Key takeaways

  • The most visible inflation indicator, the Consumer Price Index, ticked higher in February.

  • It’s another sign that moderate inflation remains stubbornly persistent.

  • It may convince the Federal Reserve to continue to maintain higher interest rates for longer.

At its peak in June 2022, inflation over the previous 12-month period, as measured by the Consumer Price Index (CPI), was more than 9%. It dropped below 4% in June 2023, but has remained in a range of 3% to 3.7% since then. February’s 3.2% CPI reading this year represents a slight uptick from 3.1% in January.1

The latest CPI numbers, along with other recent inflation data, indicate that the current inflationary cycle isn’t in the rearview mirror just yet. This may convince the Federal Reserve (Fed) for now to hold the line on short-term interest rates longer than the market currently anticipates.

Chart depicts inflation trendline February 2021 – February 2024.
Source: U.S. Bureau of Labor Statistics, U.S. Bank Asset Management Group, February 2024.

Over the past thirty years, inflation as measured by CPI has averaged 2.6% growth per year. From 2000 through 2020, inflation never exceeded 4%, and in the previous decade (prior to 2021), living costs grew at a rate of 2% or less in most years. That changed in 2021, as inflation surged and Americans had to adjust to a different environment. In 2023, inflation began to return to what are more historically typical levels. The Federal Reserve Statement on Longer Run Goals articulates a long-term inflation target of 2%, as measured by the annual change in the personal consumption expenditure (PCE) price index.3

Inflation trends as measured by the Consumer Price Index 2000 - February 2024.
Source: U.S. Bureau of Labor Statistics, U.S. Bank Asset Management Group, February 2024.

While higher costs for food and energy drove inflation’s surge in 2021 and 2022, those trends changed considerably in recent months, contributing to inflation’s slowdown. For the 12 months ending in February 2024, food costs rose just 2.2% while energy costs were down 1.9%. However, rising shelter costs are among the biggest contributors to February’s higher inflation. For the 12-month period, shelter costs are up 5.7%.1

“Shelter inflation may remain elevated, and that’s one component of CPI that hasn’t yet contributed to the overall decline in inflation,” says Rob Haworth, senior investment strategy director at U.S. Bank. “It’s an inflation measure that affects people who are looking for a home or just purchased a home at today’s higher mortgage rates, but is less meaningful to those who already own a home at lower mortgage rates that were previously in place.”

As the inflation environment evolves, investors may be asking:

  • When will inflation be lowered to the Fed’s 2% target?
  • Are there risks that inflation could move significantly higher again?
  • How should I position my investments given current inflation dynamics?

 

Looking beyond the headline numbers

Inflation is a primary focus for the Fed. As the country’s central bank, the Fed’s mandate is to promote full employment, stable prices and moderate long-term interest rates. Beginning in early 2022, the Fed raised the short-term interest rate it controls, the federal funds target rate, 11 times in an effort to slow the economy and lower inflation. One important measure the Fed monitors is “core” inflation (excluding the volatile food and energy sectors). In February 2024, core inflation rose 3.8% for the previous 12-month period, a slight drop from the Core CPI in December and January. While it’s the lowest level for core inflation since May 2021 and down significantly from its 6.6% peak in 2022,2 the core inflation rate remains well above the Fed’s 2% annual target.

Chart depicts trailing 12-month Core Consumer Price Index (CPI), a measure of inflation, 2021 - February 2024.
Source: U.S. Bureau of Labor Statistics, U.S. Bank Asset Management Group, February 2024.

“The Fed is very much focused on inflation exclusive of food, energy and shelter costs,” says Haworth, “and is also closely monitoring the pace of wage growth, which remains elevated.”

It isn’t just CPI that remains elevated. In February, the Producer Price Index (PPI), measuring wholesale costs for raw, intermediate and finished goods, jumped up. PPI for the 12 months ending in February rose 1.6%, its highest reading since September 2023.4

There was encouraging news in a data source that is considered the Fed’s preferred inflation measure, the PCE price index, is a measure of the spending on goods and services by people of in the United States. The headline PCE index uptick of 2.4% for the one-year period ending in January 2024, and the narrower “core” PCE (excluding the volatile food and energy categories) gaining 2.8% over the same period, were the lowest figures for both measures since February 2021.5

“To this point, the Fed remains firm that it wants to see inflation down to its 2% target,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management.

“That’s a favorable signal,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “Yet to this point, the Fed remains firm that it wants to see inflation down to its 2% target.” Freedman says inflation’s “stickiness” makes the Fed somewhat cautious about when it begins cutting interest rates. Given inflation’s persistence in the 3% range and an economy that has proved resilient, “There’s enough cover right now for the Fed to sit tight,” says Freedman.

Today, the fed funds target rate, managed by the Fed’s policy-making Federal Open Market Committee (FOMC), is 5.25% to 5.50%, up from close to 0% as recently as two years ago. Bond yields across the board rose commensurately in that time period. The benchmark 10-year U.S. Treasury note stood at 4.98% on October 18, but fell below 4% in late December before settling above the 4% level in early 2024. “The markets began to anticipate an early start to Fed rate cuts in 2024,” says Haworth. At its January 2024 meeting, Fed chair Jerome Powell indicated that cuts to the target federal funds rate were likely in 2024. He added however, that the policy making Federal Open Market Committee “does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”6

 

Inflation triggers

Inflation measures provide a sense of how much purchasing power is lost due to rising prices. CPI is the commonly cited statistic used to reflect inflation on a broad scale. CPI provides a measure of prices for goods and services that meet the primary needs of consumers, including food items, transportation, housing and medical care.

While temporary supply chain disruptions may have triggered a resurgence of inflation in 2021, there’s been more focus recently on contributing factors such as rising wage costs and increased demand for services, especially travel and entertainment. “With workers earning higher pay, it feeds into higher demand, reflected today in the service segment of the economy, and that is propping up inflation even as prices for some goods decline,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management.

 

How inflation can impact your portfolio

At a time when inflation began to slow from its peak in mid-2022, stocks performed better. In early 2024, the S&P 500 stock index reached new highs. While bond yields are below peak levels reached in October 2023, the bond market continues to offer attractive yields for long-term investors. Although yields on some shorter-term securities exceed yields of some longer-term bonds, Haworth says investors should consider placing more emphasis on their ultimate portfolio goals. “It may be an appropriate time to move money out of short-term vehicles and focus on positioning your portfolio in assets, such as stocks and longer-term bonds, that can help you achieve your ultimate financial objectives in the years to come.”

“We may not yet be seeing the massive disinflationary environment many are looking for,” says Freedman, “but’s it’s still an environment where we think you can own stocks, as opposed to getting more bearish.”

Haworth says as long as inflation stays sufficiently high to prevent the Fed from cutting interest rates, it puts some sectors at a disadvantage. “There are certain segments of the stock market hurt by higher interest rates, such as utility and real estate stocks,” says Haworth. He notes, however, that the stock market as a whole has been on an upswing since late 2022. “In general, stock markets can perform well in either a high or low-rate environment, but it is periods of transition from one environment to the next that can cause more significant price swings.”

The bond market is affected by inflationary news as well, since bond yields, over time, tend to track with inflation. “The bond market has to factor in what the Fed’s reaction is going to be as the economy remains robust,” says Haworth. “And that’s higher interest rates for longer, which could mean bond yields potentially move higher across the board.”

Generally, 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 persistently elevated inflation.

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

Frequently asked questions

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Disclosures
  1. U.S. Bureau of Labor Statistics, “Consumer Price Index Summary, February 2024,” March 12, 2024.

  2. U.S. Bureau of Labor Statistics, “12-month percentage change, Consumer Price Index.”

  3. Board of Governors of the Federal Reserve System, “2020 Statement on Longer-Run Goals and Monetary Policy Strategy,” Aug. 27, 2020.

  4. U.S. Bureau of Labor Statistics, “Producer Price Index News Release summary, February 2024,” March 14, 2024.

  5. U.S. Bureau of Economic Analysis, “Personal Income and Outlays, January 2024,” Feb. 29, 2024.

  6. Federal Reserve Board of Governors, “Transcript of Chair Powell’s Press Conference,” Jan. 31, 2024.

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