JPMorgan Asset Management warns that rising inflation could disrupt the usual bond market gains, even if the Federal Reserve cuts interest rates. This situation might also weaken the US dollar. If inflation goes up, the Federal Reserve may not be able to cut rates significantly. This means that easing policies could be cautious and less effective in boosting growth-sensitive assets.

Persistent Inflation and Bond Market Risks

Ongoing inflation can hurt the bond market by lowering real returns on fixed-income assets. Even with interest rate cuts, long-duration Treasury bonds may not yield large capital gains, especially if yields stay stable in a high inflation environment. When inflation remains high without sufficient policy tightening, the attractiveness of holding US dollars could decline. This might happen if the Federal Reserve seems slow to respond, making the dollar less appealing. JPMorgan points out the risk of a stagflation-like scenario, where inflation stays high, growth slows, bond gains are limited, and the US dollar gradually weakens. The inflation rate seems set to rise again, creating a tough environment. The latest Consumer Price Index report from July 2025 showed a concerning rise to 3.4%, reversing earlier cooling trends. This ongoing price pressure limits how much help the Federal Reserve can provide to the economy. With inflation rising and the Q2 GDP growth revised down to a weak 0.8%, the Fed’s ability to make further cuts is very limited after a small 25-basis-point cut in June 2025 aimed at supporting a slowing economy. As a result, market expectations for additional cuts this year are fading fast.

Implications for the Bond Market and US Dollar

For the bond market, this means big gains from falling yields are probably capped. We shouldn’t expect long-duration Treasury yields to drop much more, making call options on bond futures a risky choice. Instead, strategies that take advantage of interest rate volatility, like straddles, might be more suitable for the uncertain weeks ahead. This situation could also put downward pressure on the US dollar in the long run. If inflation remains high without the Fed raising rates to match it, the dollar will become less attractive. The U.S. Dollar Index (DXY) is already slipping below 104, and traders might consider buying puts on the dollar or calls on currencies such as the euro or Swiss franc. The risk of stagflation-lite poses a significant challenge for stocks, as slower growth hampers corporate earnings. Given this uncertainty, buying protective puts on major stock indices like the S&P 500 seems wise. Volatility, measured by the VIX, has been rising from its lows and may continue to grow. We witnessed a similar scenario back in 2022 when stubborn inflation forced the Fed to act more aggressively than markets initially expected. This experience taught us that betting on an easy Fed response can lead to losses. Therefore, being ready for persistent inflation and limited policy support is crucial. Create your live VT Markets account and start trading now.

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