The Inflation Wobble

When the war with Iran began in February, investors hoped any fallout would be contained. The longer it continues, the more they need to prepare for a potential inflation shock that may force the Federal Reserve (Fed) back into aggressive hiking mode.

Our proprietary MacroScope model, which scans historical regimes to interpret current conditions, shows the present environment has the strongest parallels with June 2021 and February 2017, with July 1999 (the height of the Dot-Com boom) close behind. Both 2017 and 2021 began as healthy expansions, with one remaining benign, while inflation soared in the other. Which path the rest of the year follows now depends on how quickly global supplies can start moving through the Strait of Hormuz again.

To us, the model reads the present environment as a mid-to-late cycle expansion, a regime that has traditionally tended to precede tighter policy and rising inflation. Maybe it’s some comfort that it currently sits furthest from the 2008 to 2009 crisis and the 2015 to 2016 growth scare.

The model's factor (Figure 1) and sector positioning reflects that caution. It still favours strong momentum and pro-growth names, but it is becoming increasingly defensive within that tilt. In practice, that means easing back from broad market swings to a neutral stance.

Figure 1. Our model is becoming more defensive

Source: Man Numeric and MSCI Barra, as at 27 May 2026.

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For industry sectors (Figure 2), that translates into picking financially stronger companies with steadier earnings, as well as strongly favouring sectors such as oil and gas and fertilisers and agricultural chemicals, which are all directly affected by the closure of the Strait of Hormuz.

Figure 2. Our model has picked the sectors most strongly affected by the war

Source: Man Numeric and MSCI Barra, as at 27 May 2026.

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The late cycle and inflation

2017 was as benign a year as a portfolio manager could wish for. Growth was solid, inflation sat just above target, the Fed tightened at a measured and well-telegraphed pace, and equities drifted higher with barely a ripple. By contrast, 2021 finished with inflation running at 5%, the Fed insisting it was transitory and it then having to trigger the most aggressive tightening cycle in 40 years.

The inflation reacceleration risk now appears very real. Energy prices are surging, the Fed has held rates for three consecutive meetings, and markets are pricing a higher chance of rate increases this year. April CPI came in at 3.8% year-on-year, a three-year high and well above the Fed’s 2% target, and the OECD has lifted its 2026 US inflation forecast to 4.2% from 2.8% only months earlier.

If the conflict eases soon and oil comes off the boil, a 2017 outcome is more likely, but if it persists, the spectre of 2021 could reassert itself.

AI and 1999

The 1999 parallel is also interesting, referencing the height of the Dot-Com frenzy. Back then tech company valuations ran well ahead of fundamentals just as the Fed was tightening into the momentum. The Magnificent Seven alone now account for roughly 30% of the S&P 500, the bulk of it tied to the AI build-out, and yet a National Bureau of Economic Research study found nearly 90% of 6,000 senior executives surveyed who had used AI reported no measurable productivity gains as yet.

These same executives predicted sizable effects over the next three years, boosting productivity at their firms by an average of 1.4% and raising output 0.8%. Whether returns of that order justify an infrastructure build-out on the current scale is the question the market is grappling with.

Warsh, and the case for staying defensive

All of this now sits with new Fed Chair Kevin Warsh who will preside over his first meeting on 16-17 June, a week after the May CPI release. The weight of political and market expectation favours lower rates, while the inflation data argues the other way. The Fed's April minutes called persistent inflation a salient risk and while almost no-one expects a rate change at the next meeting, investors will scrutinise Warsh’s every word for hawkish or dovish signals.

The benign 2017 outcome and the spectre of 2021 look equally plausible from here. The model positions for that uncertainty, leaning more defensive within a pro-growth tilt. It now all hinges on what happens in the Strait.

All data  Bloomberg, unless otherwise stated.

Author: Valerie Xiang, a portfolio manager at Man Numeric.