The Inflation Trend Is Not Your Friend for the Fed

Inflation remains uncontrolled, characterized by rising goods inflation attributed to tariffs and services inflation that is no longer declining. With 72% of CPI components growing faster than the Fed's 2% target, this trend increases the risk of a steeper yield curve, a higher term premium, and a rise in TIPS and breakevens.

Analysis

Persistent inflationary pressures are challenging the narrative of a controlled return to the Federal Reserve's target. The current dynamic is driven by two key factors: goods inflation is now rising, a trend attributed directly to tariffs, while the previous disinflationary trend in services has stalled. The broad-based nature of this inflation is a significant concern, as evidenced by the fact that 72% of CPI components are growing faster than the Fed's 2% goal. This widespread pressure suggests that inflation is not isolated and remains uncontrolled, thereby increasing the risk of significant adjustments in the fixed-income markets. Specifically, these conditions point toward a potential steepening of the yield curve, an expansion of the term premium as investors demand greater compensation for duration risk, and a consequent rise in both TIPS yields and inflation breakevens.

Key Decisions for Investors

• Investors should consider reducing duration in fixed-income portfolios to mitigate valuation risks from a potential yield curve steepening and a higher term premium.
• Given that 72% of CPI components are running hot, increasing exposure to inflation-hedging assets such as TIPS or strategies that benefit from rising breakevens may be a prudent move.
• Re-evaluate assumptions of a smooth disinflationary path, as the data indicates a more complex and persistent inflation regime that could challenge prevailing market expectations for monetary policy easing.