asset allocation  |  april 19, 2021

Inflation Clouds on the Horizon

Addressing inflation risks in a broad asset allocation.


Key Insights

  • Even at relatively low levels, inflation can substantially reduce real portfolio returns over time.

  • Unexpected inflation can inflict the most damage on long-term portfolio performance.

  • Our research suggests that allocations to real asset equities and inflation-indexed bonds can improve overall portfolio performance by dampening return volatility during inflationary periods.

Richard Coghlan, Ph.D.

Co-portfolio Manager, Real Assets Fund

Michael Sewell, CFA

Inflation Protected Bond Fund and Limited Duration Inflation Focused Bond Fund

Christopher Faulkner-MacDonagh, Ph.D.

Co-portfolio Manager, Real Assets Fund

Inflation—particularly unexpected bouts of consumer price inflation—can be highly detrimental for a portfolio’s real returns and purchasing power over time.1 Yet, many investors have little protection in their portfolios against the risk of an inflation spike. This creates potential risks at a time when U.S. inflation expectations have strongly rebounded after plunging at the onset of the coronavirus pandemic—indicating that markets are bracing for higher prices as the economic recovery strengthens.

We believe this is a good time for investors to reassess the value of asset classes that potentially can protect the purchasing power of their portfolios. Inflation-linked bonds and real assets—such as natural resource and real estate stocks—historically have performed well in inflationary environments and potentially can reduce volatility in a diversified portfolio.

A Reflationary Environment

Aside from a few temporary bursts, actual inflation and inflation expectations have been rather muted since the 2008–2009 global financial crisis. Warnings from inflation hawks that the large-scale monetary stimulus used to combat the crisis would fuel runaway inflation proved to be unfounded, as numerous factors—including widespread deleveraging following the real estate bubble of the early 2000s, sluggish economic growth, and fiscal austerity—worked to tame consumer prices. The middle of the last decade also saw a deep oil price decline stemming from oversupply, which further sapped inflationary pressures.

The global pandemic initially resulted in a steep slide in the consumer price index (CPI) and in inflation expectations as governments imposed virus-containment measures, causing demand for many goods and services to sink.

After bottoming below 0.2% in late March 2020, the five-year break-even inflation rate—a closely watched measure of the market’s inflation expectations—climbed to 2.6% as of the end of March 2021.2

Headway with vaccine administration, a rebound in oil and other commodity prices, an anticipated release of pent-up consumer demand combined with supply bottlenecks, and massive stimulus efforts by governments and central banks are among the drivers that have raised concerns that inflation could stage a comeback.

Although substantial slack in the labor market and an easing of supply disruptions are factors that could restrain a sustained surge in inflation, conditions appear ripe for an upside surprise, in our view.

  • The Federal Reserve has committed to letting the economy run hot for some time, shifting its focus from maintaining price stability to maximizing employment and—relatedly—reducing income inequality.

  • Meanwhile, the U.S. federal government has opened the fiscal spigots, including direct cash payments to households, resulting in a savings glut that consumers could draw upon when they feel more confident and are more able to spend.

Although higher inflation readings are widely anticipated in the near term as year-over-year measures reflect the impact of the pandemic-related base effects from 2020, the market currently does not appear to be pricing in a more lasting inflationary impulse. However, we believe that investors should take heed that unexpected inflation—which, by definition, cannot be forecast—is potentially more disruptive and thus can inflict the most damage on a portfolio.

Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.

1“Real” returns refer to the returns on an investment after deducting inflation.
2Source: Barclays (see Additional Disclosures).

Additional Disclosures

Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

©2021 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any
damages or losses arising from any use of this information. Past performance is no guarantee of future results.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of April 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

The Real Assets Fund is subject to market risk, as well as risks associated with unfavorable currency exchange rates and political economic uncertainty abroad. When inflation and expectations of inflation are low or declining, the fund’s investments are likely to underperform the overall stock markets. The yield and share price of the Limited Duration Inflation Focused Bond Fund will vary with interest rate changes and the level of real yields may be negative. Deflationary conditions could cause the fund’s principal and income to decline in value.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.



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