Dominique Lapointe offers an outlook on how investors, advisors can navigate when inflation looks unlikely to slow
Each month at WP, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on fixed income.
US inflation may be peaking as oil prices have pulled back, but it may also prove stickier than originally anticipated. A combination of knock-on energy market impacts as well as impacts to markets for key economic inputs like fertilizers and plastics will all add upward pressure to inflation. That should be the case even if a tenable ceasefire can hold and energy flows out of the Arabian Gulf return closer to their pre-war levels. The US Personal Consumption Expenditures (PCE) price index may tell that story, rising to 4.1 per cent in May. The reality of sustained inflation may point to a slightly different outlook for US bonds and US fixed income overall.
Dominique Lapointe, Senior Global Macro Strategist at Manulife Investment Management in Montreal, sees US inflation staying closer to three per cent through the next few months, up to the next two quarters. It’s a view included in Manulife Investment Management’s mid-year outlook. Lapointe outlined the drivers for that inflation that go beyond just a conflict-induced spike in energy prices. He explained where he sees opportunity for investors and advisors in US fixed income now and emphasized the importance of this asset class despite broader macro uncertainty.
“The Fed is not in a position to cut,” Lapointe says. “We used to think that the Fed would still cut, would still find reasons to cut and inflation would be more driven by headline and the conflict would end. And so therefore they could go back and shift to sort of the early year disinflation story that we felt and now it’s just not the case anymore.”
Why US inflation is still elevated
The supply chain disruptions caused by the US-Israeli war with Iran and Iran’s subsequent closure of the Strait of Hormuz sit at the core of the inflation picture in the US. Lapointe notes that while the tentative peace deal had brough crude oil prices down significantly, there are prices that have remained much sticker. Jet fuels, fertilizer, and plastics are all feeling a lingering impact from the war, with the added uncertainty that comes with potential Iranian tolls on the Strait of Hormuz going forward and the frequent disruptions to peace between the US and Iran.
US GDP growth has also remained strong relative to its global peers, which is somewhat inflationary, and much of that growth has been tied to the ongoing AI infrastructure buildout. The huge amount of data centre construction that has gone on in the United States has driven up the prices of key commodities, energy inputs, and technical components like memory chips. That has begun to crowd out other industries such as residential construction and device manufacturing, causing other prices to rise.
There may be some eventual deflationary pressure that AI adds to the US economy, but Lapointe believes that will largely be realized in 2028. He acknowledges, too, that AI should be deflationary to services as it replaces labour while its infrastructure buildout is inflationary to goods.
Tariffs and trade uncertainty are also driving US inflation. While their impact has slowed over time, Lapointe highlights the fact that they are still adding a few basis points to US inflation with each print. He believes that within the next year some of the supply chain issues will have resolved and US inflation should come down from its current peaks, but he expects a slow road downwards.
Where US fixed income sits now
High sustained US inflation and pressure on the US Federal Reserve to hold rates steady isn’t setting up the most opportunistic play for US fixed income assets, Lapointe admits. Nevertheless, he argues that total returns on US debt should be solid, especially as you move into longer-duration products. 10-year US treasury bonds are returning around 4.5 per cent, which is historically strong for an effectively risk-free return.
The challenge for investors, Lapointe says, is if they are trying to play one end of the curve with a view to shifts in Fed policy. The pressure on the Fed to hold is so strong that it’s unlikely that any move down in rates will be realized in the near term. At the same time, he notes that the US has been spared some of the bond market rerating that has occurred with other developed economies as high levels of fiscal debt get punished by bond investors. Despite a relatively high debt to GDP ratio in the United States, its bond market remains more stable.
Income, rather than appreciation or a sudden shift, should be the watchword for advisors as they explain US bond allocations to their clients. Lapointe says that advisors must continue to emphasize the importance of bond allocations overall in the context of a complete portfolio, with the view that despite high inflation, they offer meaningful protection against the downside.
“Fixed income is still a fundamental part of our portfolio because when things will not go as planned, even if we’re not betting on it,” Lapointe says. “When things will not go as planned, that’s when people will flow back to especially U.S. treasuries. And that’s a dynamic that we have still strong conviction on in terms of risk free exposure for the US.”
