Structural Inflation Shift Requires Real Asset Portfolio Diversification

Key Quotes

"And the reason we're calling this a regime change is because we see factors for inflation coming from both the demand side and the supply side. For example, on the demand side, the role of the infrastructure boom, the GenAI infrastructure boom, has become global. It has caused material appreciation of many commodities in 2025. We're seeing it obviously in some of the dynamics around precious metals. But we're also seeing it in industrial metals. Things like copper, things like nickel."

Lisa Shalett explains that the current inflationary environment is being driven by factors on both the demand and supply sides. Shalett highlights the global impact of the GenAI infrastructure boom, which is increasing demand and thus the appreciation of commodities like copper and nickel. This indicates a potential shift from previous inflationary periods.

"But perhaps the wrapper around all of it is how policy is shifting -- because increasingly policymakers are being constrained by very high levels of debt and deficits. And determining how to fund those debts and deficits actually removes some of the degrees of freedom that central bankers may have when it comes to actually using interest rates to constrain demand."

Shalett points out that a significant factor influencing inflation is the changing landscape of policy. She argues that high levels of debt and deficits are limiting the options available to policymakers, particularly central bankers, who may have less flexibility to use interest rates to control demand. This suggests that traditional monetary policy tools might be less effective in the current environment.

"So, on the monetary side, we're already seeing the Fed beginning to signal that perhaps they're going to rely on other tools in the toolkit. And what are those tools in the toolkit? Well, they're managing the size of their balance sheet, managing the duration or the mix of things that they hold in the balance sheet. And it's actual, you know, returns to how they think about reserve management in the banking system."

Andrew Sheets discusses the potential shift in monetary policy strategy. Shalett explains that the Federal Reserve may be signaling a move towards utilizing alternative tools beyond interest rate adjustments. These tools include managing the central bank's balance sheet and its holdings, which are related to how they manage reserves within the banking system.

"This is one of the areas where the U.S., at the minute, is facing genuine constraints. When you think about some of the forecasts that have been put out there in terms of $10 trillion of spending related to Generative AI, the number of data centers that are going to be built, and the power shortfall that has been forecast. We're talking about someone having to pay the price, if you will, to ration power until you can upgrade the grid."

Shalett identifies energy and technology, specifically AI data center construction, as a significant factor contributing to inflation. She notes that the U.S. is experiencing constraints in this area, with substantial spending on AI and a projected power shortfall. Shalett suggests that these constraints will lead to increased costs for electricity as demand outstrips supply until grid infrastructure is upgraded.

"So, the first thing that we think it's really important for folks to appreciate is that typically when we've been in these higher inflation regimes in the past, stocks and bonds become positively correlated. And what that means is that the power of a very simple 60-40 or stock-bond-cash portfolio to provide complete or optimal diversification fades."

Lisa Shalett advises investors on navigating a high inflation regime by highlighting a key historical correlation. She explains that in past high inflation periods, stocks and bonds have tended to move in the same direction, reducing the effectiveness of traditional diversification strategies like a 60-40 portfolio. This suggests a need for investors to consider alternative approaches.

"Now, all of those things may absolutely, positively be true. The problem that we have is that the alternate case, right? The case that we’re making -- that maybe we’re in a new inflationary regime is not priced, and the risk is non-zero."

Shalett addresses the market's current perception of inflation expectations. She acknowledges that factors like anchored inflation expectations and faith in policymakers and technology may be valid. However, Shalett emphasizes that the alternative scenario, where inflation is structurally higher, is not fully reflected in market pricing, presenting a non-zero risk to investors.