Geopolitics, inflation and the resiliency of markets

Geopolitics, persistent inflation, tariffs and rising government debt continue to shape the economic outlook across Canada, the U.S. and global markets. Yet despite heightened uncertainty and volatility, markets have proven remarkably resilient.

To unpack what’s happening in the economy and help investors interpret what it means for their portfolios, June Zimmer, Regional President for British Columbia and the Prairies at BMO Private Wealth, hosted the latest Market & Economic Outlook in Vancouver that featured:

• Jennifer Lee, Senior Economist, BMO Capital Markets
• Mark Bayko, Head of North American Equities, BMO Private Wealth
• Jeff Elliott, Head of Global Equities, BMO Global Asset Management

Here are some of the key takeaways from the event.

Expect the unexpected

Over the past year, investors have had to digest a shift in U.S. trade policy, threats to NATO, an invasion of Venezuela and a war with Iran that’s jolted energy markets and intensified volatility on equity markets. It’s been a lot for investors and Jennifer Lee doesn’t expect that to change. “Uncertainty is something that we have to learn to live with,” she said. “I think this is going to be sticking with us for a long time.”

Lee is focused on inflation and growth. In recent weeks, BMO economists have lowered growth forecasts for both Canada and the U.S. by 0.3  percentage points, while raising its inflation forecasts by a percentage point. The biggest contributor to its inflation forecast, of course, is the soaring price of crude, which Lee expects will average about $90 for the rest of the year, up from about $65 before the war in Iran started.

For Canada, recent events have clouded the interest rate picture for the rest of 2026. “We continue to have no more rate cuts this year,” she said. “In the U.S., we are looking for rate cuts in September and December of 25 basis points each. But I would not be writing that in blood right now.”

The situation in the U.S. isn’t much different. Even if geopolitical conflict in the Middle East were to end today, Lee said investors should expect inflation to remain closer to 3% rather than the U.S. Federal Reserve’s 2% target. There are still plenty of factors that are going to keep inflation elevated, she explained. Tariffs are still hitting prices, particularly food costs. About 60% of fruit and 40% of vegetables consumed in the U.S. are imported, she noted.

The surge in AI could put additional pressure on inflation by driving demand for electricity and water, as could the U.S. crackdown on illegal immigration. About half of the agricultural sector is comprised of undocumented workers, so finding Americans to replace them will drive up labour costs, said Lee. A similar trend is at play in the construction, leisure and hospitality industries.

The high number of retiring Americans is another theme Lee is watching. The “silver tsunami” – the wave of Americans reaching age 65 – is going to see more people leaving the workforce in the country in the coming years.

Resiliency of the markets

Although inflation remains a concern for equity markets, Mark Bayko still sees strength in the U.S. economy. The chief risk is whether anything destabilizes the American consumer, but so far, he hasn’t seen any evidence of that. “I’ve been surprised at how resilient the markets have been,” he said. Still, investors would be prudent to review their portfolios to see which companies are better able to weather higher inflation. “At the end of the day, the market will do what it will do, but if I can be confident in the quality of the businesses that I’ve invested in, then I’ve done my job well.”

If there is one positive to come out over the past 12 months, it’s that the unpredictability of the U.S. administration is forcing countries to look inward at their own economies. “We need to reinvest in our country so that we’re not relying as much on others,” he said. Still, he recognizes that this type of change isn’t going to happen overnight, meaning investors still have to look abroad to maintain a diversified portfolio.

“One of the reasons we’ve been advocating for global investing for a long time, is that Canada’s a very non-diverse economy,” Jeff Elliott said, noting that can leave investors more exposed to things like inflation. “You have banks, you have resource companies, more or less, but if you want exposure to AI, if you want exposure to health care, you cannot get that in Canada.”

 That diversification is important because it can help blunt the impact of inflation. “If I can find a company that has a new drug that cures people, it doesn’t care what inflation is,” said Elliott. “It doesn’t really care what the deficit is. Those are the places we try to spend our time to find investments.”

AI and the markets

While a Canadian may hold the Nobel Prize in Physics for AI research, the leading AI companies are all south of the border. The amount of money pouring into AI right now is staggering. Last year there was about US$350 billion investment in capex, this year it is expected to be around US$700 billion, which puts it on pace to top US$1 trillion next year, said Elliott. To put that in context, that investment is roughly twice the size of the Portuguese economy.

“That has impacts in terms of the ecosystem, both the stock market and the economy itself. It drives productivity,” he said. Still, he adds, while the economic and market impact of that investment is clear, it’s still too early to know what the full productivity impact will be.

The market is reacting as though the tech is going to completely disrupt our lives in the next six to 12 months, he notes. What Elliott is focusing on are the long-term implications around the potential for AI – if it lives up to the hype – to eliminate a number of jobs.

In a bid to gain a competitive advantage, companies are spending big money without a clear reward, he said. “I’m pretty sure the economy needs people making money to buy houses and buy stuff,” he quipped.

Given how far and how fast AI companies have rallied, Bayko said some investors are starting to book their gains. Many of these companies have done so well that investors are beginning to question whether they can continue to deliver that level of performance for the next five years.

“There’s been a realization that maybe other sectors like industrials, like commodities, which are more exposed to economic growth and spending from governments on infrastructure and defense, are seeing some tailwinds,” he said. “It’s an underappreciated opportunity.”

 

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