US inflation expectations have risen recently, perhaps in light of the consumer price index (CPI) data and potential increases in tariffs. The one-year break-even inflation rate, measured by the difference in yields between inflation-protected and nominal Treasuries, recently reached 3.99%, up from just 0.40% last September.
Rising inflation expectations don’t necessarily require investors take action with their portfolios. Expected inflation is continuously incorporated into current market prices. Stock and bond market prices should be set to a level where expected returns compensate investors for the effects of inflation. This is consistent with the long-run data, which show that most stock and bond market segments have had positive average real returns even in years with high inflation. So, if actual inflation pans out similarly to expectations, investors can likely stay the course with their current asset allocation.
Of course, there’s always the possibility of actual inflation deviating from expectations. Over the past five years, the difference between “predicted” inflation (based on the break-even number) and actual one-year CPI change ranged from –2.26 to 6.30 percentage points.1 Investors who want to reduce uncertainty in the event of higher-than-expected inflation may benefit from inflation-hedging approaches such as Treasury Inflation-Protected Securities (TIPS) or bond strategies overlaying inflation swaps.
Past performance is not a guarantee of future results. Actual returns may be lower.
In USD. Source: Dimensional using data from Bloomberg
This article originally appeared in Above the Fray, a weekly newsletter for Dimensional clients. It was not created, written, or produced by Ventus Wealth Management.
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