Insights
InflationWhat bond markets are telling us about inflation (and what they are not)
Inflation eats into returns like a silent tax. A look at how inflation-linked bonds may be a potential answer.
Author
Tom Walker
Investment Director
Duration: 3 Mins
Date: Dec 19, 2025
What if the signals from bond markets aren’t just forecasting inflation’s next move – but also hiding the risks that could blindside investors?
Inflation has been one of the defining economic stories of recent years. Living standards stalled as households navigated a post-COVID world marked by supply and demand imbalances. From meat and vegetables to utility bills and car insurance, everyday essentials became more expensive, while wages struggled to keep pace.
But that’s the past. What about the future? How will our ability to afford life’s basics change in 2026 – and will there still be room for those little luxuries?
The market’s view on inflation
One way to gauge expectations is through the inflation-linked bond market. These bonds offer a window into what investors believe inflation will look like over the coming years. But how reliable is that view? And could central banks reignite inflation by cutting interest rates too aggressively to appease political pressures?
Let’s set the scene. Chart 1 illustrates where we’ve come from – and where markets expect us to go. It captures the pandemic-driven inflation shock, followed by the more nuanced regional paths that have emerged since.
Chart 1. UK, US, and EU realized inflation and market fixings
The dotted lines highlight where markets project UK, US, and European inflation will head into October 2026. The message? They expect inflation to fall across these regions. That makes sense as COVID-era drivers such as trade disruption and supply bottlenecks continue to fade.
What could derail this story?
We believe there are a few knowns – foreseeable risks – that could push inflation off course:
- Trade tensions: The tariff story is well known. So far, their impact on everyday prices has been less severe than feared. There’s only been a limited effect on the goods component of the US Consumer Price Index.1 The question we keep asking is: When – if at all – will price rises feed through to inflation, and by how much? This matters because, at this point, markets seem to have given up on the idea that goods price inflation is coming. If it does materialize, inflation expectations would rise.
- Geopolitical risks: A resolution in Ukraine would likely cause energy and grain prices to fall – taking inflation with it.
- Fiscal policy: US government spending and Europe’s planned infrastructure and defense investments could boost economic growth.2 They could also increase demand for goods and services, making them more expensive. Hello, inflation.
These risks to the inflation outlook largely lie beyond the central banks’ control. Their job is to steer inflation back to its target in a sustainable way over the medium term. They do this by adjusting interest rates (Chart 2) – either speeding up or slowing down the economy. That, in turn, creates or quashes price pressures and therefore inflation. At least, that’s the theory.
Chart 2. Rates and inflation outlook for year-end 2026
So, given markets expect lower inflation, what’s their forecast for interest rates (Chart 3)?
Chart 3. Forecasted rate changes and inflation gap vs. 2% target
What bond markets are telling investors
Markets expect rates to fall – but not everywhere. Inflation is forecast to ease, yet central banks aren’t all moving in the same direction.
For investors, inflation eats into returns like a silent tax. So, how do investors protect their portfolio – or even turn this risk into an opportunity?
Enter inflation-linked bonds
These bonds adjust with inflation, so they deliver a real return that keeps pace with rising prices. Higher inflation? Higher returns. Lower inflation? Investors still earn a return that moves with prices.
In our inflation-linked strategies, we expect US inflation to stay higher than markets predict. We look at the inflation breakeven, or the difference between the yield on a regular bond and an inflation-linked bond. We believe it’s a quick way to see what markets expect inflation to be.
With that, our goal is simple: to find inflation-linked bonds that look attractively priced compared to our view on inflation. In other words, we take a view on inflation without taking on extra interest rate risk.
Final thoughts
Bond markets offer valuable signals on inflation, but they’re not infallible. Inflation is shaped as much by geopolitics, government spending and supply chains as by central bank rates. For investors, understanding these nuances is critical. Inflation-linked bonds provide not just protection against inflation surprises but also a useful lens on market expectations. In today’s climate, we believe they’re more than a hedge – they’re a savvy way to stay ahead.
Endnotes
1 Consumer Price Index (CPI) refers to a measure of inflation. An index of the cost of all goods and services to a typical consumer.
2 Fiscal policy refers to the use of taxation and government spending as tools to influence the economy.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
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