Inflation expectations have played a dominant but very unpredictable role in determining the returns available to investors over the past 12 months.
Equities suffered a wobble in December of 2024 as the market began to fret that rate cuts, log baked into valuations, may not happen to the extent hoped for.
Donald Trump’s initial series of tariffs, announced on an April day he labelled “liberation day”, saw equities fall.
Part of the concern was that tariffs are generally regarded as bringing inflation to the country that imposes them, which would reduce the scope for central bank interest rate cuts.
Rate cuts subsequently happened, and equity markets have more than recovered the lost ground.
Supply and demand
Inflation comes from either the supply side of the economy or the demand side.
Supply-side inflation is the result of an increased cost to bring goods or services to market, while demand-side inflation is the result of the demand for goods or services rising at a faster pace than new supply can be introduced, causing prices to rise.
In the UK, many market participants take the view that the policies introduced in chancellor Rachel Reeves first Budget were inflationary, particularly the increases to employers national insurance contributions, and the increase to the national minimum wage.
In the US tariffs are regarded as having contributed higher inflation.
Both of those factors are supply-side inflationary pressures.
The outcome is that in both the US and UK inflation remains above the target level of 2 per cent, with policymakers in the UK split on whether further rate cuts should happen.
But given that equity market returns have been strong in both the UK and US this year, despite the volatility of the macroeconomic environment, do advisers and their clients need to prepare for inflation to remain above target, and, if so, what does that mean for portfolios?
There were widely divergent opinions among those we spoke to for this article, with many taking the view that inflation will remain higher for longer, and others of the view that the peak has been reached.
Ronald Temple, chief market strategist at Lazard, says the next stage of the inflation story could be one of sharp divergence between the US and the rest of the world, with tariffs driving prices up stateside, but down everywhere else.
This is because he feels that while tariffs bring inflation to the US through higher goods prices, they reduce it elsewhere because economies such as China are faced with the potential for tariffs to make its goods uncompetitive in the US, and so sell excess supply into countries such as the UK and regions such as Europe.
