Navigating the U.S. Tariff-Induced Slowdown: Strategic Asset Allocation in a Stagflationary Outlook

The U.S. economic landscape in 2025 is increasingly defined by a fragile balance between inflationary pressures and sub-par growth. J.P. Morgan’s revised forecasts underscore a stark reality: U.S. GDP is projected to expand at a mere 0.25% annualized rate in the second half of 2025, driven by the lingering drag of tariff policies on consumer and business purchasing power [1]. Simultaneously, core PCE inflation is expected to peak at 4.6% in Q3 2025 before easing to 3.4% by year-end, reflecting the delayed pass-through of tariffs to consumer prices [4]. This combination of weak growth and persistent inflation—classic hallmarks of stagflation—demands a recalibration of investment strategies.

The Fed’s Policy Dilemma and Stagflationary Risks

The Federal Reserve faces a challenging path forward. J.P. Morgan projects that the Fed will maintain policy rates unchanged until December 2025, with the first rate cut anticipated at that time and three subsequent cuts to bring the funds rate to 3.25–3.5% by mid-2026 [6]. This delayed response reflects the central bank’s cautious stance amid a 40% probability of a U.S. or global recession by year-end [6]. However, the Fed’s reluctance to act preemptively risks exacerbating stagflationary pressures, as rising tariffs and trade tensions continue to erode business and consumer confidence [1].

Bruce Kasman, J.P. Morgan’s chief global economist, highlights three primary channels through which tariffs could destabilize the U.S. economy: (1) a slowdown in goods-producing industries, (2) increased costs for households and businesses, and (3) a sentiment shock that depresses economic activity [1]. Joseph Lupton adds that the effective ex-ante tariff rate could impose a $430 billion tax burden on U.S. households and businesses, equivalent to 1.4% of GDP [4]. These dynamics, compounded by fading fiscal support and immigration-related supply-side constraints, create a prolonged period of economic fragility [4].

Defensive Investing: Prioritizing Inflation-Linked Assets and Short-Duration Bonds

In a stagflationary environment, traditional safe-haven assets like cash or U.S. Treasuries may fall short. J.P. Morgan warns that cash historically underperforms diversified multi-asset portfolios during periods of volatility [2]. Instead, investors should prioritize inflation-linked assets and short-duration bonds to hedge against rising prices and interest rate uncertainty.

Inflation-linked assets, such as Treasury Inflation-Protected Securities (TIPS) and commodity-linked equities, offer protection by adjusting payouts in line with inflation. J.P. Morgan explicitly recommends incorporating these into portfolios, noting that they can maintain purchasing power during high-inflation episodes [3]. Short-duration bonds, meanwhile, minimize interest rate risk and provide flexibility as central banks adjust policy. These instruments are less sensitive to rate hikes than long-duration bonds, making them ideal for a stagflationary scenario where rate volatility is likely [3].

Sector Rotation: Underweighting Cyclical Equities

Cyclical equities—particularly in sectors like industrials, consumer discretionary, and financials—are highly exposed to economic slowdowns. J.P. Morgan’s analysis suggests that the S&P 500 may see slower gains due to stagflationary pressures, with downward earnings revisions and overvalued U.S. stocks posing additional risks [5]. Investors should consider underweighting these sectors in favor of defensive equities and non-cyclical industries such as utilities, healthcare, and consumer staples, which tend to perform better during economic downturns [5].

Moreover, private market investments in infrastructure and timber, as well as liquid solutions like global macro hedge funds, are highlighted as potential outperformers in a stagflationary environment [2]. These assets offer diversification and resilience against macroeconomic shocks.

Conclusion: A Strategic Reallocation for Uncertain Times

The U.S. tariff-induced slowdown, coupled with elevated inflation and a 40% recession risk, necessitates a defensive and adaptive investment approach. By overweighting inflation-linked assets, short-duration bonds, and defensive equities while underweighting cyclical sectors, investors can better navigate the stagflationary outlook. J.P. Morgan’s warnings—echoed by CEO Jamie Dimon—about geopolitical tensions, growing deficits, and inflationary pressures underscore the urgency of strategic reallocation [6]. In an era of macroeconomic uncertainty, agility and diversification will be key to preserving capital and capturing long-term value.

Source:
[1] Mid-year market outlook 2025 | J.P. Morgan Research [https://www.jpmorgan.com/insights/global-research/outlook/mid-year-outlook]
[2] The cost of holding cash in a volatile market [https://am.jpmorgan.com/ie/en/asset-management/institutional/insights/market-insights/market-updates/on-the-minds-of-investors/holding-cash-volatile-market/]
[3] Global Inflation Forecast | J.P. Morgan Global Research [https://www.jpmorgan.com/insights/global-research/economy/global-inflation-forecast]
[4] The probability of a recession has fallen to 40% [https://www.jpmorgan.com/insights/global-research/economy/recession-probability]
[5] 2025 Spring Investment Directions [https://www.ishares.com/us/insights/investment-directions-spring-2025]
[6] JPMorgan CEO Dimon Warns of US Stagflation Risk [https://www.bloomberg.com/news/newsletters/2025-05-22/jpmorgan-ceo-dimon-warns-of-us-stagflation-risk]