SUMMARY
U.S. inflation climbed to its highest level since April 2023, and markets are now expecting rate hikes from the Fed. We believe investors should consider positioning for a higher-for-longer rate backdrop rather than the cuts many anticipated only a few months ago.
Key Takeaways:
U.S. inflation reached 4.2% in May 2026, the highest since April 2023
Markets now price Fed rate hikes vs cuts expected months ago
We favor U.S. equities over international despite 2025 rotation
AI capex cycle expansion supports U.S. Tech & memory chipmakers
Bonds may offer reduced ballast
Energy-driven inflation differs from 2022 supply-chain crisis
Inflation reaccelerates and central banks turn hawkish
Headline Consumer Price Index (CPI) rose to 4.2% year-over-year in May 2026, and headline Personal Consumption Expenditure (PCE) reached 4.1%, the highest readings since April 2023.
Core PCE climbed to 3.4%, its highest level since October 2023.
The drivers differ from the 2022 inflation cycle.
Energy costs and geopolitical disruption now drive higher prices, whereas supply chain bottlenecks drove the post-COVID surge.
Today, in addition to higher energy prices, the cost of some inputs such as fertilizer (synthetic fertilizers are energy intensive and a third of seaborne fertilizer flows through the Strait of Hormuz), flows through to food prices and higher transportation costs impact the overall cost of production.
Importantly, this year's rise in inflation is not as broad based as the 2022 episode.
The European Central Bank (ECB) and some other central banks have already raised rates recently, while the Federal Reserve has responded with a clear shift in tone.
In the U.S., the Federal Open Market Committee (FOMC) delivered a hawkish pivot, removing a previously indicated rate cut.
This signals some members view a rate hike as likely this year and stresses their commitment to deliver price stability after missing the Fed's 2% inflation target for five years running.
With more hawkish central banks, and less forward guidance from the Fed expected going forward, there is a higher likelihood for more volatility.
Bottom line: U.S. inflation has climbed to its highest level since April 2023, and markets are now expecting rate hikes from the Fed.
We believe investors should position for a higher-for-longer rate backdrop rather than the cuts many anticipated only a few months ago.
This, along with the potential for reduced forward guidance from the Fed, could mean there is a higher likelihood for more market volatility.
Prior rate-hiking cycles offer a useful guide.
A different inflation regime and shifting equity leadership
Central banks have tightened aggressively more than once in recent years, and each rate hiking cycle has reshaped relative performance across regions and asset classes.
The synchronized global rate-hiking cycle pushed nearly every major equity market index lower in 2022, and international markets bore an outsized hit as zero and negative rates reversed.
A strong U.S. dollar (USD) reinforced that backdrop as the dollar reached multi-decade highs.
Then 2025 turned.
The dollar weakened, international equities and emerging markets (EMs) outpaced the S&P 500, and the Technology revaluation reversed as the AI capex cycle broadened across the U.S. and Asia.
Even so, U.S. equities still lead on a cumulative basis over a five-year time horizon, supported by resilient earnings, healthy free cash flow, and a consumer that keeps spending.
We continue to prefer U.S. equity exposure over Europe, where the macro backdrop looks weaker.
We are watching the AI capex cycle closely, and recent expansion announcements from leading memory chipmakers reinforce our constructive view on that theme.
Bottom line: International equities rebounded sharply in 2025, yet durable U.S. earnings and the AI capex cycle continue to support our preference for U.S. equities in portfolios where cash flow strength from U.S. companies are still delivering.
For suitable and qualified investors, diversifiers may strengthen portfolio resilience
Volatility has spread across equities and currencies, and that is exactly when resilience earns its keep.
Bonds have long served as a portfolio ballast, but their cushion has recently proven less reliable.
This is where a comprehensive toolkit matters.
For suitable and qualified investors, we believe select alternative strategies across public and private markets can introduce differentiated return sources.
Gold and real assets such as infrastructure, alongside lower-beta hedge fund strategies, may offer lower correlation and distinct economic drivers relative to traditional assets.
Correlation is only one lens we use.
At Citi Wealth, we also examine beta and actively utilize stress testing and other measures to identify diversifying assets.
This helps to expand the investable universe and offer risk-return profiles traditional portfolios do not capture.
Bottom line: Volatility has increased recently across equities and currencies, and we continue to expect that bonds may offer less of a ballast than they have historically.
For suitable and qualified investors, we view select alternatives and real assets as a potential diversifier through lower correlation and distinct return drivers.
