As of May 2025, U.S. consumer prices are 11.8% above the level we would have expected had inflation followed the Fed’s 2% target since January 2020. This overshoot isn’t just a blip. It represents a meaningful deviation in price stability and underscores the challenge facing monetary policy today.
The Consumer Price Index (CPI) has risen from 258.7 in January 2020 to 321.5 in May 2025. In contrast, a consistent 2% inflation rate would have taken the index only to 287.5. That 34-point gap reflects the compounding impact of pandemic-era stimulus, supply-side constraints, and persistent cost pressures.
Why This Matters
When inflation runs above target for an extended period, it changes the baseline. The cost of goods and services doesn’t just rise temporarily—it resets higher. This is why Fed officials are reluctant to cut interest rates too soon. Easing now could entrench elevated price levels and risk reigniting inflation expectations.
Market Implications
- Interest Rates Likely to Stay Elevated
Until CPI trends back toward the 2% path, rate cuts may be off the table—despite market hopes. - Real Returns Will Matter More
Investors should focus on assets that protect against purchasing power erosion. Real assets and inflation-resilient equities may outperform. - Policy Credibility Is at Stake
If the Fed abandons its 2% target just as the market is starting to price discipline, it risks undermining long-term credibility.
there are multiple historical examples that illustrate why sticking to an inflation target and avoiding premature rate cuts matters deeply—for both credibility and economic stability. Below are three key cases with implications for today’s policy decisions:
Lesson in History
1. 1970s–Early 1980s: The Volcker Era
Context:
- The U.S. experienced repeated inflation spikes in the 1970s, partly due to oil shocks and loose monetary policy.
- The Fed cut rates too soon several times, trying to stimulate growth before inflation was fully under control.
Lesson:
- These premature cuts allowed inflation expectations to become entrenched.
- Paul Volcker, appointed in 1979, had to raise rates to 20% in 1980–81 to finally kill inflation—causing a deep recession but restoring long-term credibility.
Relevance Today:
- If the Fed cuts now, while CPI is still ~11.8% above trend, it risks replaying the 1970s mistake: letting inflation get “baked in” to wages and expectations.
- Market trust in the Fed’s 2% target could erode.
2. 2010s Eurozone: Draghi’s “Whatever It Takes”
Context:
- In contrast, the European Central Bank (ECB) raised rates prematurely in 2011 in response to short-term inflation from energy prices.
Lesson:
- This move worsened the Eurozone sovereign debt crisis and led to deflationary pressure.
- The ECB had to reverse course, slash rates, and implement years of quantitative easing.
Relevance Today:
- Highlights the danger of overreacting to transitory inflation—but also emphasizes that credibility hinges on appropriate timing.
- The Fed must be cautious not to repeat either mistake: tightening too much or loosening too early.
3. Post-COVID U.S. (2021–2022): Delayed Response
Context:
- The Fed held rates near zero even as inflation breached 5% in 2021.
- The narrative that inflation was “transitory” delayed necessary tightening.
Lesson:
- This delay led to a sharp hiking cycle starting in 2022, increasing rates from near-zero to 5.25–5.50% by mid-2023.
- Bond markets suffered their worst losses in decades, and the Fed’s credibility took a hit.
Relevance Today:
- Having misjudged inflation once, the Fed must now demonstrate discipline.
- The current CPI overshoot (11.8%) reinforces the need to anchor long-term expectations—even if short-term pain persists.
Why does it matter now?
If the Fed cuts rates while the CPI remains far above the 2% trend, it sends a signal: inflation tolerance has shifted upward. That would:
- De-anchor inflation expectations
- Raise long-term interest rates (hurting valuations)
- Reduce real purchasing power
- And possibly lead to a second inflation wave
In short, credibility is a one-shot game. Lose it, and the cost of regaining it is steep—as history repeatedly shows.
Would you like a chart summary of these historical comparisons for use in a presentation or post?
The CPI gap isn’t hypothetical—it’s measurable and real. At 11.8% above the expected trend, the Fed faces a structural inflation challenge, not just a cyclical one. The Fed’s inflation target exists to preserve purchasing power and anchor expectations. With CPI still 11.8% above trend, any move to cut prematurely risks eroding hard-earned credibility. Markets may hope for easing, but the math—and history—say: not yet.
Rate cuts may come eventually—but not until this gap narrows meaningfully.
Disclaimer: Nothing here should be considered investment advice. All investments carry risks, including possible loss of principal and fluctuation in value. Finomenon Investments LLC cannot guarantee future financial results.
Image Credit: Bloomberg
