Inflation Ticks up Amid Tariff Concerns

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Despite some turbulence throughout the week, markets ended the week higher across the board. However, there is growing evidence that tariffs are beginning to put upward pressure on inflation. The latest Consumer Price Index (CPI) reading from the Bureau of Labor Statistics (BLS) shows that core inflation, which excludes volatile food and energy costs, rose at the fastest annual pace in five months. Goods inflation was 0.2 percent, while services inflation was 0.36 percent, marking a risk that inflation may be leaking into this larger side of the economy. What’s more, data from the latest Producer Price Index (PPI) suggests that some inflation is being absorbed by companies before it reaches consumers. Wholesale prices rose 0.9 percent in July, the largest monthly rise in three years. That increase was driven by both the rising cost of services, up 1.1 percent, and goods, up 0.7 percent. The question is whether those higher costs will eventually be passed on to consumers and, if so, whether price increases will be a one-time event or become a more persistent inflationary risk.

Much speculation continues about whether the Federal Reserve will cut interest rates next month, potentially providing a boost to a U.S. economy that has shown signs of sluggishness recently, particularly in the labor market. So far this year, the Fed has held off on reducing rates due to concerns about increasing inflation. After last week’s downward revisions of the jobs numbers, markets priced in a 97 percent chance of a 0.25 percent September rate cut. That figure soared to 107 percent by August 13 (meaning investors were predicting that more than one cut was possible) before falling to 87 percent after the PPI showed higher inflation than expected. We continue to believe it is too early to assume that the Fed will cut interest rates and counteract tariff-related headwinds. Much will depend on the August jobs report and whether the recent slowing in the labor market continues or worsens. If that trend persists, rate cuts are more likely.

The tension between weakening labor market growth and the potential for higher inflation was on display in data this week. Consumer sentiment fell in August for the first time in four months, according to survey results from the University of Michigan. The survey showed that consumers expect higher unemployment in the future, while inflation expectations for both the next year and five to 10 years rose sharply after a July pullback. This puts both sides of the Federal Reserve's dual mandate of full employment and stable prices at risk and further complicates their decision-making process moving forward. Investors will be listening closely for clues about the Fed’s thinking on how to balance these pressures when Federal Reserve Chair Jerome Powell speaks at the Jackson Hole Economic Symposium on Friday.

Meanwhile, many small business owners continue to report sluggish sales and earnings, according to the latest data from the National Federation of Independent Business. Despite these numbers, owners are optimistic, perhaps betting that the stimulating effect of recent policy changes will outweigh the potential economic drag caused by tariffs.

As we’ve said in prior commentaries, we believe the effect of the administration’s tariffs still largely remains to be seen for two primary reasons: They have been in place only for a short period of time; and importers, consumers and corporations planned in advance. According to the Penn Wharton Budget Model, the average tariff rate rose to 9.14 percent in June 2025, up from 2.2 percent in January, with the Budget Lab at Yale calculating that the effective tariff rate will grow to 18.6 percent if all the announced tariffs as of August 6 are enacted.

It's important to remember that with regard to tariffs, we are in uncharted territory. Overall tariffs haven’t been as high as they are expected to become since 1933, when the global economy was far different than it is today. We believe this creates uncertainty in forecasting potential outcomes and continues to point to a diversified portfolio focused on the long term as the best path forward.

Wall Street wrap

Key inflation measures rise: This month’s CPI from the BLS showed prices rising 0.2 percent in July, compared to 0.3 percent in June. On a year-over-year basis, overall inflation held steady at 2.7 percent, thanks partly to lower fuel prices. Core inflation, which excludes volatile food and energy costs, showed more movement. This figure, which is the measure the Federal Reserve focuses on, rose 0.3 percent in July and 3.1 percent on a year-over-year basis, the fastest annual pace in four months.

Prices for services overall rose 0.36 percent after last month’s increase of 0.25 percent. So-called “super core” services inflation (excluding shelter) rose 0.48 percent in July and is up 3.2 percent year-over-year.

This month’s Producer Price Index (PPI), also from the BLS, shows that wholesale prices increased by 0.9 percent in July, the largest monthly rise in three years. This increase was driven by a 1.1 percent leap in services prices, which had been tracking relatively low of late. Meanwhile, wholesale goods prices rose 0.7 percent. Higher input costs for businesses point to likely increases in prices for consumers in the coming weeks and months.

Consumer sentiment dips: Consumer sentiment declined in August for the first time in four months. Preliminary results from the latest consumer sentiment survey released by the University of Michigan show that the index fell 3.1 points from July to 58.6. While expectations for the future remained largely unchanged at a historically depressed 57.2 versus July’s 57.7, consumers’ views of their current condition fell to 60.9 versus 68 in July.

The survey indicates growing concerns about inflation, with year-ahead inflation expectations jumping to 4.9 percent from 4.5 percent. Expectation for five- to 10-year inflation also rose, to 3.9 percent from 3.4 percent, highlighting the risk that consumers may expect inflation to become a persistent feature of the U.S. economy. Additionally, about 62 percent of consumers expect unemployment to worsen in the coming year, an increase from last month’s 57 percent. While this figure is below the peak of 66 percent in March 2025, it remains at levels that have historically been associated with economic contractions and declining labor markets. Consumers across the political spectrum expect to decrease spending on items that experience inflation, although Republicans are less likely to do so than independents or Democrats. That said, “consumers are no longer bracing for the worst-case scenario for the economy feared in April when reciprocal tariffs were announced and then paused,” Survey of Consumers Director Joanne Hsu said in comments released with the survey results.

Small business optimism improves among sales concerns: Optimism among small businesses improved in July according to the latest data from the National Federation of Independent Business, rising 1.7 points to 100.3, slightly above the 52-year average of 98. The percentage of business owners expecting better business conditions rose 14 points from June to 36 percent. During the same period, however, the Uncertainty Index increased by eight points to 97, higher than historical norms.

On-the-ground business conditions largely improved in July as well. When asked to rate the health of their businesses, 13 percent said excellent, and 52 percent said good, up five and three points, respectively, from June. Meanwhile, the portion of businesses that rated the health of their companies as fair or poor fell four points to 31 percent, and the percentage that rated it poor fell three points to 4 percent.

That said, sales remain a concern for many business owners. The percentage of small business owners reporting poor sales as their top business problem rose one point to 11 percent, the highest level since February 2021. Additionally, the portion of business owners reporting higher nominal sales in the past three months fell four percentage points to -9 percent, while 24 percent reported higher average prices in July. Looking ahead, 28 percent said they plan to increase prices, down four points from June but still above the historical average.

Retail sales grow: The latest retail sales numbers from the U.S. Census Bureau show that consumer spending rose 0.5 percent in July, following a revised 0.9 percent rise in June.

Overall, nine of the 13 categories registered increased sales, led by a 1.6 percent rise in motor vehicles and parts sales. Furniture and home furnishing sales rose 1.4 percent, while sales from non-store retailers, which capture e-commerce spending, rose 0.8 percent. Overall retail sales are up 3.9 percent year over year on a seasonally adjusted basis. The latest reading builds on June’s rebound of increasing consumer spending after a two-month decline in April and May. The recovery in sales could be a sign that consumers who had stocked up ahead of levies are continuing to replenish depleted supplies. Overall, the Control Group (which is a proxy for the spending measure found in gross domestic product growth) rose 0.5 percent for the month, above Wall Street expectations of a 0.4 percent increase.

Jobless claims decrease but continuing claims remain high: The number of new jobless claims fell to 224,000, a decrease of 3,000 from last week’s revised level, indicating that employers are not laying off workers on a broad scale.

Continuing claims—the number of people who received benefits after their initial week of aid—fell slightly to 1.953 million, down 15,000 from the previous week’s revised figure but well above the 1.863 million level in the same week last year. This trend continues to suggest that layoffs remain low, but weak hiring is keeping those who become unemployed out of work longer.

The week ahead

Monday: The Homebuilders Index from the National Association of Home Builders will be out in the morning. Homebuilder confidence sagged last month due to concerns about tariffs and interest rates. We’ll monitor the latest data to see if the outlook has shifted.

Tuesday: The U.S. Census Bureau will release data on new residential construction in July. This data, along with the Homebuilders Index released on Monday, will provide insight into the home construction market.

Wednesday: The Federal Reserve will release minutes from the July Federal Open Market Committee meeting. We’ll be looking for more insight into the committee’s thinking on inflation and the labor market—as well as the debate that led two committee members to vote in favor of a rate cut last month.

Thursday: We’ll get insights into the housing market when the National Association of Realtors releases existing home sales for June. Sales declined last month for the third time in four months. We’ll watch to see if this trend has continued due to elevated interest rates.

The Conference Board’s latest Leading Economic Index Survey for July will be out by midmorning. Last month’s reading showed modest weakening with an increased risk of a recession. We’ll look at the data to see if this weakening persists or if readings have stabilized.

We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for August. U.S. business activity grew in July, as a rising demand for services counteracted a manufacturing dip. We’ll be watching to see how continued tariff uncertainty affects both sectors.

Initial and continuing jobless claims will be out before the market opens. We’ll be watching for more insight into the health of the labor market, particularly when it comes to continued claims.

Friday: Federal Reserve Chair Jerome Powell takes the stage at the Kansas City Federal Reserve’s annual Jackson Hole Economic Symposium. Historically, this meeting has served as a forum for potential shifts in monetary policy, with Chair Powell using his 2024 speech to “announce” a shift to a rate-cutting regime that began in September 2024 with three simple sentences: “We do not seek nor welcome further cooling in labor market conditions. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.” Given the current tension between potential inflationary pressures and slowing labor markets, investors will once again be listening for any indication of the path forward for monetary policy.

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