Post-Pandemic Inflationary Pressures and the Path to Resilience: BMO's 2025 Outlook for Inflation-Protected Assets and Sectors

The post-pandemic economic landscape in North America has defied expectations. What began as a temporary spike in inflation has solidified into a structural shift, with consumer prices in the U.S. up 25% since 2019 and Canadian prices rising 20% since mid-2020. The Bank of Montreal (BMO) has sounded a clear warning: the “new normal” is not a fleeting phase but a redefinition of affordability, inflation expectations, and investment strategies. For investors, this means recalibrating portfolios to include inflation-protected assets and sectors poised to thrive in a high-interest-rate environment.

The Stickiness of Inflation and Central Bank Challenges

BMO's analysis underscores that inflation has not simply returned to pre-pandemic levels—it has been permanently elevated. In the U.S., the annualized inflation rate stands at 4.6%, more than double the 1.6% average of the five years before 2019. In Canada, the situation is similarly entrenched, with prices doubling the pre-pandemic inflation trajectory. While categories like used cars and air travel have seen declines, the majority of price increases remain embedded, particularly in essentials like housing, groceries, and healthcare.

Central banks face a delicate balancing act. The U.S. Federal Reserve and the Bank of Canada must navigate a landscape where households are adjusting to higher baseline costs, yet policymakers cannot aggressively raise rates without stifling growth. BMO anticipates a slower pace of rate cuts in the U.S. compared to Canada, where the BoC may ease more aggressively to stimulate demand. This divergence creates opportunities for investors to exploit yield differentials and sector-specific tailwinds.

Inflation-Protected Assets: A Hedge Against Uncertainty

BMO's 2025 outlook emphasizes the critical role of inflation-protected assets in mitigating risks. The firm highlights U.S. Treasury Inflation-Protected Securities (TIPS) as a cornerstone of defensive portfolios. With 10-year real rates at 2%, TIPS offer a compelling real return, particularly in an environment where Trump-era trade policies could reignite inflation. For Canadian investors, BMO notes the potential of Real Return Bonds (RRBs) and the appeal of extending duration in fixed-income holdings to capture higher yields.

Gold, though less correlated with equities, is also flagged as a diversifier. The firm argues that gold's role in mitigating downside risk in a volatile geopolitical and economic climate cannot be overlooked.

Sectors Poised for Outperformance

BMO's sector recommendations for 2025 reflect a nuanced understanding of macroeconomic dynamics. Here are the key areas of focus:

1. Financials:
   Banks, brokers, and insurers are positioned to benefit from a resilient U.S. economy and reduced regulatory headwinds. BMO anticipates earnings growth as interest rates stabilize and refinancing activity in commercial real estate picks up.

2. Consumer Discretionary:
   With wage growth and easing inflation, big-ticket spending is expected to rebound. BMO highlights the potential for a rotation from the “Magnificent 7” tech giants to smaller-cap retailers and automotive companies. However, tariffs and promotional pricing could temper growth in certain subsectors.

3. Real Estate (REITs):
   Improved supply-demand dynamics, declining construction deliveries, and Trump-era deregulation are expected to bolster REIT performance. Sectors like industrial and retail real estate could see renewed demand as nearshoring and e-commerce trends continue.

4. Technology & Communication Services:
   The A.I. capital spending cycle, driven by innovations like Nvidia's Blackwell product line, remains a key growth driver. BMO also notes that a less-constrained regulatory environment under the Trump administration could facilitate M&A activity, particularly in smaller tech firms.

5. Fixed Income (Extended Duration):
   BMO recommends extending the duration of bond holdings to capture higher yields, especially in Canadian Investment Grade bonds. The firm expects yield curve steepening in both the U.S. and Canada, making longer-dated instruments more attractive.

Strategic Allocation and Diversification

For investors, the key takeaway is to build portfolios that balance growth and protection. BMO's analysis suggests a tilt toward U.S. equities, particularly in sectors like Financials and Technology, while incorporating inflation-protected assets like TIPS and gold. The firm also advocates for a tactical approach to small- and mid-cap stocks, which could benefit from tax cuts and deregulation.

Conclusion: Navigating the New Normal

The post-pandemic era has reshaped inflation expectations, creating both challenges and opportunities. BMO's 2025 outlook serves as a roadmap for investors to navigate this landscape: hedge against inflation with real assets, capitalize on sectors aligned with structural trends, and remain agile in the face of policy-driven volatility. As central banks tread cautiously and geopolitical uncertainties loom, a diversified and tactical approach will be essential for long-term resilience.

For those willing to adapt, the current environment offers a unique chance to position portfolios for both stability and growth. The question is no longer whether inflation will persist—it's how to profit from it.