by at least 0.75% at the next meeting, with the possibility of higher or extended rate hikes in the future. Between declining GDP growth and surging inflation, the Fed is faced with a tricky balancing act—how to best adjust interest rates to curb inflation without triggering an official U.S. recession. When interest rates increase, it becomes more expensive to borrow money; this slows down how companies and consumers spend their cash. 

Despite a healthy job market and high wage growth, we’ve seen a steep decline in real wages as consumer prices have outpaced what people earn. One of the preferred indicators from the National Bureau of Economic Research shows a marked weakness in consumer spending as consumers buy fewer goods and moderate their spending on services. While there doesn’t appear to be an imminent recession on the horizon, this weakness could potentially spill over into the labor and services sectors, which could in turn lead us to a more traditional contraction. Regardless of whether or not this happens, it's clear that slowed growth will be a common theme in the months ahead. 

With out-of-control inflation and a heightened chance for economic trouble ahead, what are some things you can do now?  

Reduce Expenses

On the inflation side of the equation, planning ahead and reassessing your long-term plans can help set the stage for adjustments to your financial plan. Laying out your current costs and aligning them with what you truly value will help you decide how to shift spending and cut costs in certain areas of your life. If possible, find substitutes for items or services that have surged in price and look for ways to get rid of recurring subscriptions. 

Clients have joked around on how cutting something as small as a $9.99 Netflix subscription is supposed to help when their monthly gas expense has risen by $99, but we sometimes overlook the little items that add up over time. If those don’t move the needle, look up budgeting and savings hacks that could work well for you.

My favorite savings hack is the 24-hour rule. If you want to buy an item that you don’t actually need, put the purchase on hold for 24 hours to give you time to make a rational decision. If you want to take it a step further, wait 24 hours for every $100 of price. For example, if an item costs $700, wait one week before pulling the trigger. 

Increase Income 

Today there are nearly two job openings for every person unemployed. Employers added 372,000 new positions last month, but the unemployment rate remained steady at 3.6% despite troubles in the broader economy. This puts individuals in a decent position to negotiate for a higher wage or apply to new companies that are paying more. A side hustle, such as freelancing or selling items on eBay or Craigslist, are good ways to earn additional cash.

But before you go spending this money, consider building up a larger emergency fund, paying down any debt, and investing in the stock market. 

Continue Investing

In order to keep up with inflation, getting your money invested is crucial. For longer-term investors, it’s often hard to find the perfect inflation hedge with decent returns. This makes a diversified portfolio your best strategy.

Going back to 1950, the S&P 500’s median return one year following a bear market was 23.9%. While we don’t know how long it might take for the stock market to recover this time around, a long-term investor should be handsomely rewarded by entering the market while we’re still a ways out from our all-time highs. Dollar-cost averaging is one of the most successful strategies in investing and is a great way to allocate money in a down market. 

Although the real estate market has been in an uproar over the last few years—and locking in a high interest rate may not be appealing—there are still great opportunities to be found. Housing is a great way to keep pace with inflation while creating another potential source of income. 

For shorter time horizons, it might be wise to incorporate inflation-indexed bonds such as Treasury-Inflation Protected Securities (TIPS). TIPS are a type of security issued by the U.S. government, indexed to inflation to help investors protect their purchasing power. Another great security is the Series I Savings Bond, although limited to $10,000 per individual per year. It pays a variable interest rate linked to the Consumer Price Index. Through October 2022, Series I bonds are paying a record 9.62%. 

Remember, time is on your side. As a long-term investor, it’s normal to see periods of high and low inflation over your lifetime. Despite the chaos that may be going on around you, control what you can—and with some smart planning, you can ride it out. 

Related: How Investors Can Make the Most of a Bear Market