Analysis: Assessing inflation’s impact

Despite elevated consumer inflation expectations, increases in the cost of living remain consistent with historical norms as we enter 2025’s summer months. For the 12 months ending in May, the headline Consumer Price Index (CPI), which measures the average change in prices paid by consumers for a market basket of goods and services, rose 2.4%. That’s up slightly from the previous month’s reading, but generally consistent with recent CPI levels and lower than consensus economist forecasts. ¹

May’s muted inflation numbers come amidst an environment of heightened price uncertainty, driven by previously elevated post-Covid inflation and evolving tariff policies implemented by President Donald Trump. While the Trump administration recently modified what had been significant tariff increases, consumer surveys indicate an expectation that inflation levels could top 3%. ² While economists forecast inflation in the U.S. will range between 2.7% and 3.4% in the second half of 2025.

“It takes time for cost increases to work their way through the system,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. “While tariffs have increased, it doesn’t look like the impact has drifted down to the consumer level, at least for now.” Haworth notes that consumer inflation expectations are down from recent peaks. “That may reflect a tariff pause the President recently implemented, which eased some concerns about the potential inflationary impact.”

What to expect going forward

May’s most notable cost increases came from the shelter and food categories. For the 12 months ending in May, shelter costs are up 3.9% while food costs rose 2.9%. By contrast, energy costs have declined 3.5% over the past year. ¹ Shelter cost increases, which represent a meaningful share of the CPI figures, have steadily decelerated as the housing market has gradually slowed. If this trend persists, it could offset at least some acceleration in goods prices if tariffs do flow through to consumer prices.

“Gasoline prices are down from a year ago,” notes Tom Hainlin, national investment strategist with U.S. Bank Asset Management Group. “With slower global economic growth projected, demand remains relatively contained, which is likely to help keep energy prices in check.” Core CPI, which excludes the volatile food and energy sectors, remains elevated at 2.8%, though flat with the prior two months. ¹

Consumers continue to spend

Despite consumers’ inflation fears, they are not slowing purchases. “Although people indicate in consumer surveys that they’re fearful about higher costs, they are still spending sufficiently to keep the economy moving in a positive direction,” says Haworth. In some cases, spending may have accelerated as people attempted to make major purchases before significant tariffs took effect. After declining in January, consumer spending, as measured by the U.S. Bureau of Economic Analysis, rose in three consecutive months.

How does the Federal Reserve view inflation?

The May inflation report was issued one week before the Federal Reserve’s (Fed’s) policymaking Federal Open Market Committee (FOMC) meets to assess interest rate policy . The Fed cut rates 1.0% in late 2024 but has held the line on the federal funds target rate it controls so far in 2025. The fed funds rate can impact mortgage rates, auto loans and other consumer credit products. The funds rate and expectations about its future path also influences longer-term borrowing costs and bond yields. The Fed’s 2024 rate cuts followed a period in 2022 and 2023 during which it rapidly instituted rate hikes totaling more than 5% to combat spiraling inflation. The CPI peaked at 9% in June 2022 and then began a prolonged, steady decline. ³

Statements from Fed officials indicate they aren’t in a hurry to take further action on rates, despite calls from President Trump to resume rate cuts. Based on interest rate trader activity, markets currently don’t expect another rate cut before the FOMC’s September meeting. ⁴

The Fed’s Summary of Economic Projections ⁵ indicate a desire to return the fed funds target rate to what it considers a neutral range, although, according to Haworth, “the Fed’s view of what it considers a neutral level has changed in recent years from approximately 2.5% to 3% and may continue to evolve over time.” 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. ⁵

The ‘stagflation’ scenario

The topic of “stagflation,” a combination of sluggish economic growth and elevated inflation, is frequently discussed, particularly considering President Trump’s new tariff policies. “If we have economic growth below 1% and inflation above 3%, that could be problematic,” says Haworth. The most recent 2.4% inflation reading followed first-quarter GDP growth of -0.2% (annualized). “If the Fed finds itself facing a stagflation scenario, it would find its tools not perfectly suited to respond.”

The risk of inflation reigniting may be a key factor keeping the Fed’s interest rate strategy on pause. If stagflation occurs, the Fed would be torn between lowering rates to spur economic growth or raising rates to temper inflation.

Stagflation previously occurred in the late 1970s and early 1980s. “It’s a situation to be avoided, as it’s characterized by sluggish job growth, sluggish consumer spending, and persistent inflation, which keeps interest rates high,” says Hainlin.

Inflation factors to watch

Future inflation trends are likely to be highly sensitive to tariff impacts. The lack of clarity about where tariffs will settle creates challenges for businesses. “They don’t yet know what to pass on in terms of price hikes,” says Hainlin. “They are trying to avoid a situation where they risk losing customers by raising prices, only to have tariffs level off, allowing them to lower prices later.”

Prices for energy and most other commodities, which can have a significant inflation impact, remain subdued. “While the economy is not deteriorating, it isn’t accelerating enough to spur stronger commodity demand,” says Haworth.

Inflation often influences capital markets because interest rates usually closely track inflation and economic growth trends and expectations. In today’s environment, rising living costs remain manageable in aggregate, despite challenges for lower income cohorts, thereby dampening the influence of inflation on market returns. In today’s environment, investors should consider diversifying their portfolio’s sources of income and growth. This could include higher yielding foreign equities to complement their U.S. equity allocation, as well as including real assets, such as real estate, and a more diverse fixed income exposure into structured credit and non-government agency residential mortgage-backed bonds.

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

Work with a financial professional to determine what steps may be most appropriate for your situation.