The most dangerous part of an inflation shock may come after the peak

An inflation shock is easy to recognize when prices are accelerating, central banks are scrambling, and every economic release seems to move markets.

The harder period may come afterward.

Once inflation peaks and begins falling, the pressure appears to be easing. Rate cuts move back into the conversation, and markets start looking toward the next expansion.

Investors can reasonably conclude that an extraordinary episode is returning to normal.

History suggests inflation doesn't always cooperate.

An inflation peak isn't necessarily the end

Inflation rarely follows a perfectly smooth path. Economic growth changes, commodity prices fluctuate, monetary policy operates with a lag, and governments continue making fiscal decisions while central banks try to contain price pressures.

The result can be a series of accelerations and decelerations rather than one clean inflationary cycle.

The United States experienced exactly that pattern during the 1970s and early 1980s.

Annual CPI inflation climbed above 6% in 1970 before falling below 3% in 1972. Anyone looking only at the direction of inflation could reasonably have seen substantial progress.

Then inflation accelerated again.

CPI inflation exceeded 12% in 1974 before declining to roughly 5% by the end of 1976. Another apparent victory followed.

Then came another wave. Inflation accelerated into double digits again and eventually exceeded 14% in 1980.

Viewed from decades away, we call the period "the Great Inflation." Living through it would have looked considerably messier: inflation, relief, renewed inflation, more relief, and then another surge.

Falling inflation can change investor behavior

During the periods between inflation peaks, expectations change before the underlying problem necessarily disappears.

When inflation is rapidly accelerating, uncertainty is obvious. Investors expect policymakers to respond aggressively, businesses adapt to rising costs, and households can see their purchasing power deteriorating.

Falling inflation creates a different psychological environment.

If inflation falls from 9% to 5%, and then from 5% toward 3%, the direction is encouraging. Yet prices are generally still rising. The cumulative increase in the price level hasn't disappeared, and another economic shock can change the trajectory again.

Financial markets also begin anticipating what comes next. Expectations for monetary policy shift.

Bond yields respond.
Asset valuations adjust.
Capital begins positioning around the assumption that the inflation shock is receding.

That creates another kind of risk: confidence in a trend that may not continue.

The second wave doesn't need the same cause

Expecting another inflation surge can also lead investors toward the wrong conclusion if they assume history will repeat itself.

The forces behind one wave don't have to cause the next.

• An energy shock can push inflation higher and then fade.
• Fiscal stimulus can support demand.
• Supply constraints can emerge or disappear.
• Wage pressures can change.
• Monetary conditions can loosen as policymakers respond to weakness elsewhere in the economy.

Each development can alter inflation without recreating the circumstances that caused the previous surge.

That makes inflation volatility particularly difficult to navigate. Correctly identifying what caused yesterday's inflation doesn't necessarily tell you where inflation will be a year from now.

Investors have experienced this problem before

There is an uncomfortable implication in the inflation history of the 1970s: investors didn't receive one opportunity to correctly identify an inflationary regime.

They received several opportunities to incorrectly declare it finished.

That doesn't mean today's economy is destined to repeat the 1970s. Historical analogies become dangerous when they're treated as forecasts.

Instead, the useful lesson is narrower:

A decline in inflation tells us what has happened. It doesn't guarantee what happens next.

The same principle applies in the opposite direction. A renewed inflation increase wouldn't prove that inflation will continue accelerating indefinitely.

Markets move through changing combinations of inflation, growth, policy, and expectations. Investors trying to identify the next regime in real time are attempting to make decisions before the historical narrative becomes obvious.

The peak, then, can create its own vulnerability.

During the shock, everyone knows conditions are unusual. After the peak, it becomes much easier to believe they're predictable again.

The better response may be to prepare for uncertainty rather than predict what comes next.

Rodrigo Gordillo, the president of ReSolve Asset Management and co-founder of Return Stacked ETFs, explores this philosophy in more detail on the Gold Exchange Podcast.