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VOLATILE US INFLATION CLOUDS OUTLOOK FOR MARKETS, INVESTORS SAY

Inflation is becoming more volatile and harder to anchor, keeping it front and center for investors through the rest of the year and into 2027, asset managers said at a fixed income conference last week.

Bond investors pointed to a shared assessment: inflation dynamics are no longer stable or predictable, increasing uncertainty around policy, asset valuations, and portfolio positioning across markets. But unlike past cycles, the issue is not just the level of inflation, but its volatility and the difficulty in forecasting where it goes next.

"All these individual shocks are accumulating," said Christian Schulz, chief economist at Allianz Global Investors, at the Fixed Income Leaders Summit in Boston. He pointed to drivers ranging from energy markets and climate-related food pressures to a rebound in Chinese producer prices.

The result, he warned, is a more unstable system in which inflation can fluctuate quickly and unexpectedly.

That instability is feeding directly into market behavior, investors said. Rather than relying on long-term expectations, investors and consumers are reacting to short-term price moves, pushing inflation expectations higher when prices rise, and lower when they fall.

This "adaptive" mindset, Schulz said, increases volatility and makes it harder for central banks to keep inflation anchored.

Manulife Investment Management's global chief economist Alex Grassino shared that view, describing the current environment as one defined by "rolling shocks." From the pandemic and tariffs to geopolitical tensions and rising investment in artificial intelligence, each new development has created fresh and often temporary, bursts of price pressure.

"These are things central banks have limited ability to control," Grassino said.

For policymakers, that presents a dilemma. While inflation remains a concern, the drivers are often outside the reach of interest rate policy. At the same time, political and institutional pressures are shaping how central banks respond.

Grassino highlighted a growing gap between what the Federal Reserve should do based purely on economic data and what it will do in practice. While a strong economy and a tightening labor market could justify a more hawkish stance, the Fed may be reluctant to raise rates, instead opting to hold or make limited adjustments when possible.

Markets are already reflecting that uncertainty, particularly at the short end of the yield curve, where expectations for policy shifts remain fluid.

For investors, this environment is forcing a reassessment of traditional strategies. Lori Heinel, global chief investment officer at State Street Investment Management, said inflation risks and tight credit spreads make fixed income less attractive, reinforcing a preference for equities.

"Against that backdrop… we are much more constructive on equities," she said, noting that bonds offer limited protection if inflation proves more persistent.

(Gertrude Chavez-Dreyfuss)

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