Perhaps the key macroeconomic variable that points to the potential for investors to face a new strategic investment regime is inflation. Certainly, when we have strategic conversations with investors about the medium-to-long term outlook, inflation tends to be a dominant part of that discussion.
There is much debate as to the extent to which the policies of the new US administration might be inflationary and how this might contrast with a more disinflationary trend that had become established in 2024. Yes, these policies have focused more of the debate around inflation risks in the next one to two years, but the message of this note is that there is a risk that the long-term equilibrium level of inflation could be higher than markets assume.
When we meet asset allocators around the world, we find that the majority still agree with us that the level and volatility of equilibrium long-term inflation seems set to remain stubbornly higher than before the pandemic. However, there is disagreement as to how much higher long-run forecasts of inflation should be. Also, after a period of cyclical disinflation in the last two years, the case for higher long-run inflation demands to be revisited. It is these two tasks that we attempt to cover in this note. The level of 10-year-forward breakeven inflation in the US has been relatively stable in a 2.3%–2.4% range for over two years. In other regions, expected inflation has also risen compared with pre-pandemic levels. The expectation from the breakeven rate in the US is somewhat above the Fed’s target, but we argue that there is a risk that inflation ends up being higher than this. If this is the case, it would prompt a need to change asset allocation.
