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mYCharts - November 9, 2021

Investing When Inflation Outpaces Interest Rates With Lyn Alden



One of my favorite ways to use YCharts is to keep track of various interest rates compared to various measures of inflation on one convenient chart. Historically, interest rates and inflation have often moved together, but things have been very different in 2021. We can see in the chart below that inflation has sharply diverged from interest rates in 2021.

The sharp divergence in 2021 between inflation and interest rates

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My base case, expressed in various public writings including my 2020 article on the concept of a long term debt cycle, is that the US and other countries will engage in financial repression during the bulk of the 2020s decade, meaning that interest rates will spend the majority of the time submerged below the inflation rate. If this occurs, it means that bank accounts and bonds will fail to keep up with inflation and devalue their holders’ purchasing power over time. For bank accounts and T-bills, this has already occurred throughout most of the 2010s, but it is continuing into the 2020s to a greater degree and is affecting the long end of the Treasury curve as well.

The closest historical precedent to this is the 1940s, where public debts among developed countries were so high due to economic problems and the world wars, that despite extremely high inflation spikes, their central banks held interest rates at low levels anyway. The outcome of this was that debts were significantly devalued vs inflation and yet were still paid back in nominal terms rather than defaulted on. The alternative scenario would have involved letting more bonds default, but this could have caused even higher political and social issues.

US CPI Compared to the Effective Federal Funds Rate since 1950

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This means that the US government is borrowing the short-term portion of its debt consistently below the inflation rate, and holders of those T-bills are consistently seeing their purchasing power be devalued at a mild-to-moderate rate.

Here’s a spread chart, showing the effective federal funds rate minus the inflation rate. It’s currently the lowest since the late 1970s at below -5%:

a spread chart, showing the effective federal funds rate minus the inflation rate

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Going forward, this seems to be happening to longer-term government bonds as well. The central banks of the United States, Europe, and Japan are holding rates low while also buying a considerable portion of long-dated government bond issuance, so despite rising inflation, interest rates have been subdued. Governments can also use various policies to ensure that banks, pension funds, and other large pools of capital are forced to hold government debt as collateral. 

This type of fiscal and monetary environment, such as the inflationary and financially repressed 1940s, has historically been good for value stocks and commodities while it persists. It’s also been historically good for reasonably-priced residential real estate with fixed-rate mortgages attached. Even in other inflationary periods, such as the 1970s and 2000s decades, these asset classes tend to be the winners among assets.


Lyn Alden, Founder of Lyn Alden Investment Strategy

With a background that blends engineering and finance, Lyn Alden provides investment research for retail and institutional clients at LynAlden.com. Her strategy emphasizes fundamental investing with a global macro overlay, taking advantage of individual opportunities within a broader context of long-term trends and inflection points. Lyn’s large media presence reaches hundreds of thousands of investors per month and covers a wide array of investment topics. 

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