Geopolitics, fiscal expansion, and the new inflation regime

Over the past two years, investors have taken comfort in a simple narrative: Inflation is falling, central banks are nearing the start of easing cycles, and growth remains resilient. This has reinforced a familiar playbook—lean into risk assets, expect policy support, and treat volatility as temporary. In effect, the market was behaving as if the last shock was the last shock.

Recent geopolitical developments, however, are forcing investors to confront a more uncomfortable question: Are we underestimating how fragile this disinflationary backdrop really is?

The current cycle bears a striking resemblance to earlier inflation regimes, where price pressures moved in waves rather than a single, contained shock.

Disinflation is not constant

At first glance, the data appears reassuring. Inflation has clearly rolled over from postpandemic highs. But the deeper pattern is less comforting. The current cycle bears a striking resemblance to earlier inflation regimes, where price pressures moved in waves rather than a single, contained shock. This matters because markets tend to react linearly. When inflation falls, the assumption is that policy has “worked.” Historically, however, the early disinflation phases have often reflected temporary relief rather than a full reset of market dynamics.

The current environment exhibits similar characteristics. Inflation has eased but has not returned to the structurally low levels that defined the 2010s. And crucially, that moderation has occurred despite significant external disinflationary forces, especially from China. For investors, this is a critical factor as the Asia region has been exporting disinflation to the rest of the world. But that force is unlikely to be permanent—or guaranteed.

Will history repeat (or rhyme)?

(Fig. 1) Comparing historical and current U.S. inflation cycles

As of April 30, 2026.
The chart shows U.S. headline consumer price index (CPI) year‑over‑year percentage change for the periods January 1966 to June 1984 and January 2014 to April 2026. This chart is shown for illustrative purposes only.
Source: Macrobond/U.S. Bureau of Labor Statistics.

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Policy no longer works the same way

Historically, monetary and fiscal policy worked in this sequence: tightening during expansions, followed by easing during downturns. Today, however, that coordination is less reliable as the regime may have changed. Elevated fiscal deficits despite low unemployment suggest a breakdown in the traditional policy cycle. Governments are effectively absorbing shocks that would otherwise slow the economy.

Substantial but incomplete post‑COVID disinflation

(Fig. 2) U.S. and G10+ headline CPI trends since 2000

As of April 30, 2026.
The chart is for illustrative purposes only.
The G10+ countries are Australia, Canada, China, eurozone (France, Germany, Italy), Japan, New Zealand, Norway, South Korea, Sweden, Switzerland, the United Kingdom, and the United States. The green shaded area represents the range between the highest and lowest headline CPI inflation readings (monthly year‑over‑year percentage changes) across all G10+ countries.
Source: Macrobond.

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This has two implications. First, inflation becomes harder to suppress. Monetary tightening operates against a backdrop of sustained fiscal expansion, which reduces its effectiveness. Second, policy itself becomes a source of volatility. Markets must now price not only economic cycles, but also political choices that are increasingly shaped by geopolitics rather than domestic economic conditions.

This also introduces a second‑order effect. External policy is no longer just a financial variable; it is increasingly a geopolitical tool, with the potential to influence capital flows and reshape trade dynamics.

Geopolitical shocks do not just create volatility; they reshape the structure of inflation. Prior to COVID, globalization acted as a structural disinflationary force for decades. Its partial reversal through reshoring and trade restrictions raises the cost base of production. Energy, metals, and critical materials are becoming increasingly tied to strategic competition. The rise of artificial intelligence‑related capex is also driving investment goods prices higher.

Persistent fiscal deficits and low unemployment may complicate disinflation

(Fig. 3) U.S. federal budget deficits and unemployment since 1960

As of December 31, 2025.
The chart is for illustrative purposes only.
Source: Macrobond, U.S. Congressional Budget Office, U.S. Bureau of Labor Statistics.

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Rethinking diversification

Perhaps the most immediate implication for investors lies not in inflation itself, but in how it might change portfolio diversification.1 For instance, stock‑bond correlations2 generally shift alongside inflation regimes. In low‑inflation environments, the relationship is typically negative. But once inflation moves above a relatively modest threshold—around 2.5%—that relationship tends to turn positive.

In practical terms, this means that in a world of elevated inflation, both equities and bonds can decline simultaneously. For investors, many of whom rely on global diversification frameworks, traditional portfolio construction may no longer provide the hedge it once did.

Therefore, the key risk may not be misforecasting the direction of inflation but rather misunderstanding the inflation regime itself. A world shaped by geopolitical fragmentation, persistent fiscal expansion, and ongoing supply constraints does not require high inflation to be disruptive. It only requires inflation to remain elevated enough for traditional market relationships to break down—and that bar is not particularly high.

Geopolitical shocks do not just create volatility; they reshape the structure of inflation.

Implications for investors

The most destabilizing environments are not necessarily those with the highest volatility, but those where volatility is underestimated. Today’s disinflation may feel like progress. But it may also be masking a deeper shift: from a world where inflation was cyclical and largely containable to one where it is increasingly structural and adaptive. And in that world, the next shock does not need to be larger—it only needs to arrive before the system has fully adjusted. Thus, understanding fiscal dynamics and geopolitical alignment is critical for investors, while allocating to assets that can potentially benefit from inflation variability may also become valuable in multi‑asset portfolios.

Across a range of historical shocks, real assets3 have generally demonstrated resilience when traditional portfolios struggled. During periods of oil price shocks, such as the late 1970s, real assets outperformed equities. Similarly, during the dot‑com collapse and the post‑COVID inflation surge, equities and bonds struggled, while real assets remained relatively resilient. This resilience likely reflects real assets’ higher sensitivity to inflation beta compared to equities or bonds, particularly when diversification across traditional asset classes breaks down.