Analysis: Assessing inflation’s impact

Amid growing, inflation-driven pessimism among consumers, February’s Consumer Price Index (CPI) report provided modestly encouraging news.

After four consecutive months of rising inflation, CPI for the 12 months ending in February dropped to 2.8%, compared to 3.0% in January. CPI rose just 0.2% in February, compared to January’s 0.5% increase.¹

Notably, energy costs for the 12 months ending in February are relatively flat, contributing to more favorable inflation numbers. “Oil prices dropped recently, although natural gas prices are higher,” notes Rob Haworth, senior investment strategy director for U.S. Bank Asset Management. Food costs over the same period rose 2.6%, though egg prices remained an issue. Due to millions of egg-laying chickens being destroyed in response to avian bird flu concerns, shrinking supplies resulted in higher egg prices, an issue that has drawn considerable attention. February’s inflation report shows egg prices up 10% for the month and, for the 12 months ending in February, up 59% (not seasonally adjusted). Other major inflation contributors are transportation services (+6.0% for the 12-month period) and shelter (+4.2%).¹

Positive core CPI news

Core CPI, which excludes the volatile food and energy categories, draws significant market attention. For the 12 months ending in February, Core CPI rose 3.1%, its lowest level in nearly four years.¹

“The Federal Reserve (Fed) 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.” Haworth also notes that core services are another key measurement the Fed studies. “The rate of change is flat to slower, but still elevated.”

Does the Fed have more leeway to cut rates?

February’s favorable inflation trends are one factor the Fed is likely to assess as it determines its interest rate strategy from here. 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 consumer credit products, by 1.0%. The Fed tempered expectations for 2025 rate cuts. The Fed meets in mid-March with markets not anticipating another rate cut yet. Current projections anticipate the next Fed rate cut to occur in June.²

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 is currently set to a range of 4.25% to 4.50%. 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.³ In recent months, progress toward the Fed’s 2% inflation target slowed. For the previous 12 months ending in January 2024, headline PCE trended modestly lower to 2.5%. The narrower “core” PCE (excluding the volatile food and energy categories) dropped to 2.6% compared to the 2.8% readings for the previous two months.⁴

“Though core inflation prices remain higher than overall inflation, the Fed can live with that at current levels,” says Haworth.

Trade policy’s impact on inflation

While existing inflation challenges are a key focus for markets and Fed policymakers, less clear are future inflation factors. The Trump administration implemented a range of new tariff policies, including 20% tariffs on Chinese imports and 25% tariffs on steel and aluminum imports from all countries. More potential tariffs are on the table with other countries applying reciprocal tariffs. “The magnitude of tariffs currently being proposed are well beyond previous tariff levels,” says Haworth. “This could push prices higher.”

That concern is reflected in flagging consumer confidence. The University of Michigan’s February 2025 consumer sentiment survey showed a 10% drop in consumer sentiment from the prior month’s survey. Consumers also became much more fearful of inflation. While anticipating prices rising over the next year by 3.3% in January’s survey, consumers now anticipate inflation topping 4% in the 12 months ahead.⁵

“Consumers aren’t buying into the idea of temporary inflation,” says Eric Freedman, chief investment officer for U.S. Bank Asset Management. “If tariffs should add to current inflation levels, it’s a pretty high level of price increases on top of today’s 2.8% inflation rate.”

Given uncertainty around tariff policies and other Trump administration economic measures, Fed Chair Jerome Powell says the Fed is watching potential inflationary effects. Powell notes that “survey respondents, both consumers and businesses, are mentioning tariffs as a driving factor.” Nevertheless, Powell believes most long-term measures are consistent with the Fed’s 2% inflation goals.⁶

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. Markets have been on a more volatile course in 2025’s opening months, with the S&P 500 reaching an all-time high in mid-February, only to drop more than 9% in less than three weeks.⁷ While many underlying economic and market fundamentals remain positive, policy uncertainty connected to Trump administration policy proposals may contribute to short-term market swings.

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.