Fund managers at BlackRock, Bridgewater, and Pacific Investment Management Company (PIMCO) are adjusting their portfolios to hedge against a potential new wave of inflation shocks. A fund under BlackRock is establishing short positions in US Treasuries and UK gilts, as a precaution in case interest rates fail to decline as anticipated. Bridgewater currently favors equities over bonds. PIMCO is focusing on government bond varieties, such as those with yields that already include inflation adjustments, which can offer protective buffers. Increasing evidence suggests their concerns are justified: in January, the yield gap between conventional government bonds and Treasury Inflation-Protected Securities (TIPS) widened sharply, reaching its highest level in months. Another indicator of market expectations—inflation swap rates—has also climbed. This perspective is underpinned by expectations that robust US economic strength could rekindle price growth, particularly following former President Donald Trump's nomination of Kevin Warsh for the next Fed Chair last Friday; this is especially pertinent if Warsh were to steer policymakers toward faster or larger rate cuts. Globally, rising commodity prices, massive government borrowing, and a surge in artificial intelligence-related spending are all exacerbating inflationary pressures. Ben Pearson, a senior trader at UBS Group, believes a US-led "inflationary boom" is the most significant risk that investors are underestimating this year. Pearson stated that if this scenario materializes, it would lead the Fed to "remain completely on hold" in the first half of the year and force markets to begin pricing in rate hike expectations during the second half. Steven Barrow, head of G-10 strategy at Standard Bank, predicts that the 10-year Treasury yield could surge to 5% from the current level of around 4.25%, if the White House's desire for rate cuts is thwarted. This would present a challenging start for Warsh. If confirmed by the Senate, he would assume the role in May upon the conclusion of Jerome Powell's term. For investors, the challenge lies in balancing Warsh's long-standing reputation as an inflation hawk against his willingness to accommodate Trump's demands for lower interest rates.

Their cautious stance contrasts sharply with the more widespread market belief that the inflation which plagued bond returns in the post-pandemic years is now largely under control. In the Eurozone, investors broadly expect price growth to stabilize around the target level—or even slightly below it. Although long-term inflation expectations have risen in tandem with US indicators, they remain only marginally above the European Central Bank's 2% target. The situation in the UK is more ambiguous. Gilts have been favored in recent months, based on the view that disinflation would allow the Bank of England to resume cutting rates. However, a series of positive economic data has forced traders to reconsider the pace of easing. In early January, markets considered the likelihood of two more rate cuts this year as very high. Now, the probability of a second cut by year-end is only about 50%. Elsewhere, the situation in Australia has demonstrated that inflation pessimists may be correct. Due to persistently rising domestic price growth, traders have increased bets anticipating a rate hike at the central bank's Tuesday meeting—a potentially awkward policy pivot occurring less than six months after the last rate cut.

But the focus for global investors remains squarely on the world's largest economy, the United States, which is also where opinions are most divided. Steven Williams, head of global fixed income for EMEA at Amova Asset Management, is convinced that price pressures are easing and suggests the Consumer Price Index (CPI) could fall below 2% before summer; the index is currently stable around 2.7%. "All the signs tell me the disinflation trend will continue," he said, "If our inflation view materializes, there will be two, or maybe even four, rate cuts this year." Money markets are currently pricing in two 25-basis-point cuts for 2026. This stands in stark contrast to the view of Peter Orszag. The CEO of Lazard recently suggested that US inflation rebounding to above 4% by year-end is not only possible but represents the "most likely scenario." Predicting inflation has rarely been as fraught with uncertainty as it is now. Resurgent trade tariff tensions and the booming development of emerging technologies are clouding the outlook. Furthermore, investors must also contend with Trump's intermittent threats regarding Iran—which have already triggered a spike in oil prices—and the rapid appreciation of industrial metals. The message from the Fed, as it held rates steady last week, was that inflation remains "somewhat elevated." Strategist Simon White stated that Kevin Warsh "will have a tough job, whatever happens: either defending rate cuts when inflation is clearly a problem, or advising President Trump that rate hikes are necessary. With inflationary pressures rising across the board, prolonged inaction will not be a viable option." Bridgewater pointed to the AI boom as another source of uncertainty. The hedge fund giant believes that even if the technology ultimately proves disinflationary by boosting productivity and lowering costs, the virtually unlimited demand for chips, electricity, data scientists, and other resources in the short term could exacerbate the 'challenging environment' for bonds. Tom Beck, co-manager of BlackRock's $4.1 billion BlackRock Tactical Opportunities Fund, has been increasing short positions in long-dated US Treasuries and UK gilts since late last year. He anticipates that strong economic growth and rising commodity prices will continue to exert upward pressure on consumer prices. Amid this uncertainty, Treasury Inflation-Protected Securities (TIPS) offer a potential hedging instrument. Of course, TIPS themselves are not without risks. Brian Quigley, a senior portfolio manager at Vanguard, noted that if oil prices—which are closely correlated with TIPS performance—collapse, breakeven inflation rates could decline rapidly once again. He adopted a strategy betting on a steepening of the US Treasury yield curve at the start of the year and has maintained that position. But for PIMCO, TIPS offer cheap insurance: long-term breakeven inflation rates remain low, even though inflation is above central bank targets and faces risks of re-acceleration in the near term. "If inflation runs above the Fed's target—as it has for the past four or five years—we think that's good protection," Michael Cuggino, a senior portfolio manager at the firm, said in an interview last week.