Key takeaways

  • While U.S. inflation slowed considerably in the past year, the headline inflation number drifted higher in the summer of 2023.

  • Core inflation, excluding food and energy prices, remains elevated, though it is trending lower.

  • The Federal Reserve’s goal is a long-term annual inflation rate of around 2%.

Americans have reasons to be encouraged by 2023’s generally downward inflation trend, but living costs moved slightly higher in both July and August. Inflation, as measured by the Consumer Price Index (CPI), which peaked at 9.1% (for the previous 12-month period) more than a year ago, now stands at 3.7%.1 While this represents a notable improvement, inflation (for the previous 12-month period) trended higher in both July and August 2023.


Inflation trends – 2021-2023
Consumer Price Index year-over-year2

Source: U.S. Bureau of Labor Statistics, U.S. Bank Asset Management Group.

Much of the recent run-up in the so-called “headline inflation number” (CPI) is attributed to rising energy prices. While far below the peak levels reached in the first half of 2022, oil prices have rebounded in recent months due in large part to announced production cuts by Saudi Arabia and other members of the Organization of Petroleum Exporting Countries (OPEC). Those cuts are designed to limit supplies and push prices higher, even if demand remains steady. Energy costs (as measured by CPI) rose 5.6% in August 2023. After dropping to less than $68/barrel in June, the price of oil is now approaching $90/barrel. That is still well below peaks of more than $120/barrel reached in the first half of 2022.

Source: Federal Reserve Bank of St. Louis, West Texas Intermediate Crude Oil – Cushing, Oklahoma. As of September 5, 2023.

Other major drivers of August’s CPI uptick were food prices (up 4.3% over the past 12 months), shelter costs (up 7.3%) and transportation services (up 10.3%). By contrast, used car prices have declined 6.6% in the past year, and energy costs over the past year are actually down 3.6%, mainly driven by reduced costs for fuel oil and natural gas.1

As the inflation environment evolves, investors may have questions that include:

  • When will inflation decline to more normal levels?
  • Are there risks that inflation could reverse course and begin moving significantly higher again?
  • How should I position my investments given current inflation dynamics?


Looking beyond the headline numbers

The Federal Reserve (Fed) closely monitors inflation data as it determines its monetary policy. As the country’s central bank, the Fed is mandated by Congress to promote full employment, stable prices and moderate long-term interest rates, so monitoring inflation is essential to its function. Dramatic interest rate hikes the Fed put in place beginning in early 2022 were in response to rising inflation. One important measure the Fed monitors is “core” inflation (excluding the volatile food and energy sectors). In August, core inflation rose 4.3% for the previous 12-month period, a notable drop from July’s 4.7% reading.1 That represented the lowest Core CPI level in nearly two years. While generally trending in the right direction, core inflation remains well above the Fed’s 2% annual increase target.

Source: U.S. Bureau of Labor Statistics, U.S. Bank Asset Management Group.

CPI’s June 2022 peak represented the largest jump in the cost-of-living since 1981. The significant decline since that time indicates the progress resulting from Fed policies. Fed Chair Jerome Powell has made clear that despite favorable inflation trends, the Fed remains committed to achieving 2% long-term inflation.3 Yet the pace of declining inflation has tapered off. “The last mile of that journey back to inflation in the 2% range may be the most difficult one,” says Rob Haworth, senior investment strategy director at U.S. Bank. “The Fed is very much focused on inflation exclusive of food, energy and shelter costs as well as the pace of wage growth, which remains above the Fed’s target.”

“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.”

Tom Hainlin, national investment strategist at U.S. Bank Wealth Management

The U.S. Commerce Department’s Personal Consumption Expenditure price index, or PCE, is another important inflation gauge, and when excluding volatile food and energy prices, is considered one of the Fed’s preferred inflation measures. The broad PCE inflation measure rose 3.3% for the one-year period ending in July 2023. While this represents a notable improvement from its June 2022 peak of 7.0%, which was the highest level in more than 40 years, July’s number was up from 3.0% in June. The narrower “core” PCE gauge (excluding the volatile food and energy categories) rose 4.2% over the 12 months ending in July 2023, a slight increase from June’s report.5 The core PCE figure has declined more modestly so far in 2023. “Up until now, the overall inflation trend has been down, attributable in large part to improvements in energy and food prices,” says Haworth. “Challenges continue among other types of products and services.”


Inflation triggers

Inflation represents increases in the cost-of-living over a given period. It’s a measure of how much purchasing power is lost due to rising prices. CPI is the commonly cited statistic used to illustrate inflation on a broad level. 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.

Inflation often occurs due to an imbalance between supply and demand across segments of the economy. This began to occur in 2021. Temporary supply chain disruptions contributed to the problem and a burst in demand from consumers following the brief economic pause caused by the onset of the COVID-19 pandemic. Haworth notes the slowing of inflation after it peaked in June 2022 indicates that supply and demand have largely normalized.

More recently, higher inflation was driven by wage costs and increased demand for services such as 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 Hainlin.


Seeking a return to normal

The Fed’s major 2022 policy shift demonstrated an intense focus on lowering inflation. The Fed raised rates from near zero percent over the course of 2022 and in the first half of 2023. Today, the federal funds target rate, the primary interest rate managed by the Fed’s policy-making Federal Open Market Committee (FOMC), is 5.25% to 5.50%. This has had far reaching effects on the broader bond market, with interest rates higher across the board. “The Fed has not ruled out more rate hikes, but the markets now expect that interest rates will remain near current levels well into 2024,” says Haworth. Fed Chair Powell seemed to confirm this expectation in comments made after the Fed’s May 2023 rate hike. “It will take some time (for inflation to slow) and in that world…it would not be appropriate to cut (interest) rates and we won’t cut rates.”6

Another aspect of the Fed’s monetary tightening strategy was to end its “quantitative easing” program. Under that program, the Fed purchased $120 billion in U.S. Treasury and mortgage-backed bonds each month to help add liquidity to the nation’s money supply to boost lending and economic activity. Now the Fed has reversed course, trimming $95 billion per month from its balance sheet which had grown to nearly $9 trillion in assets.


How to manage inflation in your financial life

After stock and bond markets reacted negatively to escalating inflation and subsequent interest rate hikes in 2022, markets exhibited a turnaround in the first seven months of 2023 before sustaining a modest decline in August. In the bond market, a major question is whether interest rates will continue to rise, even if the changes won’t be as dramatic as they were in 2022. As of early September 2023, the yield paid on the 10-year U.S. Treasury note exceeds 4%, considerably higher than at the start of 2022 when the same security was paying just over 1.5%.

“Interest rates across the bond market are still significantly higher than they were before the Fed changed its policy in 2022,” says Haworth. Notably, yields on some shorter-term securities are outpacing those of longer-term bonds, an unusual situation. Yet Haworth says despite the appeal of short-term fixed income investments generating higher yields, investors may want to put more emphasis on their longer-term 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.”

Haworth says stocks may still be subject to volatility, but the environment is showing signs of improvement. “Our previous cautious outlook for stocks was tied to concerns about potential weakness in corporate earnings,” says Haworth. “Earnings growth slipped in the first two quarters, but there are signs that the environment could stabilize later in the year.”

Generally, a consistent long-term strategy tends to work to the benefit of most investors. This should preclude any dramatic changes to your asset allocation strategy in response to the inflationary environment.

Take time to assess how the changing inflation picture might impact other aspects of your financial plan. For example, if you have variable interest rate loans, consider locking in a long-term fixed rate on the loan. This may help you avoid future interest rate increases, which could result from the current inflationary environment.

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

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  1. U.S. Bureau of Labor Statistics, “Consumer Price Index Summary, July 2023,” August 10, 2023.

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

  3. Federal Reserve Board of Governors, “Transcript of Chair Powell’s Press Conference,” May 3, 2023.

  4. U.S. Bureau of Labor Statistics, “Job Openings and Labor Turnover Summary, July 2023,” Aug. 29, 2023; and “Employment Situation Summary, August 2023,” Sep. 1, 2023.

  5. U.S. Bureau of Economic Analysis, “Personal Income and Outlays, July 2023,” Aug. 31, 2023.

  6. Mercado, Darla, “Fed recap: Here are Chair Powell’s market-moving comments after the latest Fed rate hike,”, May 3, 2023.

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