Every few decades, investors are handed a new playbook. From roughly 2000 to 2022, the playbook has read; inflation has been relatively stable, bonds have often provided a buffer for stocks, and the Federal Reserve has often intervened. Recently, that playbook has been redrawn. Inflation has awakened, the traditional stock/bond seesaw no longer works as reliably as it once did, and the new Fed leadership is signaling they are less likely to play ball if we hit a rough patch.
Where Inflation Stands: Sticky, Not Spiraling
According to the most recent Consumer Price Index (CPI), the picture is one of nagging persistence rather than acceleration. In August, the CPI held steady but remained below the three-year high reached in May. It’s good progress, but at 3.4%† year-over-year growth, inflation is still well above the Fed’s 2% long-term targeti.
| June | July | August | |
|---|---|---|---|
| Headline CPI (Year-over-Year%) | +3.5% | +3.4% | +3.4%† |
| Core CPI, ex-food & energy (YoY%) | +2.6% | +2.5% | +2.4%† |
| Headline CPI (Month-over-Month%) | -0.4% | +0.1% | +0.4%† |
| Core CPI (MoM%) | 0.0% | +0.2% | +0.3%† |
Looking beneath the surface, the story becomes a bit clearer:
- Energy has been the main culprit. Energy prices were up a striking 16.3%† over the past twelve months, jumping up 2.1% in August alone. This is what economists call a supply shock, and it is dominating the headline number.
- Food, another volatile component, was up 2.7%†, with grocery prices staying flat in August while restaurant prices were up slightly.
- Core inflation nearly hit home. At 2.4%†, core CPI is within shouting distance of the Fed's 2% goal and has slowly drifted lower. That is a meaningfully better picture than the headline implies, which bears some watching.
- Shelter continues to cool (+3.0%† year-over-year, down from 3.2%†), though it still accounted for roughly one-third of August's increase — a reminder that housing costs move like a glacier, not a river.
What all this means:
The 1 percentage-point gap between headline (3.4%†) and core (2.4%†) inflation is arguably the most important feature. It tells us that today's inflation problem is concentrated in volatile, supply-driven categories rather than broadly embedded in goods and services. That’s a good sign for the eventual path of inflation, but it is cold comfort to a household filling a gas tank and paying for groceries.
Where it might go from here:
If energy prices level off, headline inflation could gradually fall toward core inflation in the coming quarters. But, if energy shocks continue (and they have proven to be stubborn) we could be looking at a 3%-handle inflation rate for longer than the market anticipates. Our working assumption is for inflation to remain between 3.0% to 4.0% rather than tumble down to 2%. In other words, we’re planning for a range, not a point estimate.
Why a Good Economy Still Feels Bad
Here is the paradox many of you have raised with us — the economy is expanding, unemployment remains low, wage growth has been relatively firm and yet consumers share they feel squeezed.
Three explanations may explain that contradiction:
First, to consumers, price levels matter more than price changes. Inflation staying flat at 3.4%† does not make anything cheaper. It means prices are still climbing. Cumulatively, the price level for a typical basket of goods is dramatically higher than it was five or six years ago, and households compare today's prices to their pre-Covid memories, not to last month's CPI print.
Second, the type of inflation matters. The components rising fastest (energy at 16%†, food at nearly 3%†) are non-discretionary and purchased frequently. Most households stare down gasoline and grocery prices weekly. This gives inflation an emotional weight far above its statistical weight, which is precisely why consumer sentiment (i.e., emotions) tends to run well below what encouraging employment and income data would suggest.
Third, inflation-adjusted salary gains are modest. Nominal wage growth has been reasonably strong, but with headline inflation at 3.4%†, a good portion of every raise is consumed before it is spent. Purchasing power has the potential to increase.
The investment implication:
Watch consumer behavior, not consumer mood.
Historically, gloomy sentiment surveys have been poor predictors of actual spending and investment success (see page 13 of our last Quarterly Market Perspective). Where we do pay close attention is in the makeup of consumer spending and financial patterns of the consumer. Are they spending more or less than last month? Are they trading down to private-label brands? Are auto loan payments stretched? Are credit card delinquencies among lower-income households rising? These are the tells that matter for the economy, and they are the metrics we monitor most closely for signs the consumer is genuinely cracking rather than just worrying.
The New Fed Chair brings a Hike and New Communication Style
Kevin Warsh assumed the role of Federal Reserve Chair in late May 2026 ii, and his public remarks at several meetings highlighted a significant shift in monetary policy communication.
In facts his words presaged action. At the most recent policy meeting, the Federal Open Market Committee increased the target range for the benchmark rate a quarter of a percent to between 3.75% and 4.00%. Furthermore, the underlying tone has leaned increasingly hawkish. While headline numbers have shown minor moderation, policymakers continue to stress that inflation remains uncomfortably above the long-term target.
In his post-meeting speech, Chairman Warsh reinforced this vigilance, stating that the central bank’s foremost priority remains price stability. He noted that despite some resilient economic performance and modest cooling in headline figures, underlying inflation trends have yet to show convincing improvement. With a near full complement of Fed officials receptive to additional tightening before year-end, the likelihood of an incremental rate increase remains elevated. iii Clearly, this represents a major shift in Fed policy, but it’s only the first shoe to drop.
A Double Whammy - the End of the Roadmap Era
For nearly twenty years, the Fed effectively handed investors a roadmap with detailed guidance. That roadmap has now been withdrawn. Less guidance means the market must price policy off incoming data rather than official signals. That new lack of clarity may potentially influence interest rate volatility. Historically, bond market reactions have often been influenced by each CPI and employment release. From an investment standpoint, the Fed communication overhaul further emphasizes the importance of diversification within the interest rate sensitive sleeve of portfolios. Not only are bonds and cash equivalents likely to experience wider swings, but low profitability and debt-laden stock issuers will potentially be challenged by higher discount and refinancing rates.
The Uncomfortable Truth: Stocks and Bonds Now Move Together
This is the concept we most want you to take away.
The classic “60/40” portfolio worked nicely for decades primarily because stocks and bonds were negatively correlated. In other words, when equities fell, Treasuries rallied, softening the blow. That relationship was never a law of physics. It was a feature of a low, stable inflation regime.
When inflation is elevated and uncertain, the correlation flips positively. The mechanism here is straightforward: in a low inflationary world, bad news about slowing economic growth usually results in stocks getting hurt and bonds getting helped. In an elevated inflationary world, bad news about inflation tends to drive yields up, which hurts both stocks (higher discount rates) and bonds (price diminution). In this scenario, both sides of the 60/40 fall simultaneously. Investors experienced this painfully in 2022, and it was one of the defining characteristics of the 1970s.
The practical consequence:
A portfolio that consists of traditional stocks and bonds only may be far less diversified than historical statistics suggest. Diversification must be built across inflation sensitivities, not merely across simple asset types.
Building a Portfolio for This Regime
If stocks and bonds can decline in unison, it may be beneficial to consider assets whose returns are driven by different factors. Here is how we build resilience in each sleeve:
Equities/Growth Sleeve (“the 60”):
International developed and emerging market equities: International markets don’t always move for the same reasons as the U.S. domestic market. There are different inflation dynamics, different central banks, different currency exposures. A weakening or strengthening dollar creates return streams less correlated with U.S. domestic outcomes. International stocks are an underappreciated diversifier.
Real Estate Investment Trusts (REITs): Real estate offers exposure to tangible assets and the potential for rising rental income based on inflation. We view REITs as a long-horizon inflation participant rather than a short-term hedge, and we favor stable and growing property types (e.g., data centers, cell phone towers, etc.).
Commodities: Historically, commodities have often been considered as a strategy to potentially mitigate the effects of inflation. With energy up 16.3%† year-over-year, commodity exposure is one of very few allocations that profits from the price shock hurting household budgets. It is volatile and offers no yield, which is why the allocation is modest and deliberately sized for the current environment.
Bonds/Stability & Income Sleeve (“the 40”):
Treasury Inflation-Protected Securities (TIPS): TIPS can be considered as a potential inflation hedge. The principal value of TIPS adjusts with headline CPI, the very measure running at 3.4%† (not the 2.4%† core rate). TIPS can be a useful tool for managing the purchasing power of the conservative portion of your portfolio, and they are especially relevant now because the inflation challenges are concentrated in the energy and food components that headline CPI captures and core CPI excludes.
High-yield bonds: In an environment where investment-grade prices are elevated (i.e., tight spreads), high yield offers a different experience: a return driven more by corporate credit quality than by interest rate moves. With the economy expanding and unemployment low, the economic backdrop is supportive for many high yield companies.
Liquid alternatives: This is where we address the correlation problem most directly. Strategies such as managed futures, market-neutral equity, and global macro derive returns from price trends and relative value rather than from the direction of stocks or bonds. Their historical value has been strong precisely in stock/bond drawdowns like 2022 iv.
The Final Point: Diversification as Behavioral Insurance
The biggest reason we build portfolios in the manner described has less to do with statistics than with human nature.
Decades of evidence suggest that the greatest destroyer of investor wealth is not inflation, recessions, or bear markets. It is selling at the bottom. A portfolio that falls 30% may test conviction more than a portfolio that falls 15%. The asset classes described above are designed with the aim to mitigate the impact of drawdowns, which could potentially help you maintain your investment during market downturns.
“Staying invested” is not just a slogan. Staying invested is the mechanism by which positive long-term outcomes are achieved. Our job is to help build a portfolio that we believe will help you navigate through a difficult stretch, with the aim of supporting your long-term financial goal.
Two action items:
First, reassess your stance on cash. Cash yields look attractive at today's rates, but cash is a decaying asset against 3.4%† inflation. Fidelity’s financial consultants can help you determine the appropriate amount of cash to hold and the appropriate amount to invest.
Second, and by all means, please call your consultant before you act. If the next couple CPI prints unsettle you, that is the moment to talk, not time the market.
Thank you for reading this message. We’ll be back in touch after the next few Fed meetings to wrap up what has been a fascinating 2026!