A Higher Inflation Future and the Need for Real Assets

What You Need to Know

The risk of higher equilibrium inflation is a key marker of the notion that investors face a new regime. Recent policy announcements have lent more weight to the idea that the path of inflation might be upward. In this note we focus on the disparate forces that imply a higher long-term level of inflation.

Deglobalization is inflationary by fragmenting supply chains and labor markets. Demographic changes are also potentially inflationary, in part by virtue of fewer working age people but also the resulting significant increase in the need for (hard-to-automate) care.

The very elevated levels of public debt and the lack of a realistic way to raise real growth imply that inflating away debt would be a politically expedient option across advanced economies. We also think that the energy transition will take much longer than anticipated in the finance industry, leading to greater inflation volatility.

The call to action for investors is to pivot to a higher weight in real assets (which include public equities), more focus on inflation hedges including Treasury Inflation Protected Securities (TIPS), non-fiat assets and physical assets. It also calls for a change in governance structure that puts more emphasis on preserving purchasing power.

Additional Contributors: Robertas Stancikas, Alla Harmsworth, Harjaspreet Mand and Maureen Hughes

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.