Inflation’s underappreciated comeback

The T. Rowe Price Fixed Income Platform’s high-conviction that inflation expectations are set to move higher over the next 3–12 months presents a timely and actionable opportunity for investors. Current market pricing, in our view, does not fully reflect the magnitude or persistence of the inflationary pressures building in the U.S. economy. We believe properly positioned portfolios can benefit from a potential repricing of inflation risks, offering both return potential and crucial diversification in an environment of heightened macro uncertainty.

Our thesis: Why inflation expectations are set to move higher

Macro and fundamental drivers:

• Fiscal policy: The potential for more fiscal stimulus—particularly through retroactive income tax reductions and new corporate investment incentives—remains underappreciated by markets. If enacted, these measures could provide a meaningful boost to demand and reinforce upward pressure on prices.
• Tariffs at century highs: The U.S. is operating with tariffs at historically elevated levels, and new measures introduced in 2025 are expected to remain in place. These tariffs are set to be a persistent source of upward pressure on input costs, with the impact likely to become more evident in inflation data over the coming quarters.
• Corporate margins and pass-through: Tariffs function as a tax on importers. While many companies initially absorbed these costs by drawing down inventories in Q1, those stockpiles have now been largely depleted. As a result, we expect to see more cost pass-through to consumers, with higher prices likely to show up in inflation data in the months ahead.
• Weaker U.S. dollar: The dollar has depreciated notably year-to-date, reducing U.S. purchasing power and making imports more expensive. This dynamic is feeding directly into higher costs for businesses and consumers, supporting a more persistent inflationary environment.
• Labor market tightness: Although labor demand has moderated, supply has also been constrained due to recent policy changes affecting migrant workers. This supply-side constraint is likely to be a headwind to the recent deceleration in wages, adding to inflationary pressures that markets may be underestimating.
• Energy and geopolitical risks: Ongoing geopolitical tensions, particularly in the Middle East, have increased volatility in energy markets. While gasoline prices have seen some recent relief, electricity and other energy costs are trending higher, and further supply shocks combined with mounting demand for energy to supply the ‘AI revolution’ remain a risk to the inflation outlook.

How did we arrive at these conclusions? Our fully integrated research platform.

Our inflation outlook is rooted in a research-driven investment process that is the foundation for all decisions across our Fixed Income Platform. This process is built on three core pillars:

• Fundamental research: Deep sector and company-level analysis to identify real-world drivers of pricing power, cost pressures, and margin dynamics.
• Macro research: Top-down assessment of policy, currency, and global economic trends that shape the inflationary environment.
• Quantitative research: Rigorous signal-based frameworks that integrate commodity and breakeven momentum, macro trends, and valuation to identify actionable opportunities.

When all three research pillars align, as they do today, the result is a “platform consensus view” that guides positioning with conviction across portfolios.

Our Quantitative Research shows:

• Breakeven and commodity momentum: Our proprietary breakeven quantitative framework, which integrates commodity and breakeven momentum, macro, carry, and value signals, is currently flashing strong long signals for 5-year inflation breakevens. Momentum remains robust in key inflation-sensitive sectors—particularly metals.
• Macro signal strength: Macro signals, including the effects of persistent tariffs and currency depreciation, continue to support a long inflation bias. Our combined signal score is at its highest conviction level year-to-date, which supports our fundamental view and reflects broad alignment across our research pillars.
• Market underpricing (i.e., valuations): Despite these persistent pressures, market-based measures of inflation expectations (such as TIPS breakevens and zero-coupon inflation swaps) remain subdued. This suggests that investors are still underestimating the risk of an inflation surprise in the coming quarters.

Investment implications

Given our differentiated outlook, we believe investors should consider:

• High grade intermediate fixed income, especially flexible mandates that can dynamically allocate across sectors, geographies, and currencies.
• Low duration, high grade fixed income and enhanced cash for stability and liquidity.
• Sub-investment grade credit as an attractive alternative to equities, given compelling yields and historical lower volatility – though security selection is paramount at this stage of the cycle.
• Remain cautious on the long end of the curve, as we see the risk of higher long-term rates if inflation surprises to the upside.

For more details on how these views are being implemented across T. Rowe Price’s Fixed Income Platform, please reach out to our team for more information and to continue the discussion.