Has the Fed given up its focus on core inflation?
Headline inflation is still a problem, but core inflation has fallen to its lowest level in more than five years. How should investors position for the uncertain future course of rates policy?
Published: SEPT 28, 2026
The Federal Reserve has begun to raise rates thanks to sticky inflation. But how broadly based are the roots of that inflation? The headline consumer price index (CPI) rose 0.4% in August from the month before and 3.4% year-over-year. Stripping out food and energy, though, core CPI rose 0.3% on the month and fell to 2.4% y/y, the lowest level since March 2021.
As the chart below shows, energy is doing much of the heavy lifting. How long will the Fed’s hiking cycle continue? Is this a relatively abbreviated unwind of the 2025 insurance cuts – a small set of “insurance hikes”? Or does the central bank have a more dogged pursuit of the inflationary white whale in mind? Given the improvement in core CPI, it could be that the Fed would turn towards a dovish footing, especially if oil retreated.
For now, winter is coming, oil stockpiles are down and substitutes and replacements have not been found or implemented. If a peace deal is struck, oil prices might plummet. Without one, it’s harder to see how energy prices can come down very much. Investors are left to wonder, then, not only when the Iran war might end, but also whether slowing core inflation alone could be sufficient to reassure the Fed.
Our outlook:
With regard to oil, it’s a binary question – will the war end soon or not? Rather than betting on one side of such an uncertain future, shorter duration securities offer an opportunity to capture the higher yields on offer without facing the volatility longer-duration bonds would suffer if rate hikes continue further for longer.
- Sticky soft landing scenario — Inflation moderates gradually, growth slows but stays positive, and the labor market cools but remains healthy. Potential portfolio considerations: We believe diversified equities could work well, with a tilt toward large-cap quality and international names potentially benefiting from stable global growth; small caps may have less support without a stronger growth catalyst; emerging-market equities look attractive. In fixed income, short-duration strategies (roughly one- to three-years) allow a nimble stance without betting on rate-cut timing, and investment-grade credit is favored over high yield given moderate growth and contained spreads. In our view, emerging market debt can perform reasonably well if the US dollar stays range-bound.
- Inflation persistence scenario (stagflation lite) — Growth weakens while inflation remains sticky from energy costs, wages, tariffs, and geopolitics. Potential portfolio considerations: Historically, large-cap, quality stocks with pricing power tend to hold up better against margin pressure; value tends to outperform growth, and small caps may be more vulnerable to tightening conditions. Ultra-short and floating-rate fixed income reprices automatically if the Fed hikes, offering a potential hedge, while investment-grade credit may be preferable to high yield for its stronger balance sheets. Emerging market debt is likely to lag, as sticky inflation and a firmer dollar work against it.
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
The Institute of Supply Management (ISM) manufacturing index is a composite, forward-looking index derived from a monthly survey of U.S. businesses.
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