Analysis: Assessing inflation’s impact

Current inflation affects the economy by raising the cost of living, influencing interest rates, and shaping investment decisions. The May 2026 Consumer Price Index (CPI) rose 4.2% over the past year as energy prices continued to push official inflation readings higher. ¹ Investors also watch the Personal Consumption Expenditures, or PCE, price index because the Federal Reserve (Fed) uses core PCE inflation as its preferred benchmark for price stability, and the May core PCE price index rose 3.4% from a year earlier. ²

Inflation affects households and investors in different ways, but the connection starts with purchasing power. When prices rise faster than incomes or investment returns, each dollar buys less across everyday expenses, savings goals and portfolio income. Higher inflation can also influence interest rates because the Fed may keep policy tighter when price gains stay above its 2% goal.

CPI: Energy prices lift current inflation

The May CPI report showed broad inflation pressure at the headline level, but energy prices drove much of the increase. Energy prices rose 3.9% in May after increasing 3.8% in April and 10.9% in March, and the energy index accounted for more than 60% of the monthly increase in the all-items CPI. Gasoline prices rose 7% in May and increased 40.5% over the prior 12 months, reinforcing the link between energy costs and the current inflation outlook. Inflation remains high enough that interest rate expectations can change quickly as new data arrives.

Core CPI, which removes food and energy to show underlying inflation trends, rose 0.2% in May and 2.9% from a year earlier. That core reading suggests inflation pressure outside food and energy remains more moderate than headline CPI, but it still runs above the Fed’s longer-run inflation goal. Investors should avoid treating one data point as a complete trend because energy, shelter and services can move at different speeds.

Shelter costs are important because housing represents a large share of consumer budgets and official inflation measures. The shelter index rose 0.3% in May and 3.4% over the prior 12 months, while rent and owners’ equivalent rent also continued to increase. Owners’ equivalent rent estimates what homeowners would pay to rent a similar home, so it helps CPI capture housing costs even when homeowners do not pay monthly rent.

Shelter inflation changes often update slowly in the official data because leases reset gradually rather than all at once. In a December 15, 2025, speech, Fed Governor Stephen Miran explained that the Fed’s preferred PCE shelter index lags market rents because rents usually reset when people move or renew leases. He said the earlier “catch‑up” in measured shelter inflation is largely complete and described current elevated readings as an after‑echo of past imbalances. That view supports the case that shelter inflation could fall faster as the data catch up to today’s slower rent growth. ³

Inflation push and pull: Conflict, tariffs and market expectations

Geopolitical conflict can raise inflation when it disrupts energy supply or raises shipping and insurance costs. Higher oil and gasoline prices can lift headline inflation quickly, and they can also raise costs across transportation and supply chains before those increases reach consumers. If energy costs stay high, they can weigh on consumers and businesses at the same time as each must adjust to higher costs without extra income. That mix makes the outlook more difficult for markets and policymakers.

“Markets are sensitive to sustained, accelerating inflation, but underlying inflation ex-energy has been modest in recent months,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. However, Haworth warns that inflation is not the only trigger for market volatility, adding, “Labor market weakness could suggest higher economic slowdown odds, which would represent a material market development, although recent labor market data has been encouraging.”

Tariffs remain a consideration for inflation because they can raise the cost of imported goods and the materials U.S. companies use. Recently, the Supreme Court ruled that President Trump cannot impose tariffs under the International Economic Emergency Powers Act (IEEPA), which canceled most of the 2025 tariffs tied to that authority. After that ruling, the administration announced a temporary 15% global tariff under Section 122 of the Trade Act of 1974 while it considers other options.

To gauge the impact of tariff policy, we measure the “effective tariff rate,” which compares customs revenue to the total value of goods imports. Businesses can absorb part of that cost, pass part of it to consumers, or shift supply chains, so tariffs can affect inflation unevenly and with a delay.

However, market-based inflation expectations suggest fading concerns. “The capital markets can provide a valuable source of information about the forward view for inflation, which often reflect new information faster than lagging economic data or official forecasts,” says Bill Merz, head of capital markets research for U.S. Bank Asset Management Group. Expectations for headline CPI can be inferred from billions of dollars of bond transactions and their resulting prices. These readings indicate future inflation expectations are lower than when the Middle East conflict began, and lower than average expectations over the past three years.

Interest rates and current inflation: What investors should watch

The Fed held the federal funds target range at 3.50% to 3.75% at its June 17, 2026, meeting and said economic activity continued to expand at a solid pace despite elevated uncertainty tied partly to the Middle East conflict. Inflation remains elevated relative to the Fed’s 2% goal, in part because supply shocks have driven price increases in certain sectors, including energy. That combination keeps interest rate expectations sensitive to each new inflation, labor market and consumer spending report.

The Fed’s June projections moved toward a firmer inflation outlook. Policymakers projected 2026 PCE inflation at 3.6% and core PCE inflation at 3.3%, both above the Fed’s longer-run 2% objective. The median projection for the federal funds rate signals that the Fed may need to hike interest rates if inflation stays elevated.

Investors should focus on the interaction among energy prices, tariffs, shelter costs, consumer spending and Fed policy rather than any single inflation report. If energy prices fall and shelter inflation slows, pressure on headline and core inflation could ease. If energy shocks, tariffs or resilient demand keep inflation elevated, the Fed may keep rates higher for longer or consider additional tightening in the form of interest rate hikes.

The path ahead remains data dependent because inflation can shift quickly when energy markets, policy decisions or consumer and business behavior change. A diversified investment strategy can help investors stay aligned with long-term goals while inflation and interest rate expectations adjust. Investors should expect this outlook to keep changing as new reports are released.

Why inflation matters to investors

Inflation matters to investors because it can reduce the real value of portfolio growth over time. Even when an account balance rises, those gains may buy less if the cost of goods and services continues to increase. For long-term investors, the goal is not only to grow assets, but also to preserve purchasing power.

For long-term investors, inflation is not just a short-term headline. It is an ongoing part of portfolio planning, retirement income planning, and wealth preservation. A sound investment approach aims to outpace inflation over time so investors can maintain spending power and stay on track toward long-term financial goals.

How inflation erodes purchasing power over time

Inflation reduces purchasing power by making everyday goods and services more expensive over time. As prices rise, each dollar buys less than it did before. This gradual change can affect household budgets, retirement planning, and long-term savings goals.

The long-term impact can be significant. Based on the Consumer Price Index from the U.S. Bureau of Labor Statistics, something that cost $1 at the start of 2000 cost about $1.93 by the start of 2026. That means prices nearly doubled over that period, showing why inflation remains an important part of financial planning and investment strategy.

Inflation and the difference between nominal and real outcomes

Inflation explains the difference between nominal returns and real returns. A nominal return is the number shown on an investment statement, paycheck, or savings account. A real return adjusts for inflation and shows how much buying power actually increased after rising prices are taken into account.

For example, a bond may pay a 5% nominal yield over a year. If inflation averages 2% during that same period, the real return is closer to 3%. Investors track this difference because strong long-term results depend on growing wealth faster than the cost of living.

Why inflation is a long-term risk, not a short-term event

Many people notice inflation when prices jump in a given month or year. Investors usually focus on inflation as a long-term risk because prices tend to rise over time, even when inflation slows for a period. That steady increase can gradually reduce the future value of savings and investment gains.

For long-term investors, inflation is not just a short-term headline. It is an ongoing part of portfolio planning, retirement income planning, and wealth preservation. A sound investment approach aims to outpace inflation over time so investors can maintain spending power and stay on track toward long-term financial goals.

What investors should do now

The best response to an uncertain inflation path is to stay focused on what you can control. Inflation remains a key driver of interest rates and market volatility, and tariffs and energy shocks can create short-term setbacks even when the longer-term trend is improving. A disciplined plan and a broadly diversified portfolio can help investors avoid making lasting decisions based on a single report or a short burst of volatility. That approach can keep long-term goals at the center of the plan.

If inflation continues to cool, especially if shelter inflation keeps easing with a lag, the case for lower rates can strengthen. If energy prices rise sharply or tariffs become more inflationary than expected, that timeline can shift. Talk with your financial professional about how your portfolio aligns with your goals, time horizon, and comfort with short-term swings, and discuss whether any adjustments make sense for your situation.

FAQs

What is the current inflation rate?

In May 2026, CPI increased 4.2% over the prior 12 months and rose 0.5% for the month. ¹ Those figures reflect the average change in prices across a broad basket of goods and services. Inflation can still feel uneven because housing, food and energy prices do not always move in the same direction as the overall average.

Why does “core” inflation matter?

Core inflation removes food and energy because those prices can move sharply from month to month. In May, core CPI rose 0.2% for the month and 2.9% from a year earlier, which showed that underlying inflation pressure was still present. ¹ Core measures can help investors see whether inflation is easing in the parts of the economy that tend to move more slowly.

Why does the Fed focus on PCE inflation instead of CPI?

The Federal Reserve has said it targets 2% inflation over time as measured by the core Personal Consumption Expenditures price index. PCE can better reflect how consumers change what they buy when prices move, and it covers a broader set of spending categories. That is why PCE often carries more weight when investors think about the path of interest rates.