Inflation is the single most important macro variable for asset pricing. When inflation is low and stable, central banks can maintain accommodative policy, discount rates stay low and financial asset valuations are supported. When inflation runs above target — as it did in 2021-2023 — the Fed tightens aggressively, discount rates rise and valuations compress across equities and bonds simultaneously. The US inflation rate, measured as year-over-year change in the Consumer Price Index, has historically targeted 2% by the Federal Reserve. Understanding the composition of inflation matters as much as the headline number: services inflation driven by wages is stickier and harder to reduce than goods inflation driven by supply chains, which means a headline decline can mask an underlying persistence problem. Core inflation — excluding food and energy — is the measure the Fed watches most closely since it strips out volatile components. For investors, inflation expectations embedded in TIPS breakeven rates and the nominal-real yield spread are the market's forward-looking view on where inflation is heading, and positioning across asset classes should reflect a clear view on whether the inflation environment is accelerating, stable or decelerating from here.
