Inflation is back. Where next for investors?

Central banks are having to walk a fine line. After being criticised for being too slow to act in 2022, policymakers may be encouraged to move quickly to subdue any inflationary fire early on. Yet, acting too aggressively increases the risk of recession. One significant difference between today’s situation and 2022 is that interest rates are currently much higher than they were then and the fiscal lever that was heavily employed post-pandemic is largely exhausted as governments grapple with already exorbitant debt levels.

The response

Beyond the US, recent economic activity has been relatively lacklustre, notably in the UK and Europe. The prospect of continued low growth and prolonged elevated energy costs means a stagflationary scenario is increasingly looming. This has led to yields climbing to multi-year highs across various developed market sovereign bond markets.

However, the impact of the conflict will likely play out very differently in different regions. Growth concerns have mainly focused on Europe and the UK. The US, thanks to its energy independence and support from the AI capex cycle, is seen as largely protected.

Asset class implications 

Inflation is likely to be the most significant factor for investors in the near to medium term, and the longer the conflict goes on the greater the risk of a potential economic downturn. In the following sections we consider how the major asset classes might be affected by this environment and what the implications might be for investors. 

Bond markets in a world of structural regime change

The central challenge for fixed income investors is supply‑led inflation which cannot be easily suppressed through tighter monetary policy without undermining growth. The result is a more stagflationary backdrop. Central banks are responding by staying restrictive for longer. For bond markets, this means sustained pressure on long‑dated yields and reduced scope for duration to act as a reliable hedge.

Importantly, bond markets are no longer pricing inflation alone; fiscal sustainability and political credibility are now embedded in spreads and curves. Currency weakness further compounds the challenge for energy‑dependent economies. These forces are increasing volatility and exposing balance‑sheet vulnerabilities across sovereigns, corporates and households.

This creates a world of greater dispersion, where returns depend less on duration and more on careful assessment of inflation risk, fiscal credibility and geopolitical exposure. This requires greater distinction between the risk of individual borrowers.

The key to navigating an increasingly challenging environment 

In such an environment, traditional fixed income strategies require adjustment. Nominal bonds, once a reliable hedge against downturns, are more exposed when inflation surprises to the upside. By contrast, inflation-linked assets can offer a more direct hedge against the deteriorating growth–inflation trade-off. They are not a panacea, but they may prove a valuable form of insurance.

Within corporate markets, while spreads initially moved wider immediately post the start of the Iran conflict, they have since returned to historically tight levels, reflecting the market’s resilience, strong demand, a tailwind provided by cautious central bank positioning and strong supply arising from the AI capex cycle. In the interim, corporate bonds continue to be a key source of dependable income for investors, and should remain, in our view, a core component of bond allocations.

For emerging markets, the global shift to higher rates has mixed implications. After years of exhibiting improving fiscal discipline, rising energy costs are starting to bite, notably in energy-importing countries, particularly in parts of Asia. In this environment, even modest external shocks risk triggering capital outflows and loss of market access.

We believe defensive positioning, with sufficient flexibility to respond to arising opportunities, is key to navigating an increasingly challenging bond environment. In an environment of uncertainty, liquidity will be important. An active approach enables investors to move up the quality curve, uncovering pockets of value, as well as mitigating risks should spreads widen.

Equities in an inflationary world

History and fundamentals suggest that equities can flourish in an inflationary environment, particularly when investors focus on the right regions, styles and exposures. Equity strategies oriented toward Asia and emerging markets, value, income and infrastructure stand out as potential beneficiaries of a renewed emphasis on real assets, pricing power and shorter duration.

The value of real assets

As equities represent claims on real assets and real economic activity, corporate revenues and cash flows can grow in nominal terms as prices rise, providing a degree of inflation pass-through. Historically, periods of moderate inflation have often coincided with solid equity returns, particularly for companies able to reprice goods and services, control costs, and reinvest at higher nominal returns. Whilst inflation can compress valuations through higher discount rates, the earnings channel matters at least as much, especially when inflation is accompanied by nominal growth rather than macro instability.

Infrastructure as an inflation hedge

Traditionally associated with real assets, infrastructure equities can play an important role in inflationary environments – tangible capital, essential services and inflation-linked revenues – with the liquidity and governance characteristics of listed equities. Many infrastructure businesses benefit from revenue models explicitly linked to inflation, while others have monopolistic positions and high barriers to entry that enable cost pass-through over time. Post an era of underinvestment, rising fiscal spending and energy transition requirements, infrastructure equity strategies offer exposure to structural capex cycles with embedded inflation protection. 

Shorter duration and value equities

A defining feature of inflationary regimes is the repricing of duration. Within equities, this creates a clear distinction between growth models reliant on long-term expectations and businesses generating cash today.

Value-oriented equities characterised by nearer-term cash flows, tangible asset backing and lower valuation multiples tend to exhibit shorter duration than growth stocks. This can make them more resilient to rising real rates and inflation volatility. Importantly, value exposures often overlap with sectors such as financials, energy, industrials and materials, all of which stand to benefit from reflationary dynamics and capital spending cycles.

Asia and emerging markets: inflation beneficiaries, not victims

Asia and emerging markets (EM) are frequently perceived as more vulnerable to inflation, but this view overlooks factors such as improved policy credibility at EM central banks, higher nominal GDP growth, and the regions’ exposure to real asset supply chains. Asia and EM equities also trade at persistent valuation discounts to developed markets, in our view offering a margin of safety against sudden shifts in market momentum. 

Growing dividends can provide real income 

In an inflationary regime, equity income strategies can offer a means of capturing real yield while retaining upside to nominal growth. Dividends can grow alongside earnings and inflation, delivering income streams that preserve purchasing power over time.

Equity income strategies tend to focus on sectors such as financials, utilities, infrastructure and energy, which are often underrepresented in growth-dominated benchmarks. As a result, they can serve both as return generators and as portfolio stabilisers. 

Private credit – relative resilience

In a higher-for-longer environment, private markets typically offer a mixed, but directionally positive outlook. Private credit remains attractive, with floating-rate income streams providing some insulation from inflation. However, there is a sharp distinction between headline yields and durable returns in a higher-for-longer scenario. Europe’s private credit market has always been less dependent on leverage-driven growth relative to the US, with a bias towards more disciplined, senior lending. In a slower growth world with tighter fiscal constraints and a more cautious policy backdrop, quality will persevere. European private credit, with stronger underwriting discipline and covenants, would be the more prudent choice, in our view.

Within private credit, refinancing risk will be a key pressure point, but the impact will vary. For Europe, leverage levels have historically been lower than the US. Europe also has less fiscal flexibility and shallower capital markets, relative to the US. With less accommodating capital markets and delayed rate cuts, the risk therefore is less about immediate distress and more about duration. This favours senior and selectively structured direct lending. Also, in this environment asset-backed finance offers opportunities. ABS, in particular, can benefit from floating-rate coupons and structural protections with the ability to enhance resilience further by focusing on senior tranches. 

Real estate – renewed focus on income

Should higher energy costs feed into inflation and delay rate cuts or prompt hikes, real estate could face a more constrained near-term outlook. Higher borrowing costs are likely to suppress property investment activity and limit uplifts in values, shifting the balance of returns towards income over capital growth. In this context, assets in supply‑constrained sectors where rents can continue to rise should prove more resilient. The result is a market defined by cautious sentiment but stable income, with tighter development pipelines reinforcing rental growth over the medium term.

Private corporate & infrastructure equity – challenging times

Higher debt cost and lower valuation multiples can prove challenging for private and infrastructure equity. In practice however, the actual impact will depend on portfolios’ construction and resilience. Private equity portfolios built with modest or no leverage will be insulated to an extent from rising borrowing costs. Strategies with a focus on value creation rather than financial engineering should also be far less impacted by rising rates.

Private equity funds with holdings developing innovative technologies to deliver lower cost solutions to customers are likely to be minimally impacted by higher rates. This would be in stark contrast to legacy, incumbent companies which typically have greater interest rate sensitivity. Infrastructure and real asset investments will benefit from their inflation-linked revenues – a natural hedge against rising prices. Even in an uncertain rate environment, this characteristic can bolster the stability of returns. 

The views expressed on this webpage should not be taken as a recommendation, advice or forecast, nor a recommendation to purchase or sell any specific security.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.