Analysis: Assessing inflation’s impact

Headline inflation continued accelerating in August but remains near early 2025 increases. The August Consumer Price Index (CPI) release reported prices increased by 2.9% over the past 12 months, above July’s rate of change of 2.3% and close to January’s 2025 3.0% increase. ¹ Though this inflation level remains well above the average in the pre-pandemic decade and elevated relative to the Fed’s 2% target.

Investors and economists worried that this year’s higher imported goods tariffs might boost prices and lead to rising inflation. However, while certain goods prices increased relative to pre-tariff levels, the impact has not been as large or as widespread as investors initially feared. “Investors today watch inflation closely because of the uncertainty related to tariff impacts,” says Bill Merz, head of capital markets research for U.S. Bank Asset Management Group. Prices for often-imported goods like household furnishings, household supplies and apparel have accelerated so far this year.

Core inflation holds steady

Volatile food and energy prices greatly impact inflation as measured by the broad, commonly cited headline CPI number. However, market professionals often focus on core inflation measures, which exclude volatile food and energy costs. In August, the 12-month core CPI remained stable versus July at 3.1%. ¹

Shelter costs increased by 3.6% year-over-year, comprising more than one-third of the CPI goods and services basket, significantly contributing to sticky inflation. ¹ All items less food, energy and shelter accelerated to 2.7% year-over-year from 2.3% in January, driven by higher costs for medical and transportation services. ²

A second key consumer inflation measure, the Personal Consumption Expenditures (PCE) price index, rose to 2.6% year-over-year in July, in line with the prior month. Core PCE, which excludes food and energy, increased to 2.9% year-over-year through June. ³ Both indices, CPI and PCE, measure the prices consumers pay for goods and services. The Federal Reserve targets PCE inflation in assessing the Fed’s 2% inflation target.

The Trump tariff question

Inflation peaked at over 9% annually in June 2022 and has since trended lower with some fluctuations since September 2024. ² However, President Trump's tariff plans raise inflation concerns. In June, the Federal Reserve's (Fed's) Federal Open Market Committee projected that core PCE inflation will reach 3.1% by year’s end. ⁴

At 2025’s start, U.S. tariff revenue equaled an effective tariff rate of 2.5%, calculated as tariff revenue divided by imported goods values. By July, it approximated 10.5%, while recently negotiated tariff rates range from 10% to 20%, though some reached higher levels. ⁵ If negotiations fail to lower current announced tariffs, the Yale Budget Lab estimates that the effective rate could nearly double, although some forecasters anticipate effective tariffs will land in the mid-teens after substitution effects. ⁶ “Investors are assessing what tariff rate or tariff policy duration will ultimately lead to higher prices,” says Tom Hainlin, national investment strategist with U.S. Bank Asset Management Group. “In other words, what’s the threshold when businesses can no longer avoid passing on higher tariff costs to consumers?”

How will higher tariffs impact inflation during 2025’s concluding months? “Our proprietary model suggests higher prices will likely continue creeping into inflation data,” says Merz. According to the Fed, all 12 regional districts within its jurisdiction report increasing inflationary pressures related to tariffs. ⁷

Producer prices, which reflect business costs, indicate a mixed picture. The Producer Price Index rose 2.6% in August on a year-over-year basis, compared to 3.3% in July, while prices excluding food and energy rose 2.8% versus July’s 3.7% increase. ⁸ Moderating producer prices conflict with multiple business surveys indicating higher input costs, further complicating the inflation picture.

When will the Fed cut interest rates?

In 2022 and 2023 the Fed rapidly raised interest rates to combat inflation, then cut rates by one percent in late 2024. This year, inflation hasn't improved, and President Trump’s tariff policies add to inflation’s uncertain path. So far, the Fed kept interest rates steady this year.

President Trump continues to criticize the Fed's rate-cutting reluctance. However, Fed Chair Jerome Powell has indicated a likely rate cut at their upcoming September meeting. The Fed currently expects two rate cuts this year, with recent softening labor market data leading investors to expect three cuts by year-end.

Market concerns beyond inflation

“Markets could be sensitive to sustained, accelerating inflation,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. However, Haworth warns that inflation is not the only key measure that could trigger market volatility. “Further  labor market weakness may suggest higher economic slowdown odds, which would represent a material market development,” notes Haworth.

“Ultimately, it comes down to what the consumer is doing, and despite weaker labor market data, consumer spending remains strong.” says Merz.

Rapidly evolving changes characterize the current environment, including the possible inflationary effects from increased tariffs. Investors benefit from keeping a broadly diversified portfolio, which could include such inflation sensitive assets as Treasury Inflation Protected Securities or Global Infrastructure.

“We continue to emphasize multiple return and income sources within client portfolios, and having a global perspective and the flexibility to embrace a variety of asset classes will likely benefit investors,” notes Eric Freedman, chief investment officer for U.S. Bank Asset Management Group.

It’s important to remember that a consistent long-term strategy tends to benefit 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.