(Kitco News) – The Fed is likely to follow a ‘dangerous logic’ of preemptive rate cuts which will stoke inflation, so investors need to diversify into alternative and international assets – like gold – to protect themselves, according to David Kelly, Chief Global Strategist at J.P. Morgan Asset Management.
In an updated inflation forecast published to LinkedIn on August 11, Kelly wrote that the inflation temperature is about to rise.
“It should be a low-grade fever, triggered by tariff impacts but mitigated by low energy prices, declines in shelter inflation, and global economic sluggishness,” he said. “But it should also linger well above the Fed’s 2% target, as the initial impact of tariffs is supplemented by the effects of a weakening dollar, a lack of labor supply and fiscal stimulus in the first half of 2026. It could, of course, be further sustained by another round of fiscal stimulus before the mid-term elections.”
“In a still-growing economy, this persistent inflation overshoot ought to be enough to convince the Fed to maintain interest rates at current levels, which are not restrictive by historical standards,” he added. “However, given political pressure, we now expect them to cut the federal funds rate by 50 basis points this year and 75 basis points next year.”
Kelly said these rate cuts probably won’t be enough to boost economic growth or raise overall inflation, but they could further inflate housing and other asset prices.
“Moreover, while it might temporarily cut borrowing costs for the government, it could worsen the long-run fiscal outlook by enabling the federal government to run even bigger primary deficits and eroding investor confidence in the Fed’s determination to hold inflation in check,” he warned. “For investors, the persistence of inflation would limit potential capital gains on high-quality bonds, even with the Fed easing or in a weaker growth scenario. It could also, in time, put further downward pressure on the dollar.”
“This underscores the need to broaden the diversification of portfolios to include alternative and international assets.”
J.P. Morgan Asset Management has updated its inflation forecast to reflect the latest tariffs. “As of today, we estimate an average static tariff rate levied on imported goods of 17.4%, assuming no change from last year in the share of imported goods coming from individual countries,” Kelly said. “In reality, though, importers have switched their purchases to try to reduce tariff impacts. For example, imports from China, which now face a 39.7% average tariff rate, have fallen from 13% of total goods imports in 2024 to just 8% in the second quarter of this year, while the share of imports from Mexico, which are taxed at an 11.6% rate, has risen from 15% to 16% over the same period.”
Because of these changes in sourcing, he expects the true average effective tariff rate on imports will peak at 14.4% rather than 17.4%. “This compares to an average effective tariff rate in 2024 of 2.4%,” he pointed out. “It is also worth noting that tariff revenues, while rising quickly, are still lagging behind the numbers suggested by even these effective rates. This is likely because higher tariffs only apply to goods that had not already been shipped when the new rates came into effect.”
Kelly’s conservative estimate is that three months after the new tariffs take effect, 50% of the cost will begin to be passed through to consumers over the following three months. “Under this assumption, tariffs would still add 1.0 percentage points to the year-over-year growth rate of the consumption deflator in the fourth quarter,” he said. “This bump to year-over-year inflation would be sustained through the second quarter of 2026, fade in the second half of 2026 and peter out in the first quarter of 2027 – assuming that tariff rates don’t change in a meaningful way from today’s levels.”
It is important to underscore that there is plenty of uncertainty around these projections as we have no recent precedent for tariffs of this scale,” he warned. “We will, of course, adjust these estimates as we get more information on steady-state tariff revenues, import prices, and consumer prices.”
Kelly also listed several factors that could cause this inflation to last longer.
“First, the trade-weighted dollar has fallen by 7% year-to-date, which, all other things being equal, would tend to increase import prices,” he said. “While overall import prices have been restrained by falling fuel prices, this lower dollar will impede any potential reduction in non-energy import prices that might have occurred if foreign producers were planning to absorb some of the cost of higher tariffs.”
Secondly, while wage growth was been relatively stable at 3.9% year-over-year in July, “the immigration crackdown, by tightening labor supply, should, at a minimum, hold wage inflation at this level and could boost it,” he wrote.
“Third, according to CBO estimates, the OBBBA will reduce individual income taxes by $24 billion this fiscal year and $131 billion next fiscal year, relative to the current policy baseline,” Kelly said. “This reflects tax breaks on auto loans, overtime, tips and state and local taxes as well as increases in the standard deduction, the child tax credit and an enhanced senior deduction. Most of these breaks are back-dated to January 1st, 2025, setting up the potential for a bumper crop of income tax refunds in early 2026 that could boost both consumer spending and inflation.”
Lastly, Kelly said Congress may introduce further fiscal stimulus in late 2025 or early 2026 to ensure economic growth is strong heading into the mid-terms. “This could, of course, also sustain higher-than-target inflation,” he noted.
“Given all of this, (although ignoring, for now, the possibility of further tariff increases or further fiscal stimulus), we expect year-over-year CPI inflation to rise from 2.8% in July to 3.5% by 4Q2025, before drifting down to 2.8% by the fourth quarter of 2026,” he said. “We expect year-over-year consumption deflator inflation to rise from 2.6% in July to 3.3% in 4Q2025, before drifting down to 2.4% by 4Q2026.”
While Kelly believes that above-target inflation “should be sufficient reason for the Fed to keep short-term interest rates where they are, given continued economic growth and an unemployment that that is exactly at the Fed’s 4.2% long-run expectation,” there’s another type that’s often overlooked: asset price inflation.
“Much has been said about rising consumer prices in recent years, with the CPI increasing by 26% in the six years ending in June 2025,” he wrote. “However, it is worth recognizing that over the same period, the median price of an existing single-family home has climbed by 51% while the S&P500 has risen by an astonishing 111%. While super-low interest rates over much of this period have greatly increased the wealth of American households, they have also pushed home prices to unaffordable levels for many young families while generating asset bubbles that could well end badly. While not directly part of their mandate, the Fed would be well advised not to add further fuel to already bubbly asset inflation.”
Lastly, Kelly said that the Federal Reserve “has no good reason to limit borrowing costs for the federal government.”
“While it may seem attractive to lower interest costs that now account for more than half of deficit spending, the real problem with deficits is not the market’s unwillingness to finance it but the public’s unwillingness to elect representatives who are serious about tackling it,” he said. “Lower short-term interest rates could well lead to higher long-term interest rates almost immediately, if investors concluded that the Fed was willing to accept higher inflation in the long run to mollify the administration in the short run and that monetary policy would not act as any real check on fiscal largesse going forward.”
“All of this being said, we do expect the Fed to cut rates by 25 basis points in September and a further 25 basis points in December,” Kelly wrote. “While the outlook for inflation and unemployment don’t justify this easing, we expect the Fed to follow through on it anyway. Their rationale may be that it is a close call either way, and, with inflation expected to fall eventually, there may not be much harm in cutting rates preemptively.”
Kelly calls this “a dangerous logic.”
“Monetary policy is a long series of close calls and throughout its history, the Fed has made these calls in accordance with its mandate from Congress and, as Jay Powell frequently puts it, solely in service to its public mission,” he said. “If it strays from this, even in a close call, and even to try to ward off a more direct attack on its independence, it risks further eroding trust in the U.S. financial system and thus, U.S. financial assets and the dollar.”
“Given this risk, and the probability of continued, somewhat elevated inflation, it still makes sense for investors to broaden the diversification of their portfolios to include some alternative assets, particularly those that can best offset inflation, as well as international assets denominated in foreign currencies,” Kelly concluded.
JP Morgan has consistently been telling investors that geographic and currency diversification is the key to successfully navigating today’s markets in 2025, and they expect gold to hit $4,000 per ounce by Q1 2026.
In May, Grace Peters, global head of investment strategy at JPMorgan, said that both European and U.S. equities should perform well in 2025, while gold is set to outperform.
“The notion that growth is going to be positive, corporate earnings will be positive, the Fed will cut a bit, but not extensively, is the backdrop that we see, is what lands us to this notion of geographic diversification, still being pro-risk here, but in an intentionally diversified way,” she said.
When asked how JP Morgan is looking at gold in this environment, Peters said, “We still like it.”
“There's a few different things we're trying to solve for,” she explained. “U.S. overweight positions is one, so diversifying by geography and by currency is one of the elements, but also just broader geographic hedging. And there's definitely been a way over the last couple of years as to how gold has traded, and we think that those structural changes are likely to keep playing out.”
“We came into this year with a price target for gold of $3,500,” Peters said. “We've just broken through that [in late April]. So again, looking 12 months forward, north of $4,000, we think, would be a new reasonable price target for gold, with key drivers being still emerging market central banks. When you look at EM positions versus DM central banks, there's quite a lot of room still for EM central banks to position closer to where their DM counterparts are, and also retail ETF buying.”
She added that with the expectation of GDP being positive, JP Morgan expects that demand for gold from jewelry and the tech sector should also be resilient and could grow over the next 12 months.
