This morning, the Bureau of Labor Statistics (BLS) released the January 2025 Consumer Price Index (CPI) report, and the numbers make one thing clear—inflation isn’t going back to 2% anytime soon. The headline CPI increased 0.5% for the month, following a 0.4% rise in December, bringing the 12-month inflation rate to 3.0%, up slightly from December’s 2.9%. Core inflation, which excludes food and energy, remained elevated at 3.3% over the past year, reinforcing the reality that price pressures persist in many parts of the economy despite the Federal Reserve’s tightening cycle.
Shelter costs continued to be a significant driver, rising 0.4% in January, accounting for nearly 30% of the monthly increase. Rent and owner-equivalent rent both increased 0.3%, and even though shelter inflation has cooled from its peak, it remains above historical norms. Energy prices jumped 1.1% in January, led by a 1.8% increase in gasoline prices and a 1.8% rise in natural gas costs. Meanwhile, food prices rose 0.4%, with food at home climbing 0.5%—most notably due to a staggering 15.2% spike in egg prices.
Underneath the headline figures, other categories showed notable price changes. Used car and truck prices rebounded 2.2%, reversing months of declines. Motor vehicle insurance, one of the fastest-rising components of CPI, surged another 2.0% in January and is now up 11.8% over the past year. Medical care costs climbed as well, with prescription drug prices jumping 2.5% in just one month, and airline fares increased 1.2% as travel demand remained strong.
Despite this persistent inflation, many mainstream economists and Federal Reserve policymakers continue to assume that inflation will drift down to 2% over time. The data suggests otherwise. Consumers still have ample cash reserves, many are insulated from higher interest rates due to fixed-rate mortgages, and federal deficit spending remains a major inflationary force. All of these factors have made inflation stickier than expected, and there’s little reason to believe that will change in the near future.
Consumer Cash Balances and Spending Power
One of the biggest reasons inflation has been stubborn is that consumers still have a surprising amount of cash. During the pandemic, fiscal stimulus, enhanced unemployment benefits, and lower spending opportunities led Americans to accumulate an unprecedented $3 trillion in excess savings. By early 2024, much of that had been spent, but total cash balances remained historically elevated.
According to the Federal Reserve, household liquid assets (cash and deposits) were still around $4.3 trillion in Q3 2024, significantly higher than pre-pandemic levels. The personal savings rate, however, has returned to more typical levels, hovering around 3–4%, compared to 7–9% before the pandemic. While the massive consumer spending tailwind is fading, many households still have enough liquidity to continue spending despite inflation, keeping price pressures intact.
Why Fixed-Rate Mortgages Are Delaying the Effects of Tight Monetary Policy
Another reason inflation hasn’t fallen faster is that most U.S. homeowners are not feeling the impact of higher interest rates. Unlike other countries where variable-rate mortgages are common, 92% of U.S. homeowners with mortgages have fixed-rate loans, meaning their payments haven’t changed even as the Federal Reserve has aggressively raised interest rates.
Many borrowers locked in 30-year fixed rates around 3% in 2020–2021, so while today’s mortgage rates are hovering around 6.5–7%, these homeowners aren’t affected. Instead, the burden of higher rates falls disproportionately on first-time homebuyers and those looking to move or refinance, which has slowed housing market activity but hasn’t significantly reduced consumer spending. This “lock-in effect” is one of the reasons why monetary policy is taking longer to cool inflation than in past cycles.
The U.S. Government Is Fueling Inflation with Deficit Spending
While many believe the Federal Reserve is solely responsible for controlling inflation, federal deficit spending continues to pour fuel on the fire. The U.S. government ran a $1.8 trillion deficit in Fiscal Year 2024, making it one of the largest on record outside of a crisis. Total gross federal debt has now ballooned to around $35–36 trillion, or approximately 120–125% of GDP, a level last seen after World War II.
Perhaps even more concerning is the fact that interest costs on the national debt have surged, becoming a major budget item. In Fiscal Year 2023, the government spent $659 billion on interest payments alone, and that number is expected to rise to $882 billion in FY2024. At the current pace, interest expense now consumes about 17% of total federal spending, up from single digits just a few years ago. The combination of high deficits and rising debt service costs ensures that fiscal policy remains a key driver of inflation, even as the Fed tries to counteract it with higher interest rates.
Market Expectations and the Potential for a Volatile Second Half of 2025
Despite the evidence that inflation remains sticky, most economists and market participants still expect it to moderate over time. The Federal Reserve’s own projections show PCE inflation slowing to 2.5% in 2025, with CPI likely settling slightly above that level. Treasury breakeven inflation rates imply that markets expect inflation to stabilize in the 2.3–2.5% range in the coming years.
The big question is whether these expectations will hold. Wages continue to rise at a strong pace, with average hourly earnings up about 4.0% year-over-year, faster than the pre-pandemic norm of 3%. The unemployment rate remains low at 4.1%, and there are still roughly 1.5 to 1.7 job openings per unemployed worker, suggesting continued strength in the labor market. These factors point to persistent inflationary pressures, particularly in the service sector, where wages are a primary cost driver.
Meanwhile, commodity prices have generally stabilized after their wild swings in 2021–2023. Crude oil prices have ranged between $75–$85 per barrel, and gasoline prices fell about 11% in 2023. However, any renewed spike in energy costs, geopolitical risks, or supply chain disruptions could quickly reignite inflationary pressures, as happened during the Ukraine crisis.
The second half of 2025 could be especially volatile. If inflation remains stuck above 3%, the Federal Reserve will face a difficult choice: turn more hawkish and keep rates higher for longer, or begin to acknowledge that 2% inflation may no longer be a realistic target. Either scenario could cause market turmoil, particularly if rate cuts don’t materialize as quickly as investors currently anticipate.
Final Thoughts
Inflation has come down from its 2022 peak, but the notion that it will smoothly return to 2% is wishful thinking. Consumers still have more cash than expected, homeowners are shielded from rate hikes, and government deficits remain massive and inflationary. As we move further into 2025, it’s likely that many economists will continue to dismiss inflation as a major concern—until the data forces them to reconsider. The second half of the year could bring market volatility as the Federal Reserve and investors grapple with the reality that inflation isn’t going away quietly.
At Euro Pacific Asset Management, we continue to position portfolios for an inflationary environment, focusing on high-quality businesses, hard assets, and strategies that can withstand economic uncertainty. To learn more about how we navigate these challenges, contact an advisor or explore our investment offerings at EuroPac.com.
