Core Inflation Softens, but the Final Mile to 2% Remains Sticky

The Consumer Price Index (CPI) rose 0.2% in January and increased 2.4% year-over-year, according to the Bureau of Labor Statistics. Core CPI, which excludes food and energy, rose 0.3% in January and 2.5% year-over-year. While inflation continues to moderate, core CPI remains above the Federal Reserve’s 2% target. The broader CPI was helped by a 1.5% monthly decline in energy prices.

The CPI components suggest that inflation’s glide path through the “final mile” will remain sticky. Services less energy services rose 0.4% in January and are up 2.9% year-over-year. Shelter increased 0.2% on the month and 3.0% over the past year. Medical care services rose 0.3% in January and are up 3.9% year-over-year. These service categories continue to keep core inflation above the Fed’s target.

Progress is real. The chart below shows core CPI has finally taken an incremental step to a lower inflationary regime. Yet the path lower remains gradual and sticky.

The Tariff Effect on Core Goods

The CPI for commodities less food and energy commodities increased 1.1% year-over-year and remains a key contributor to overall disinflation. This category could contribute to even lower inflation this year if the U.S. avoids enacting new tariffs.

In Liberty Street Economics, the New York Federal Reserve published a quick study that demonstrates a tariff incidence of roughly “94 percent” in the first eight months of 2025 and “86 percent” by November, meaning the vast majority of tariff costs showed up in import prices paid by U.S. consumers. The average tariff rate rose to about 13 percent, and tariffed goods experienced price increases of roughly 11 percent relative to comparable untariffed goods. Fed Chair Jerome Powell noted at the January press conference on monetary policy that inflation could be closer to target absent tariff effects. This study provides supporting data.

However, from a policy of economic warfare, tariffs have likely achieved a primary aim: a significant reduction in imports from China. The study pointed out that “in the first eleven months of 2025, China’s share of U.S. imports fell by another 5 percentage points, slipping below 10 percent”. Chinese imports accounted for nearly 25% of U.S. imports in 2017 and declined to around 15% in 2024 following the tariff increases implemented in 2018 and 2019.

The inflationary consequences of tariffs could be secondary to this strategic goal. Importers have shifted supply chains to blunt the otherwise inflationary impact of the higher tariffs. The general disinflationary environment during the first round of tariffs also likely helped embolden today’s heightened tariff regimes.

The strategic objective may be clear. The inflationary implications are less so.

Are Tariffs an Enduring Inflationary Force?

The New York Fed study does not argue that tariffs create a self-sustaining inflation spiral. It documents substantial pass-through into prices during 2025. If no new tariffs are enacted, year-over-year comparisons will eventually absorb this price shock. Base effects alone would allow the tariff impulse to fade.

However, continued or expanded tariffs would introduce new price-level increases. Repeated rounds would transform a one-time adjustment into recurring upward pressure on core goods. Ongoing uncertainty around tariff policy remains a significant wildcard. Persistent uncertainty could encourage firms to raise prices preemptively in anticipation of future cost increases.

Reluctant Disinflation

Disinflation is underway, but the path for the final mile to 2% remains sticky. This phase can best be described as reluctant disinflation, the mirror image of sticky inflation.

The bond market remains broadly unconcerned about renewed inflationary pressure. Bond prices rose following the CPI release. After gaining 1.3% ahead of the report amid rising equity volatility, the iShares 20+ Year Treasury Bond ETF (TLT) added another 0.5% after the data. With TLT trading well above its upper Bollinger Band – a signal of short-term extension – I took profits on a large TLT position.

In recent weeks, I have shifted toward buying dips and selling rallies in TLT rather than fading strength. As long as the bond market remains confident that inflation will continue moderating, my inflation hedge remains concentrated in commodities as the U.S. in particular positions itself to run the economy hot with lower interest rates, high investment, and fiscal stimulus.

Be careful out there!