Inflation is one of the most important things to track as an investor. If you have money, then you’d better be aware of any change in its purchasing power.

[ad#Google Adsense 336×280-IA]Can you name the biggest influence on inflation?

No, it’s not government policy or interest rates. It’s inflation expectations.

The best way to keep an eye on future inflation… is to keep an eye on people who are keeping an eye on future inflation. Confused? It’s hard not to be. Fortunately, our central bank can help.

While we don’t always agree with the folks at the Federal Reserve, they are some of the most useful sources for dollar watching out there.

And they recently upgraded their inflation expectations, ending a long period of stagnation for our currency.

What does that mean for your portfolio? It depends on your personal allocation. This chart gives you an overview of how various sectors respond to inflation.

Different investment sectors respond in different ways. Let’s look at some of the biggest winners and losers of rising inflation expectations.

Much-Needed Good News for Energy Investors

The energy sector has had a rough couple of years. The oil glut sent the price of energy giants like Chevron (NYSE: CVX) and Exxon Mobil (NYSE: XOM) in a downward spiral. But rising inflation expectations may finally change that.

If you were alive in the 1970s, then you saw how strongly fuel prices affect inflation. A brief OPEC embargo sent the dollar into a decade-long tailspin. Luckily, that relationship goes both ways.

Inflation makes the price of everything increase. That’s good news for any merchant – but it’s especially lucrative for the folks who sell oil and other fuels.

That’s because they have considerably less competition than most industries do. Oil companies can quickly raise prices at the pump when their wares become more valuable. The reasoning is simple: Everybody needs it, and they’re one of only a few companies that have it.

Sellers of other goods, like groceries or clothing, must be ever vigilant to keep their prices competitive with other stores. But since the energy industry is such an oligopoly, they can charge what they want for their products.

That’s why beaten-down companies like Chevron and Exxon Mobil are poised to outperform the broader market during an uptick in inflation.

No Relief for Lenders

In a recent Lecture Notes, we described how banks are getting clobbered by low interest rates. When you make your living by lending money, it’s tough to learn that your debtors owe less than you expected.

Rising inflation expectations hurt banks because of the same principle. Suppose you lend your friend $100. He goes out and spends that $100 – but he agrees to pay you $110 later.

Then inflation strikes, and the value of the dollar decreases by 20%. (We’re using a big, round number to make this example simpler. A dollar inflation of 20% would be a doomsday scenario in real life.) You can’t just increase your friend’s debt unilaterally, so you take the $110 back when the loan expires.

The problem is that $110 isn’t worth as much as it was when you made the loan. Thanks to inflation, it’s now worth just $88 in yesterday’s money. In real terms, you’re down 12% on what should have been a profitable high-interest loan.

It’s easy to see how this kind of inflation-fueled debt devaluation hurts banks. Rising inflation expectations could make matters worse for struggling banks like Deutsche Bank (NYSE: DB) or Bank of America (NYSE: BAC).

To make matters worse, these banks invest some of their assets in currencies, including the dollar. Inflation means a weakening dollar – and therefore even bigger losses for lenders.

Inflation is a strange creature. Money only has value because we say it has value. And thus, changes in the price of money depend on what people think about the price of money.

After 10 years of a strong dollar, we may finally be moving into a period of inflation again. Make sure your portfolio is ready to meet your expectations.

— Samuel Taube

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Source: Investment U