Trumpflation Threatens Record-Breaking US Stock Market Rally

The stock market's record-breaking rally is facing a new threat from inflation, which some investors are calling 'Trumpflation'. This refers to price pressures linked to trade, energy, and foreign policy proposals. The Dow Jones, S&P 500, and Nasdaq Composite have reached all-time highs this year, driven by strong corporate earnings and the excitement around artificial intelligence.

However, inflation concerns have resurfaced, raising fears that the Federal Reserve may need to keep interest rates tight or even raise them again. Trailing 12-month inflation rose from 2.4% in February to 4.2% in May before easing to 3.5% in June. Core personal consumption expenditure inflation, which excludes food and energy, remained at 3.3% in June.

The Federal Reserve Bank of Cleveland's Inflation Nowcasting tool suggests that core PCE could remain around 3.3% in July, still above the Fed's 2% target. Tariffs, geopolitical risks, and the artificial intelligence boom are adding pressure on prices. The minutes of the Federal Open Market Committee's June meeting revealed that policymakers were concerned about core goods inflation, partly due to tariffs and AI-related pricing pressures.

The risk for stocks is not just inflation itself, but also the Fed's response. If inflation stays above target, the central bank may be forced to hold rates higher for longer or raise them again. Higher interest rates typically hurt equity valuations by making future earnings less valuable and increasing the appeal of bonds and cash.

Bond markets are sending a warning, with yields on long-term Treasury bonds climbing significantly. This suggests that investors are not fully convinced inflation is under control. The stock market has often recovered from shocks in the past, but the near-term setup is less comfortable due to high valuations, rising margin debt, and the dominance of AI stocks.