June 12, 2026

Key takeaways

• Inflation has moved back into focus, driven mainly by higher energy prices rather than broad-based price pressure.
• Central banks are facing a difficult trade-off: higher energy prices lift inflation, but tighter monetary policy can also weaken growth just as consumers are feeling pressure from higher prices.
• Traditional core bonds struggle when inflation drives yields higher, reinforcing the need for a broader approach to fixed income.

Inflation has returned to the centre of the market conversation. Headline United States (US) inflation rose by 4.2% in May, largely led by higher energy prices following the conflict in Iran. Gasoline has been the most visible pressure point.

So far, the underlying inflation picture looks less alarming. Core inflation, which excludes food and energy, increased more modestly at 2.9% from a year earlier. Some goods prices declined and services inflation cooled, suggesting the latest increase is still being driven more by energy than by broad-based price pressure.

The risk is not simply that gasoline prices rise. The risk is that higher energy costs ripple through the economy into transportation, food, freight, business costs and wages. That can make inflation more persistent and reduce consumer spending power, because money spent on energy is money not spent elsewhere.

Central banks are facing a difficult trade-off

The inflation challenge is not the same everywhere. Europe is more exposed to higher energy costs, and the European Central Bank has responded more forcefully to renewed inflation pressure. The concern is that higher energy prices could become embedded in wages, business costs and inflation expectations.

The US Federal Reserve (Fed) is in a different position. Higher energy prices are pushing inflation upward, but raising interest rates cannot resolve supply constraints in the oil market. Tightening too aggressively could weaken growth just as consumers begin to feel pressure from higher prices. For now, this supports a more patient approach while the Fed assesses whether the larger risk lies in persistent inflation or slowing growth.

Canada sits somewhere in between. The Bank of Canada (BoC) is balancing higher inflation risk against a weaker domestic economy. Raising rates could slow growth further, while cutting rates could make inflation more persistent. Holding steady allows the BoC to balance both risks.

The chart below shows where central banks across the Group of 10 developed economies stand, ranked by policy rate from highest to lowest.

Why this matters for bonds

Higher inflation has pushed bond yields higher as investors reduce expectations for rate cuts and consider the possibility that central banks may need to keep rates elevated for longer. This matters because when yields rise, bond prices fall.

Bonds are most vulnerable when inflation, rather than slowing growth, is driving markets. When inflation is rising, stocks and bonds can come under pressure at the same time. That is why traditional bonds may not provide the same near-term protection clients expect. For context, at the start of the year, the yield of the FTSE Canada Universe Bond Index was 3.5%. Year-to-date, the index had a return of only 1.2%.

However, this does not mean bonds no longer provide diversification within portfolios. The source of market stress matters. If higher energy prices begin to threaten economic growth, high-quality bonds can still provide important protection as yields fall in response to weaker growth expectations.

A broader approach to fixed income

For clients, the key lesson is not to avoid bonds, but to take a more balanced approach to fixed income. We continue to favour a diversified approach that combines high-quality bonds (for stability) with income-oriented exposures that are more resilient as bond yields rise. This includes selective exposure to high-yield, emerging market credit and mortgages, where yields are attractive and return drivers can differ from traditional government bonds. Presently, this diversified approach within the CCLPC Enhanced Income Portfolio provides a yield advantage of approximately 2% over the universe bond index.

High-yield can offer stronger income when company fundamentals remain solid. Emerging market credit provides exposure to a wider range of countries and industries, including some that may benefit from higher commodity prices. And mortgages can offer attractive income with less reliance on falling interest rates.

Bottom line

Inflation has become more uneven and less predictable. Bonds still matter, but the fixed income playbook needs to be broader. In this environment, portfolios should emphasize income, diversification and flexibility rather than relying only on traditional core bonds.

Disclaimer

This material, including any attachments, is provided for informational purposes only and is not intended as investment, legal, accounting, or tax advice. It has been prepared without regard to individual financial circumstances or objectives, and readers should consult independent professionals, as applicable. All views, opinions, estimates and projections contained in this material constitute Connor, Clark & Lunn Private Capital Ltd. (“CC&L Private Capital”)’s judgment as of the date of publication and are subject to change without notice. Certain information contained herein is based on information obtained from third-party sources that CC&L Private Capital considers to be reliable. Past performance is not indicative of future results, future returns are not guaranteed, and loss of capital may occur. This material is intended for the use of the recipient only and no matter contained herein may be separately used, disseminated, distributed, reproduced or copied by any means, in whole or in part without express prior written of CC&L Private Capital. This is not an offer to sell or a solicitation to buy any securities and should not be construed as a sales communication.