Inflation has kept investors on edge this year, but the uncertainty stems less from inflation itself than from its unclear path ahead. The key question is how long price pressures will persist before inflation moves back toward the Fed’s 2% target and whether those pressures will intensify or ease in the months ahead.

This uncertain inflation outlook has added to market volatility and complicated expectations for monetary policy. Given the current macroeconomic backdrop, the balance of risks appears to tilt toward a more persistent inflationary environment, potentially keeping price pressures elevated for longer than expected.

A Two-Sided Inflation Challenge

According to Chicago Fed President Austan Goolsbee, as quoted on Reuters, inflationary pressures were already being driven by supply-side factors, with strong demand now adding another layer of pressure, potentially prompting the Fed to accelerate the pace of interest rate hikes.

Per Goolsbee, the AI investment boom could create broader inflationary pressures, while elevated services-sector inflation suggests that price pressures are driven by more than just higher oil prices.

The view that inflationary pressures have extended beyond the recent surge in oil prices was also reinforced by Minneapolis Federal Reserve President Neel Kashkari. As quoted on another Reuters article, Kashkari noted that inflationary pressures remain broad-based across the U.S. economy, extending beyond the effects of higher oil prices.

AI Spending Adds to Inflation Pressures

Speaking with CNBC-TV18, JPMorgan Chase (JPM Quick QuoteJPM - Free Report) CEO Jamie Dimon said AI investment remains robust, with hyperscaler spending potentially reaching $1 trillion next year, compared with about $300 billion last year and $700 billion this year, as quoted on CNBC.

While the surge is supporting economic growth, Dimon warned that it could also add to inflationary pressures. According to Dimon, the rapid increase in AI spending could “add a little bit to inflation,” as stronger demand for workers, factories, power plants, equipment and materials puts upward pressure on costs.

Over the longer term, however, Dimon said AI could have a deflationary effect. While he remains hopeful that price pressures will ease, he cautioned that inflation could remain elevated and may even rise somewhat.

The potential for AI spending to fuel inflation in the near term could add another layer of uncertainty to the inflation outlook.

Energy Prices Threaten to Keep Inflation Sticky

Energy-driven inflation has emerged as a key headwind for investors and markets since the onset of the Washington-Tehran conflict. Rising geopolitical tensions in the Middle East have heightened concerns over oil transportation and potential supply disruptions, contributing to higher oil prices and renewed inflationary pressures.

Energy-driven inflationary pressures could complicate the outlook for the Fed. While markets are expecting further interest rate hikes to contain inflation, a renewed surge in oil prices could make the path of monetary policy less certain, particularly regarding the magnitude and frequency of future rate hikes. This could add another layer of uncertainty for financial markets.

A near-term resolution to the geopolitical unrest in the region appears unlikely, potentially keeping oil prices elevated for an extended period. Persistent volatility in oil prices could, in turn, keep inflation expectations elevated and add to the uncertainty surrounding the inflation and interest-rate outlook.

War-Driven Costs Cloud the Inflation Outlook

The Washington-Tehran conflict could fuel inflation through two channels: higher oil prices and the economic costs of the war, both of which could add to overall price pressures. According to a report by the Congressional Budget Office (CBO), the Pentagon has incurred approximately $38.1 billion in costs from the war with Iran through Aug. 1, while every additional month of fighting could add another $2 billion to $3 billion to the cost, as quoted on CNBC.

As per the CBO, the war is expected to raise year-over-year PCE inflation by 0.5 percentage points by the first quarter of 2027. Core PCE inflation could also be 0.3 percentage points higher as higher energy costs filter through supply chains.

How to Navigate Persistent Inflation

Given the current environment, investors may consider a measured tilt toward defensive funds while maintaining a long-term investment outlook. Rising inflation and broader economic headwinds could increase market uncertainty, making diversification and prudent portfolio positioning increasingly important.

Investors with heavy exposure to higher-risk assets or limited diversification may consider gradually shifting toward a more balanced allocation. Such an approach could help cushion portfolios against near-term volatility while keeping investors positioned for long-term opportunities.    

ETF to Watch as Inflation Pressure is Likely to Persist

Below, we have highlighted a few ETF areas that investors may consider increasing exposure to as inflation risks are expected to persist, helping protect portfolios from potential economic headwinds.

Dividend ETFs

Dividend-paying securities serve as primary sources of reliable income for investors, particularly during periods of equity market volatility. These stocks offer dual advantages — safety, in the form of payouts, and stability in the form of mature companies that are less volatile to large swings in stock prices. Companies offering dividends often act as a hedge against economic uncertainty.

Investors can consider Vanguard Dividend Appreciation ETF (VIG Quick QuoteVIG - Free Report) and Vanguard High Dividend Yield Index ETF (VYM Quick QuoteVYM - Free Report) , with dividend yields of 1.51% and 2.84%, respectively. VIG has a Zacks ETF Rank #1 (Strong Buy), whereas VYM has a Zacks ETF Rank #2 (Buy). Regarding annual fees, both VIG and VYM charge 0.04%.

Quality ETFs

Amid market uncertainty, quality investing emerges as a strategic response, providing a buffer against potential headwinds. Investing in such high-quality companies can mitigate volatility for investors.

Investors can look at funds like iShares MSCI USA Quality Factor ETF (QUAL Quick QuoteQUAL - Free Report) and JPMorgan U.S. Quality Factor ETF (JQUA Quick QuoteJQUA - Free Report) .

QUAL is both the largest and the most liquid fund, with a one-month average trading volume of about 899,000 shares and an asset base of $46.96 billion. Meanwhile, JQUA stands out as the cheapest option, charging an annual fee of 0.12%, while also offering the higher dividend yield of 1.05% among the two.

Consumer Staple ETFs

Increasing exposure to consumer staple funds can bring balance and stability to investors’ portfolios. Consumer staples include everyday necessities that typically see steady demand across economic cycles, making the sector less sensitive to economic fluctuations. Consumer staples stocks are often favored for their defensive characteristics, steady growth potential and relatively low volatility, particularly during economic downturns.

Investors can consider State Street Consumer Staples Select Sector SPDR ETF (XLP Quick QuoteXLP - Free Report) and Vanguard Consumer Staples ETF (VDC Quick QuoteVDC - Free Report) .

Among the abovementioned funds, XLP stands out as a well-rounded option. The fund is the cheapest option, charging an annual fee of 0.08%, while also offering a higher dividend yield of 2.65%.

XLP is also the largest and most liquid fund, with an asset base of $14.04 billion and a one-month average trading volume of about 9.92 million shares.