Markets have a habit of hearing what they want to hear. Right now, they appear to be hearing that inflation is basically over and central banks are nearly done. Henry Allen, a macro strategist at Deutsche Bank, would like a word.
Allen warned this week that investors are significantly underestimating how much monetary tightening central banks will need to deliver to bring inflation to heel. The gap between what markets expect and what the data implies, in his view, is uncomfortably wide.
The disconnect in plain terms
Here is the core problem Allen is pointing to: PCE inflation, the Federal Reserve’s preferred gauge, was running at 3.7% as of June 2026. Meanwhile, market pricing only bakes in roughly 31 basis points of Fed rate hikes through December 2026. That is not much firepower for a central bank still fighting an inflation rate nearly double its 2% target.
The US ISM services index is adding fuel to Allen’s argument. Prices paid by service-sector businesses are rising at the fastest pace since inflation peaked post-pandemic, when CPI briefly touched 5%. Services inflation is notoriously sticky, which means it tends to linger well after goods prices cool off.
Allen’s concerns are not new. He has been flagging this disconnect since August, consistently pointing out that historical tightening cycles under comparable inflation conditions required more than 100 basis points of hikes. The current market-implied path falls well short of that threshold.
What Deutsche Bank actually expects
Deutsche Bank’s base case calls for two 25-basis-point Fed rate hikes in September and December 2026, which would lift the federal funds target to approximately 4.1%. The ECB is expected to follow with its own tightening given persistent energy-driven price pressures across Europe.
Labor markets are not helping the inflation fight either. The unemployment rate stood at 4.1% as of July 2026, which is historically low. A tight labor market tends to sustain wage growth, which feeds into services costs, which keeps the services component of inflation elevated.
Geopolitics are complicating the picture further. Allen specifically called out the ongoing Middle East conflict and supply chain disruptions as ongoing upward pressures on oil, gas, food, and metals prices.
What this means for risk assets
Allen’s warning carries a specific implication for investors holding equities and credit: valuations priced for a near-perfect soft landing look vulnerable if the rate path turns out steeper than expected.
Allen put it plainly: “something will have to give.” That is a measured way of saying that current asset prices and current rate expectations cannot both be right simultaneously.
The cycle peak for the Fed funds rate, as Allen noted in his August commentary, was being priced by markets at just 47 basis points above current levels by mid-2027. That is a remarkably modest adjustment given the inflation backdrop.