Cash is trash: Inflation forces savers to invest or lose purchasing power

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Inflation forces savers to invest

Inflation reaccelerates on both sides of the Atlantic

The US headline CPI figures exceeded the 3.6% consensus and reached the fastest annual rate since May. Core CPI, which excludes food and energy, rose 0.3% month-over-month and 2.6% year-over-year. This is 0.2 percentage points higher than in August. Gasoline jumped 9.1% during the month and largely contributed to the overall increase.

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In the euro area, the 3.8% rate was the highest since September 2023 and above the 3.6% forecast. Energy inflation surged to 18.8% from 14.3% the previous month, while services inflation reached 3.2%.

“While much of the lost purchasing power is due to rising energy costs, there is no reason to expect that to fade in the near term,” said Eric Winograd, chief US economist at AllianceBernstein.

Energy shocks dominate, but the core remains persistent

Geopolitical factors result in growing oil and gas prices, as reflected by consumer indices. In the US, the energy index rose 5.2% in September. In Europe, the effect was even stronger. Christopher Hodge, chief US economist at Natixis, described the US report as “certainly hotter than I expected… and, more troublingly, [the inflation] is broad-based.” Jeffrey Roach, chief US economist at LPL Financial, stated that “inflation pressures are broadening beyond energy, suggesting the last mile back to target could remain bumpy and keep interest rates elevated.”

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Euro-area services inflation has stayed well above the European Central Bank’s 2% target for more than three years. So central banks have to deal with inflation that is more persistent than projected earlier in the year. Moreover, traditional monetary and fiscal tools appear to be less effective than before.

Central banks face a policy bind

The Federal Reserve raised its benchmark rate by 25 basis points in September to a 3.75%–4.00% range. This is the first case of increase in three years, and further tightening is likely. The ECB has completed two rate increases this year. Jack Allen-Reynolds of Capital Economics said the September data “don’t alter our view that the ECB is most likely to wait until December to raise interest rates again.” However, further energy shocks may lead to further adjustments in policy implementation.

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Both institutions are trying to control inflation without facing recession. But the current measures have limited influence over supply-driven shocks. The situation in the labor market will probably determine the degree and intensity of central banks’ measures in the following months.

Cash loses its appeal as real returns turn negative

With headline inflation reaching 3.7% in the US and 3.8% in the euro area, the real return on cash and short-term deposits has become negative for most savers. However, Treasury Inflation-Protected Securities still offer positive real yields. The 10-year TIPS real yield was 2.84% as of mid-October, while the five-year was 2.64%. So some holders can secure a return above official CPI if the securities are held to maturity.

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Holding large cash balances implies a considerable opportunity cost. Over a period of several years, the losses in purchasing power become substantial. Retirees and institutions with long-duration liabilities traditionally face the highest risks. Therefore, the growing number of people recognize the need to take urgent response measures to preserve their savings.

Popular options for navigating sticky inflation

In this environment, market participants rely on several approaches to minimize their losses or even generate income above a purchasing power decline. Inflation-linked bonds such as TIPS or euro-area equivalents are widely used due to the positive real yields currently available. Laddering across maturities allows to manage reinvestment risk if price pressures weaken. Equities in sectors that have historically demonstrated pricing power may also be reasonable, but additional expertise in these spheres is needed.

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Bitcoin and other digital assets are another option that is becoming even more popular. Many investors perceive BTC as a store of value independent of traditional monetary tools. But as with any volatile asset class, actual results vary widely. In any case, at current rates, capital left in cash steadily loses value, so protective measures become objectively required.

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