Bond markets are quietly pricing the highest inflation expectations in nearly four years. Equity markets continue to trade at or near record highs. One of them is wrong, or both are right and the gap is the risk.

The 5-year breakeven inflation rate, a widely followed Wall Street gauge of average expected inflation over the next five years, climbed to 2.72% on Tuesday morning. That is the highest level since August 2022, when the post-pandemic inflation shock was still in full swing. The 10-year breakeven rose to 2.50%, the highest since March 2023.

Translation: bond traders are putting real money on the bet that the Fed's 2% inflation target is slipping further out of reach.

Historically, episodes of rising market-based inflation expectations have forced the Federal Reserve into the hiking lane. The 2021–2022 breakeven climb that peaked just above today's level preceded the most aggressive tightening cycle in four decades.

That leaves a key question on the table. Why is the stock market refusing to flinch at either rising inflation or a central bank that may have run out of room to ease?

The Rate-Cut Trade Has Quietly Died

The shift in interest-rate expectations has been dramatic over the past week. Polymarket now prices a 59% probability that the Federal Reserve will hold interest rates flat for the entirety of 2026. The most striking detail is what sits beneath that headline: the implied odds of a rate hike (25%) are now greater than the odds of a single 25 basis-point cut (19%).

That is a regime change. Coming into the year, every major Wall Street bank had penciled in two to three Fed cuts. The Iran war, the Hormuz blockade, and oil parked above $100 per barrel have rewritten that script line by line.

Goldman Sachs now expects Brent to average $90 in the fourth quarter, up from $80 under its previous forecast, on the assumption that Gulf exports will not normalize until late June. Brent traded as high as $114 intraday on Monday, the highest since May 2022, after fresh Iranian missile strikes on UAE infrastructure. Diesel now trades a hair's breadth from its 2022 record. Gasoline averages $4.50 a gallon nationally, and crossed $6 a gallon in California last week.

So Why Are Stocks Still At Record Highs?

The answer comes in two parts, and both lead back to the same place: the U.S. consumer and the AI capex cycle.

"Consumer spending and AI are responsible for the entirety of domestic demand growth," said Aditya Bhave, U.S. Economist at BofA Global Research. Bhave added that the dynamic has held since the start of last year. Together, they solve the puzzle.

Since the first quarter of 2025, every other engine of the U.S. economy has been running in reverse. Residential investment has contracted. Non-AI capex has contracted. Government spending has contracted on average. The only two things keeping final domestic demand positive are households swiping cards and hyperscalers pouring concrete for data centers.

The consumer leg of that argument got fresh data on Monday from BofA Institute. Liz Everett Krisberg, head of the BofA Institute, and senior economist David Tinsley reported that median household savings and checking balances rose roughly 9% between January and end-March, broadly matching the post-tax-refund jump seen in 2025. Households earning under $50,000 hold median checking and savings balances roughly 70% above where they sat in 2019 in nominal terms, and more than 40% higher once inflation is stripped out, according to Bank of America internal data.

Tax refunds are amplifying that cushion. The IRS reports the average refund this season is running 11% above 2025, with the latest weekly print landing near $3,521 per household and cumulative refunds clearing $265 billion through mid-April.

The other pillar holding stocks up is the AI build-out, and it has not blinked. Goldman Sachs estimates that AI capex will account for roughly 40% of S&P 500 earnings-per-share growth this year. Hyperscaler spending is pacing toward $670 billion to $770 billion in 2026, a number that has stayed firm even as oil broke above $110.

The earnings tape backs up the bull case. With 63% of the S&P 500 – as tracked by the SPDR S&P 500 ETF Trust (SPY) – already in, blended first-quarter earnings growth is tracking at 27.1% year-over-year, the strongest pace in five years and more than double the 13.1% rate analysts had penciled in heading into reporting season, per the latest FactSet Earnings Insight report.

The Read

The market is not ignoring inflation. It is pricing a different question: whether earnings can grow fast enough, and AI capex can stay strong enough, to offset rates that stay higher for longer. So far the answer has been yes. The Iran war remains the key risk that could derail both pillars: spending via inflation, AI capex via energy supply bottlenecks. Both transmission channels run through Hormuz.

The S&P 500 closed Monday at 7,200.75, just 0.4% below Friday's record. The 5-year breakeven inflation rate sits at a four-year high. One of those signals will eventually have to bend toward the other. The unanswered question is which one moves first.