The writer is co-global head of investment strategy for JPMorgan Private Bank
The risk is known — but under-appreciated. A growing market consensus sees the Federal Reserve continuing to cut rates next year even as growth picks up. Yet many investors shrug off a key embedded risk: cyclical and structural forces could push inflation higher, leading to a rise in US bond yields. Today, rates markets price in a low probability of higher inflation or tighter monetary policy.
This investor complacency could prove to be a costly mistake. Three powerful forces — fiscal stimulus, investment in artificial intelligence and monetary policy easing — look poised to reignite growth across developed markets. But with economies close to full capacity despite some labour market softening, inflationary pressures are building. Investors may need to rethink their portfolio playbook.
In many ways, 2025 has set the stage for the current market juncture. In the first half of the year, a surge in AI-related capital expenditure contributed 1.1 per cent to US GDP growth, outpacing consumer spending as the leading driver of economic expansion. As underlying, non-AI-related growth cooled, it helped ease wage pressures and pulled inflation closer to central bank targets. In response, the European Central Bank cut rates four times, and the Federal Reserve initiated three rate cuts.
In 2026, we expect the One Big Beautiful Bill Act will deliver an extra $20bn to $30bn directly into the hands of US consumers. True to form, they will spend that money quickly and boost overall demand. On the AI front, capex will continue to accelerate globally as Europe and Asia rapidly build out their own infrastructure for the technology. Finally, in the wake of policy rate cuts, easier financial conditions will support rate-sensitive sectors and perhaps lay the foundation for a synchronised global expansion. All these cyclical forces will add upward pressure on inflation.
In addition, several structural trends threaten to keep inflation elevated and more susceptible to volatility and uncertainty. Persistent fiscal deficits and rising sovereign debt may tempt policymakers to tolerate higher inflation. Meanwhile, global geopolitical fragmentation is driving up costs as companies reconfigure supply chains. Resource constraints are taking a toll, with surging power demand from AI and data centres straining energy infrastructure. Climate change and evolving regulations add further volatility to input prices.
We can’t precisely calibrate how these forces might impact the global economy. On balance, we believe they will keep inflation above central bank targets over the next decade and — this is key for investors — more susceptible to upward shocks.
A new inflation environment demands a new approach to asset allocation and portfolio construction. Higher inflation regimes typically result in more elevated correlations between stocks and government bonds. Indeed, half of the worst drawdowns for traditional stock-bond portfolios occurred during inflationary episodes that triggered central bank rate hikes in the 1970s and 1980s, and most recently in 2022.
While bonds can still perform their established role in portfolios — providing income and defence against growth shocks — we need to look beyond traditional fixed income. Equities can deliver strong returns amid “warm” inflation of roughly 2.5 to 3 per cent. Indeed, modest inflation can support corporate revenue growth. But diversification is more important than ever. History tells us that real assets tend to perform well in inflationary regimes. Infrastructure may offer long-term contractual, inflation-resilient cash flows. Real estate also can provide an inflation hedge.
And investors can consider less-correlated strategies such as hedge funds and non-traditional assets — for example, real estate or private credit strategies. Over the past decade, a 60/30/10 portfolio (with 60 per cent in equity, 30 per cent in bonds and 10 per cent in alternatives) has outperformed the traditional 60/40 portfolio almost 70 per cent of the time, and in every instance since 2021 as inflation moved higher.
In addition, commodities, especially gold, can serve as valuable hedges against geopolitical and inflation risk. The price of gold has risen more than 60 per cent in 2025, reaching an all-time inflation-adjusted high. Further gains seem possible in the year ahead.
Uncertainty is inescapable. That’s why investors need to stress-test portfolios against a range of inflation scenarios, focusing on assets that maintain purchasing power. The promise of growth in 2026 is real — but so too is the risk of higher and more volatile inflation.
