U.S. Stagflation Risks

Inflation, however, remains stubbornly elevated, defying hopes of a swift return to the Federal Reserve’s 2% target. The CPI rose 2.9% year-over-year in May 2025, with core CPI, excluding volatile food and energy, climbing 3.2%. The Producer Price Index (PPI) for final demand increased 2.6% year-over-year, indicating that input costs are still filtering through supply chains. The Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred gauge, rose 2.5% in April 2025, further highlighting persistent price pressures. Falling productivity, down 1.5% in Q1 2025, and surging unit labor costs, up 6.6%, exacerbate these inflationary dynamics, as businesses pass higher costs to consumers, creating a feedback loop that threatens price stability.

This stagflationary environment poses a dilemma for policymakers and investors alike. While weak growth might typically prompt monetary easing, elevated inflation constrains the Federal Reserve’s ability to cut rates aggressively. The Fed’s cautious stance, with only two 25-basis-point cuts projected for 2025, reflects this bind. For markets, stagflation signals heightened volatility, as traditional growth-driven assets falter and inflation hedges gain traction. The challenge lies in balancing exposure to assets that can weather both economic stagnation and rising prices.

Private-sector hiring is particularly weak, as evidenced by the ADP National Employment Report, which showed only 37,000 jobs added in May, far below the 110,000 forecast and down from April’s revised 60,000. Initial jobless claims for the week ending June 1, 2025, rose to 247,000, exceeding expectations of 235,000, signaling increasing layoffs. The JOLTS report for April 2025 reported 8.1 million job openings, down from 8.5 million in March, indicating reduced labor demand. These metrics suggest that businesses are scaling back hiring amid economic uncertainty, particularly as tariff-driven cost pressures and slowing consumer demand weigh on corporate confidence.

The labor market’s weakness directly feeds into stagflation dynamics. Reduced hiring and rising unemployment curb consumer spending power, further dampening economic growth. Simultaneously, rising labor costs, with average hourly earnings up 4.0% year-over-year in May, contribute to inflationary pressures, as firms pass these costs onto consumers. For financial markets, a deteriorating labor market signals caution for equities, particularly in consumer discretionary sectors, while bolstering the case for inflation-hedging assets like precious metals.

The trade deficit’s dramatic collapse to $61.6 billion in April 2025 from $138 billion in March highlights the immediate impact of tariffs, as reduced imports reflect both stockpiling exhaustion and higher costs deterring purchases. While this narrows the deficit, it portends future supply shortages and price spikes, particularly for consumer goods and industrial inputs. The lag effect of tariffs, with firms having pre-stocked inventories, suggests that inflationary pressures may intensify in late 2025, as supply chains adjust to higher costs. However, some argue tariffs could spur domestic production, reducing reliance on imports and mitigating inflation over time. This view, though, overlooks the short-term disruption to industries like autos and construction, which face immediate cost pressures and reduced competitiveness.

For financial markets, tariffs are a mixed bag. Bonds face pressure from rising inflation expectations, pushing yields higher, with the 10-year Treasury yield reaching 4.8% in June 2025. Equities in tariff-sensitive sectors like manufacturing and retail may struggle, but domestic producers could benefit longer-term. Commodities, particularly precious metals, are poised to gain, as tariffs exacerbate inflation fears and dollar weakness, with the dollar index below 99 in June 2025. The interplay of these forces underscores the need for selective exposure in portfolios.

The rally in precious metals is tightly linked to the broader economic narrative. Stagflation, with its dual threat of weak growth and high inflation, erodes confidence in fiat currencies, boosting demand for hard assets. The labor market’s weakness and tariff-driven cost pressures further amplify economic uncertainty, driving investors to safe havens. A declining dollar, down below 99, enhances metals’ appeal, as it increases their affordability for foreign buyers and hedges against currency devaluation. Unlike equities, which face volatility from slowing growth, or bonds, pressured by rising yields, precious metals offer stability in this environment, with potential for further upside if inflation accelerates.

Counterarguments suggest that metals could face headwinds if the Federal Reserve adopts a more hawkish stance to combat inflation, strengthening the dollar and capping price gains. However, with the Fed constrained by weak growth, aggressive tightening seems unlikely. The structural demand for metals, particularly silver and platinum in industrial applications, further supports their bullish outlook. For investors, allocating to precious metals, either through physical assets or ETFs like the iShares Silver Trust, offers a compelling hedge against the stagflationary storm.

Higher yields pose challenges for fixed-income investors, as bond prices fall, particularly for longer-duration securities. Corporate bonds, especially in high-yield sectors like manufacturing, face additional risks from tariff-related cost pressures and slowing growth, which could increase default rates. However, some investors see opportunity in shorter-duration Treasuries, which offer attractive yields with less exposure to inflation-driven price declines. The bond market’s dynamics also impact equities, as higher yields raise borrowing costs for companies, particularly in growth sectors like technology, which have underperformed in 2025, with the Nasdaq Composite down 11.1% from its 2024 close.

The interplay of stagflation and fiscal policy complicates the bond market outlook. While inflation drives yields higher, weak growth could cap their rise if recession fears intensify. Investors must balance yield-seeking strategies with capital preservation, favoring high-quality, short-duration bonds to mitigate risk. The bond market’s sensitivity to inflation and Fed policy underscores its role as a barometer of economic health, with implications for portfolio construction in this volatile environment.

Corporate earnings expectations have softened, with S&P 500 earnings growth for 2025 revised down to 11.5% from 14.8% at the year’s start. Revenue growth projections fell to 5.4% from 5.8%, reflecting tariff-related disruptions and weaker consumer demand. Small-cap stocks, tracked by the Russell 2000, have corrected 10% from recent highs, as smaller firms lack the pricing power to absorb cost increases. However, some argue that tariff policies could benefit domestic manufacturers over time, potentially lifting mid-cap industrials. This optimism is tempered by near-term challenges, as elevated inventories and subdued business sentiment, with the NFIB Small Business Optimism Index barely improving in October 2024, signal caution.

Investors should focus on defensive sectors like healthcare and utilities, which offer stability amid economic uncertainty. Selective exposure to domestic industrials with strong balance sheets, like Caterpillar, could capitalize on long-term tariff benefits. Equities remain vulnerable to stagflation’s dual pressures, requiring a disciplined approach to sector allocation and risk management.

Real estate faces headwinds from rising costs and higher interest rates. The 30-year fixed-rate mortgage fell to 6.65% in March 2025 but remains elevated, suppressing existing home sales, which are at levels not seen since the Global Financial Crisis. Commercial real estate, particularly office spaces, struggles with high vacancy rates, down 5% year-over-year in Q1 2025. Tariff-driven construction cost increases further deter new projects, with housing starts down 5.2% in April 2025. Investors should avoid overexposure to real estate, favoring REITs in resilient sectors like industrial warehouses over office properties.

For investors, precious metals stand out as a primary hedge, with silver and platinum offering both inflation protection and industrial demand exposure. Allocating 10-15% of portfolios to metals, via physical assets or ETFs, can mitigate stagflation risks. In bonds, short-duration Treasuries and high-quality corporates provide yield with reduced duration risk, targeting maturities under five years. Equities require selective exposure, favoring healthcare and energy while avoiding tariff-sensitive sectors like consumer discretionary. Cryptocurrencies, though volatile, merit a small allocation (2-5%) for speculative upside in a weakening dollar environment. Real estate, particularly commercial, should be underweighted due to cost and rate pressures.

​Looking ahead, risks include an escalation of trade tensions, potentially pushing CPI above 3.5% by Q4 2025, or a sharper labor market downturn, with unemployment possibly hitting 4.5% by year-end. Opportunities lie in policy shifts, such as tariff exemptions for USMCA partners, which could ease inflation, or unexpected Fed easing if growth collapses. Investors must remain agile, prioritizing capital preservation and inflation hedges while capitalizing on sector-specific resilience. The stagflationary storm demands a disciplined, forward-thinking approach to safeguard wealth and seize emerging opportunities.