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Are We Halfway Through a Recession?

Stagflation—what is it? Is it coming? Is it already here? How can we fight it? Here’s what you need to know regarding this concept from the 1970s that we’re hearing more and more about these days.

What is Stagflation?

Historically, the Federal Reserve has raised interest rates to help combat inflation or stoke economic activity. Based on our current environment and the fact that the Fed is only just now taking action, many people argue they are late to the game and have some makeup work to do. As a result, the Fed is actively hiking its benchmark interest rates faster than originally intended.

Looking back to the late 70s and early 80s, the Fed didn’t do enough to curb inflation. There were then some supply chain shocks in the form of an oil embargo, and stagflation set in.

Stagflation is stagnant economic growth combined with continued high inflation. Slow growth and rising prices—that’s stagflation in a nutshell. We wanted to reintroduce our clients to this term to make sure you understand where it fits in historically and how it’s playing out in today’s economic climate.

Inflation is the dragon in all of this that the Fed has to slay. It wasn’t slain effectively in the 70s because the Fed didn’t raise rates fast enough, extending that period of stagflation well into the 80s. Only time will tell whether today’s Federal Reserve will repeat history or learn from it.

Are I Bonds the Answer in Today’s Choppy Economic Environment?

Have you heard about a 100% legitimate investment opportunity guaranteed by the US government to pay returns of over 7% and rising? It’s called an inflation-adjusted US savings bond, or I bond for short.

Americans purchased over $11 billion in I bonds in the first six months of 2022 compared to just $1.2 billion in the same periods of 2020 and 2021. Why the sudden popularity? Well, I bonds are inflation-adjusted, so they’re currently paying considerably more than the average savings account.

How Do I Bonds Work?

I bonds work similarly to traditional savings bonds—they accrue interest monthly, pay interest when you cash them out (so you don’t pay taxes along the way), and are backed by the US government. Here are the key differences with I bonds:

  • The rate they pay is linked to the consumer price index (CPI). With the CPI at 8.5% as of May 2022—the highest since December 1981—I bond interest rates have also skyrocketed.
  • Interest compounds twice a year. This is double the usual rate, increasing the principal value even faster.
  • Interest accrues for up to 30 years or until you cash out the bond.

What’s the Catch?

Here are three things to keep in mind before buying I bonds:

  • Because they compound twice a year, I bonds are subject to two rate changes per 12-month period. As long as the rate remains high, your returns will as well. But if the rate falls in the coming years, so will your returns.
  • The annual limit is $10,000 per person, which isn’t a particularly large amount. A separate program also allows you to put $5,000 of your tax refund into I bonds, giving you another option to boost your investment.
  • I bonds have an early withdrawal penalty. They are fully locked up for the first 12 months after the initial purchase, and there’s a penalty of three months’ interest if you cash out within the first five years.

If you’re concerned about stagflation and want professional advice for handling your investments, turn to Nelson Financial Planning. We’ll help you change your life with a successful financial plan that provides peace of mind for the future. Contact us online or call our Winter Park, FL, office at 407-629-6477 to learn more.