Inflation in the United States continues to rise, with the price index for American consumer spending (PCE index), the Fed’s preferred measure of inflation, rising at a rate of 4.2 percent in the year ended July, its highest level in over 30 years. Furthermore, core prices rose 3.6 percent, excluding volatile goods like food and energy. The figures come as a result of rising demand for products and services, which has outpaced supply systems’ ability to keep up following the Covid-19 lockdowns. Although the Fed is optimistic that inflation will fall, noting that it would likely lower its $120 billion in monthly asset purchases this year, the figure is still significantly above the Fed’s target of 2% inflation.
However, we believe that inflation will continue to be slightly higher than historical levels for some years. Personal savings, for example, have increased as a result of the epidemic, and the continuance of low interest rates over the next two years could result in higher prices for goods and services. Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Compared to the S&P 500, which is up roughly 18% year to date, the theme has returned around 15%. Exxon Mobil has been the best performer in our topic, with a year-to-date gain of 28 percent. Chubb’s stock has also performed well this year, with a gain of roughly 20% thus far. Procter & Gamble, on the other hand, has been the worst performer, with its stock climbing only roughly 4% year to date.
Inflation in the United States surged to its highest level since 2008 in June, as the economy continues to recover from the Covid-19-related lockdowns. According to the Labor Department, the consumer price index increased by 5.4 percent year over year, while the core price index, which excludes food and energy, increased by 4.5 percent. Prices have risen as a result of increased demand for products and services, which has outpaced enterprises’ ability to meet it. Although supply-side bottlenecks should be resolved in the coming quarters, variables such as large stimulus spending, a jump in the US personal savings rate, and a continuance of the low-interest rate environment over the next two years could suggest inflation will remain high in the near future.
So, how should equities investors respond to the current inflationary climate? Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Year-to-date, the theme has returned nearly 16%, roughly in line with the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up around 35%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our topic, with a year-to-date gain of about 43%. Procter & Gamble, on the other hand, has underperformed, with its price holding approximately flat.
Inflation in the United States has been rising as a result of plentiful liquidity, skyrocketing demand following the Covid-19 lockdowns, and supply-side limitations. The Federal Reserve increased its inflation projections for 2021 on Wednesday, forecasting a 3.4 percent increase in personal consumption expenditures – its preferred inflation gauge – this year, a full percentage point more than its March projection of 2.4 percent. The central bank made no adjustments to its ambitious bond-buying program and said interest rates will remain near zero percent through 2023, while signaling two rate hikes.
So, how should stock investors respond to the current inflationary climate and the possibility of increased interest rates? Stocks in the banking, insurance, consumer staples, and energy sectors might stay constant or possibly gain from increasing inflation rates, according to our Inflation Stocks theme. The theme has outpaced the market, with a year-to-date return of almost 17% vs just over 13% for the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up almost 31%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our subject, climbing 56 percent year to far. Procter & Gamble, on the other hand, has lagged the market this year, with its shares down approximately 5%.
Inflation has been rising, owing to central banks’ expansionary monetary policies, pent-up demand for commodities following the Coivd-19 lockdowns, company inventory replenishment or build-up, and major supply-side constraints. Now it appears that inflation is here to stay, with the 10-Year Breakeven Inflation rate, which represents predicted inflation rates over the next ten years, hovering around 2.4 percent, its highest level since 2013.
So, how should equities investors respond to the current inflationary climate? Stocks To Play Rising Inflation is a subject that contains stocks that could stay stable or possibly gain from higher inflation rates. The theme has outpaced the market, with a year-to-date return of almost 18% vs just over 12% for the S&P 500. However, it has underperformed since the end of 2019, returning only roughly 1% compared to 30% for the S&P 500. The theme consists primarily of stocks in the banking, insurance, consumer staples, and energy sectors, all of which are expected to gain from greater inflation in the long run. Metals, building materials, and electronics manufacturing have been eliminated because they performed exceptionally well during the initial reopening but appear to be nearing their peak. Here’s some more information on the stocks and sectors that make up our theme.
Banking Stocks: Banks profit from the net interest spread, which is the difference between the interest rates on deposits and the interest rates on loans they make. Higher inflation now often leads to higher interest rates, which can help banks increase their net interest revenue and earnings. Banks, on the other hand, will benefit from increased credit card spending by customers. Citigroup and U.S. Bank are two banks in our subject that have a stronger exposure to retail banking. Citigroup’s stock is up 26% year to date, while U.S. Bancorp is up 28%.
Insurance stocks: Underwriting surplus cash is often invested to create interest revenue by insurance companies. Inflationary pressures, which result in increased interest rates, can now aid boost their profits. Companies like The Travelers Companies and Chubb, who rely on investment income more than their peers in the insurance industry, should profit. This year, Travelers stock has increased by around 12%, while Chubb has increased by 8%.
Consumer staples: Consumer equities should be able to withstand increasing inflation. Because these enterprises deal with critical products, demand remains consistent, and they can pass on greater costs to customers. Our theme includes tobacco behemoth Altria Group, which is up 21% this year, food and beverage behemoth PepsiCo, which is almost flat, and consumer goods behemoth Procter & Gamble, which is down around 1%.
Oil and Gas: During periods of rising consumer prices, energy stocks have performed admirably. While growing economies are good for oil demand and pricing, huge oil corporations have a lot of operating leverage, which allows them to make more money as revenue climbs. Exxon Mobil, which has gained a stunning 43 percent this year, and Chevron, which has risen roughly 23 percent, are two of our theme’s picks.
Heavy equipment manufacturers, electrical systems suppliers, automation solutions providers, and semiconductor fabrication equipment players are among the companies in our Capex Cycle Stocks category that stand to benefit from increased capital investment by businesses and the government.
What if you’d rather have a more well-balanced portfolio? Since the end of 2016, this high-quality portfolio has regularly outperformed the market.
Is inflation beneficial to banks?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic output.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
Is inflation bad for banks?
They lose because they are net monetary creditors. However, they benefit as demand deposit issuers. The second effect may easily outweigh the first with more indexing and more accurate forecasting of future inflation.
Bankers have recently learned to recognize and manage interest rate risk. Bankers learned of the need to hedge their balance sheets against this risk by applying duration analysis, thanks in large part to the efforts of the editor of this journal in a series of articles in American Banker. The duration of equity (a value-weighted average of the durations of assets and liabilities) was set to zero to protect the bank from interest rate risk. With this position, the bank was considered to be immune to modest changes in interest rates. However, this immunization technique only safeguarded the bank’s nominal market value, not its real market value that is, the bank’s market value in today’s dollars, not the bank’s market value in inflation-adjusted dollars. This post aims to start a conversation on how to correct this oversight.
Do banks profit or lose money as a result of inflation? Is it the rate of inflation or the rate of change that matters? Is the impact of pricing changes symmetric? Is it true that disinflation has the same but opposite effects as inflation? What role do expectations play in the process? Is it possible for banks to avoid these consequences?
We’re mostly interested in the impact of shifting prices on net interest income and capital values here. The impact of inflation on noninterest revenue and expenses, as well as the real resource production function of banks, will be discussed in future articles. This latter assumption equates to the plausible (but controversial) belief that actual (inflation-adjusted) noninterest revenue and expense are unrelated to price changes for the purposes of this article.
The focus is on how inflation affects banks, rather than how banks have been affected by specific inflations. As a result, we exclude factors such as increased bank competition and regulatory changes (both of which have a significant impact on bank earnings), as these are not always caused by inflation.
We start by going over the economic literature and the basic “overview” ideas. We then show how both theories are subsets of a broader approach whose major components are rates of change in expectations and portfolio adjustment speeds. The more comprehensive hypothesis serves as a foundation for future research.
In the economics and finance literature, the impact of inflation on actual bank earnings has been extensively explored. There are two competing and opposing models. Banks, according to Alchian and Kessel (A-K), are net monetary creditors (i.e., their nominal assets are greater than nominal liabilities). As a result, rising prices would reduce the value of their nominal assets more than their nominal liabilities. As a result, banks will lose money during an inflationary period.
The inflation tax school, on the other hand, argues that because banks’ demand deposits account for a component of the money supply, they should be able to capture a piece of the inflation tax and so profit during an inflation….
What industries benefit from inflation?
Inflationary times tend to favor five sectors, according to Hartford Funds strategist Sean Markowicz: utilities, real estate investment trusts, energy, consumer staples, and healthcare.
Do banks fare well during a downturn?
First, during a recession, interest rates tend to fall. Because banks’ principal business model is to lend money and profit, lower interest rates tend to result in reduced earnings. For instance, if a bank’s average vehicle loan interest rate is 5%, it will make significantly more money than if the average rate is 3%, all other circumstances being equal.
Second, and more importantly, during recessions, unemployment tends to rise, and more consumers get into financial difficulty. Consumers sometimes have difficulties paying their bills during recessions, which can result in an increase in loan losses for banks.
The longer answer, though, is that each bank is unique. Consumer banking (accepting deposits and lending money) is very cyclical, particularly for banks that specialize in riskier forms of lending like credit cards. Investment banking, on the other hand, performs even better during stormy times, therefore banks with strong investment banking businesses typically see profits hold up well. Goldman Sachs, for example.
Who benefits the most from inflation?
Inflation is defined as a steady increase in the price level. Inflation means that money loses its purchasing power and can buy fewer products than before.
- Inflation will assist people with huge debts, making it simpler to repay their debts as prices rise.
Why are banks so afraid of inflation?
When the rate of inflation differs from expectations, the amount of interest repaid or earned differs from what they expected. Unexpected inflation hurts lenders since the money they are paid back has less purchasing power than the money they lent out.
Why are banks so opposed to inflation?
Even if the economy is sluggish and inflationary pressures appear faraway, David Leonhardt explains why the Fed is so hawkish on inflation:
Why is the Fed more hawkish than the rest of the economics profession? Part of the explanation rests in how the policy-making committee’s 12 voting members are picked. They are a mix of presidential appointees who must be confirmed by the Senate and serve 14-year terms, as well as regional Fed presidents who are chosen by independent boards that include private-sector financial leaders.
Banks frequently have more to lose from inflation than from unemployment, according to David Levey, a former managing director at Moody’s and another critic of the Fed’s passivity. Inflation lowers the future worth of the money owed to them by their borrowers, such as homeowners, automobile buyers, small businesses, and others.
“Mr. Levey claims that the Fed regional banks “reflect, in essence, the financial community, which is conservative and hawkish.” “Inflation irritates creditors, but it benefits borrowers.” Regional bank presidents Richard W. Fisher of Dallas, Narayana R. Kocherlakota of Minneapolis, and Charles I. Plosser of Philadelphia were among the three recent dissenters.
This is, without a doubt, the traditional viewpoint, and it was true at one time. Is this, however, still the case? Or, perhaps, my actual question is whether it should still be true. Isn’t most long-term debt either indexed to inflation or insured against inflation risks in some way (typically via linkages to LIBOR or treasury spreads or something similar)? Shouldn’t banks now days be unconcerned about inflation as long as it stays within a reasonable range? I’m sure there’s a flaw in my grasp of finance here, but I’m not sure why the creditor/debtor division on inflation still remains.
What is creating 2021 inflation?
As fractured supply chains combined with increased consumer demand for secondhand vehicles and construction materials, 2021 saw the fastest annual price rise since the early 1980s.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
What do you do with cash when prices rise?
Maintaining cash in a CD or savings account is akin to keeping money in short-term bonds. Your funds are secure and easily accessible.
In addition, if rising inflation leads to increased interest rates, short-term bonds will fare better than long-term bonds. As a result, Lassus advises sticking to short- to intermediate-term bonds and avoiding anything long-term focused.
“Make sure your bonds or bond funds are shorter term,” she advises, “since they will be less affected if interest rates rise quickly.”
“Short-term bonds can also be reinvested at greater interest rates as they mature,” Arnott says.