Analysis: Assessing inflation’s impact

While Federal Reserve (Fed) policymakers and investors wait for clear signals that inflation, which has dissipated greatly since 2022, continues to recede, the latest data tells another story.

For the fourth consecutive month, the headline Consumer Price Index (CPI) number moved higher. After dropping to as low as 2.4% for the 12 months ending in September 2024, CPI for the 12 months ending January 2025 is now up to 3.0%. CPI rose 0.5% in January alone, its largest monthly hike since mid-2023.

Changes in the headline number reflect, in part, rising food and energy costs. For much of 2024, energy prices declined, but the trend was reversed in December and in January, the price pickup continued. Food costs are another major contributor to CPI’s recent trend. Due to millions of egg-laying chickens being destroyed in response to avian bird flu concerns, shrinking supplies resulted in higher egg prices, a major consumer concern. January’s inflation report shows egg prices up 15% for the month and 53% (not seasonally adjusted) for the 12 months ending in January.¹

Core CPI also rises

As notable as the primary CPI number is the core CPI figure. Core CPI excludes the volatile food and energy categories. Core CPI rose 3.3% for the 12 months ending in January, a slight increase from December.1 Notably, there’s been little movement in Core CPI since early 2024.

“The Federal Reserve is most focused on core data versus the headline CPI number,” says Rob Haworth, senior investment strategy director for U.S. Bank Asset Management. “Shelter costs are one area that is closely monitored here.” Shelter costs make up more than one-third of CPI. In the 12 months ending in January, shelter costs rose 4.4%, contributing to inflation’s upward trend, although the category’s increase is down from previous peaks. Transportation services costs, which include components such as auto insurance and repairs, are up 8.0% from January 2024.¹

All eyes on the Fed

From September to December 2024, the Fed reduced the federal funds target rate, a key rate that can impact mortgage rates, auto loans and other key borrowing measures, by 1.0%. A combination of slowing inflation and rising concerns about labor market strength were key factors motivating Fed rate cuts. At its January policymaking meeting, the Fed held interest rates steady. “Recent strong labor reports put more of the Fed’s focus on inflation again,” says Haworth.

In recent Congressional testimony, Fed chair Jerome Powell confirmed that the Fed’s interest rate policy may not change much in the near term. “With our policy stance now significantly less restrictive that it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance,” said Powell.²

Does inflation’s recent uptick raise the prospect of the Fed shifting its stance and again raising the fed funds target rate? Haworth doesn’t see an immediate risk. “It will take more sustained inflation before the Fed flips its rate stance,” says Haworth. “To this point, the Fed likely views the recent inflation upturn as transitory.”

Nevertheless, interest rate trades currently see no more than a modest chance of another Fed rate cut before July.³

Trade policy’s impact on inflation

While existing inflation challenges are a key focus for markets and Fed policymakers, future inflation factors are less clear. The Trump administration is threatening to impose 25% tariff increases on products imported from two key trading partners, Mexico and Canada. “The magnitude of tariffs currently being proposed are well beyond previous tariff levels,” says Haworth. “This could push prices higher.” President Trump did implement an additional 10% tariff on Chinese goods and implemented a 25% tariff on steel and aluminum imports.

Also on the table are an extension of tax cuts included in the Tax Cuts and Jobs Act, which expire after 2025. President Trump is also seeking additional tax cuts on Social Security income and tipped income for service workers. If implemented by the Republican-led Congress, the total package of tax cut extensions and new tax cuts could have stimulative economic effects, which may prove inflationary.

Favorable, long-term inflation trend

The Fed has indicated a desire to return the fed funds target rate to what it considers a neutral range, although, according to Haworth, “It’s not clear if the Fed now considers its neutral level to be 3% or 4%.” The rate currently stands at the 4.25% to 4.50% range. The Fed targets 2% inflation, as measured by the annual change in the personal consumption expenditure (PCE) price index, a measure of spending on goods and services.⁴ Progress on meeting the Fed’s 2% inflation target stalled in recent months. For the previous 12 months ending in December 2024, headline PCE trended modestly higher, at 2.6%. The narrower “core” PCE (excluding the volatile food and energy categories) stayed steady in December at 2.8%, the same as the prior two months.⁵

“Though core inflation prices remain higher than overall inflation, the Fed can live with that assuming, as is the case for now, that core costs remain level,” says Haworth.

After soaring in 2021, inflation as measured by CPI, has declined in three consecutive years, though it remains above levels consistently achieved between 2009 and 2020.⁶

As for inflation’s future direction, Haworth says “There are a lot of questions about the impact of changing government policy, such as potential higher tariffs. Other factors such as the ability of consumers to continue to boost economic growth will have a hand in how much the Fed feels it needs to cut interest rates or whether it needs to shift direction.”

How inflation can impact your portfolio

As inflation leveled off in 2023 and 2024, equity markets responded favorably. In 2024, the S&P 500 registered its second consecutive year of 25%-plus total returns.⁷ Investors may want to consider an overweight allocation to equities relative to fixed income investments, while retaining a neutral weight in real assets.

At the same time, it’s important to remember that a consistent long-term strategy tends to work to the benefit of most investors. This likely precludes any dramatic changes to your asset allocation strategy in response to today’s capital market environment.

Be sure to talk with your financial professional about what steps may be most appropriate for your situation.