Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton.
Do you expect inflation to stick around or even rebound in 2025? That probably seemed unlikely several months ago, but inflation has come in hotter than most forecasters expected. Uncertainty is looming over the impact of potential tariffs and other policies from the new Trump administration. The Federal Reserve has lowered its forecasts for interest-rate cuts in 2025. At the same time, market watchers are expecting a strong economy to persist. Yet they say that under the hood, some price pressures are moderating. Morningstar Inc.’s markets reporter Sarah Hansen has been tracking this story. She joined the podcast to talk about what she’s learned.
Thanks for being here, Sarah.
Sarah Hansen: Thanks for having me.
What’s Changed About the Inflation Outlook
Hampton: It seems like the markets and the Fed’s perspective on inflation has changed over the past few months. What’s different?
Hansen: This is one of the biggest stories in markets right now. A lot of strategists and economists that I’ve spoken with over the past month or so now consider stalled progress on inflation to be actually one of the biggest risks for stocks and bonds this year. And that was certainly not the case just last quarter.
Here is the backstory. The Fed has been grappling with inflation for more than two years at this point after it spiked in the aftermath of the pandemic. That’s when we saw it hit 8%, 9%—40-year highs. We have made a lot of progress over the past two years in bringing price pressures lower, but we’re still a little bit off from the Fed’s target. They’re aiming for 2% as measured by something called the PCE Price Index. And right now the annual inflation rate is about 2.4%, and it’s even a little higher, 2.8% when you exclude food and energy prices, which can be pretty volatile.
So, we’re not on target, we’re not far off. We’re in this kind of last mile of the inflation rate, but it’s proving to be pretty bumpy. At the end of last summer, we had a lot of confidence that inflation was going lower, but in November/December we started to see a handful of readings that showed progress slowing down. And combine that with the potential inflationary impact of some of President Trump’s policies like tariffs and tighter immigration, and you have a recipe for nervous investors is the long and short of it.
Why Inflation Is Running Hotter Again
Hampton: Why is inflation running hotter again?
Hansen: First, I want to be totally clear that we’re not seeing a huge acceleration like we saw a couple of years ago, but we are seeing signs that progress is slowing down, especially toward the end of last year. And that’s to do with a couple of things. One of them is strong economic growth, which is a good thing. One of them is strong consumer spending on both goods and services. And then there are also kind of idiosyncratic factors at play, things that change on a monthly basis like gas prices or airfares or things like that.
What Stubborn Inflation Means for Investors and the Economy
Hampton: Can you talk about what stubborn inflation would mean for investors and the economy?
Hansen: Absolutely. There’s a big reason why markets are watching inflation so closely right now, and it has to do with interest rates and it has to do with the Fed.
The Fed began lowering rates in September after a long period of keeping them pretty high, and they had the confidence to do that because we saw a few consecutive months of really encouraging inflation ratings. But now that that progress has started to stall, it’s looking like the Fed may actually have to keep rates higher for a little bit longer.
It’s also possible that the Fed could decide it’s totally done cutting rates for a while if the inflation picture starts to look really stubborn. And financial markets tend to prefer lower rates, just conventional wisdom. Lower rates make borrowing and doing business cheaper. And higher rates, mean that future cash flows from companies are worth less.
So long and short of it, markets like rates to be lower. Stubborn inflation means that rates might stay higher, and then there’s also a risk that higher inflation can actually dent that strong economic growth we’ve seen for the past couple of years.
Markets’ Response to Inflation
Hampton: Let’s talk more about the markets. How are they responding to all of this?
Hansen: Both stock and bond markets, are behaving in a way that suggests investors expect inflation to remain a little bit sticky. Longer-term bond yields, which tend to track expectations about the path of inflation and the path of the economy more so than the path of the Fed, are significantly higher than they were in December, which suggests that investors are kind of bracing for a higher inflation environment.
And then on the stock side, sectors that are more sensitive to higher inflation— consumer defensives, real estate—they’ve underperformed the broader market. So, there are signs that investors are responding to this threat in their market positioning.
Why Investors Need to Pay Attention to Inflation Drivers
Hampton: Talk about why it’s important to keep an eye on what’s currently driving inflation.
Hansen: Absolutely. That is actually the silver lining here. It seems like a lot of the stubbornness that we’ve seen in inflation is being driven by the strong economic growth that we just talked about. And it’s a good thing because it points to resilience under the surface, and it suggests that consumers and the economy will be able to keep up with price pressures that are slightly higher.
It also suggests that even with all the uncertainty surrounding the details of new policies in Washington investors still think those policies will be stimulative for growth.
It would be much more problematic if we were seeing inflation alongside slowing growth. That’s closer to what economists call stagflation, and it would be a much bigger problem for consumers and for financial markets, but it’s not what we’re seeing now.
What Economists Think Is Next for Inflation
Hampton: What are economists expecting over the next few months when it comes to inflation?
Hansen: Economists generally expect inflation to continue on its downward path this year, to continue the progress that we’ve seen, and eventually return to the Fed’s 2% target. This is what Morningstar’s chief economist thinks, and this is what the Fed expects over the long term, too. For most analysts, a re-acceleration in inflation is not the base case, but it is a risk that’s worth keeping an eye on.
Over the short term, it is kind of less clear. We’ve had a few months of bumpy data, and that could continue for a while. And again, sometimes that bumpiness has to do with those idiosyncratic factors like a spike in gas prices, changes in airfare costs, and insurance costs. Those kinds of things can really move the needle month to month. And then there’s the open question about how new policies from Washington will impact inflation, and we just don’t have a clear answer on that yet.
Bottom Line for Investors
Hampton: What’s the bottom line for investors, Sarah?
Hansen: Bottom line is the inflation story is evolving pretty quickly right now. We actually had an encouraging report a few weeks ago that sent markets significantly higher on the day. Investors had been waiting for some good news and they got it in December with a softer print, which kind of pushed back against this narrative that inflation could re-accelerate.
But as always, a discouraging report a few weeks from now could have the opposite effect, especially when markets are watching the data this closely. So, for investors, it’s really important to prepare for that kind of volatility, to know that it’s normal, and to know that fluctuations in the markets on the back of this data will happen. And it’s important to remember that one month of data does not tell the whole inflation story.
Hampton: That is a great reminder, Sarah. I know you’re busy reporting on what’s going on in the markets. Thanks for making time today to come on investing insights.
Hansen: Thanks so much. It was a pleasure.
What’s New in the Markets
Here’s the markets in brief for the week ahead: The Federal Open Market Committee is scheduled to meet for the first time in 2025. The two-day meeting will begin on Tuesday, Jan. 28. The Fed is expected to announce its interest-rate decision the next day.
And on the Q4 earnings front, AT&T T is scheduled to report its results on Jan. 27, Boeing BA on Jan. 28, and Tesla TSLA on Jan. 29.
Meanwhile, changes coming from Washington could reroute where the electric vehicle industry is headed in the US. One of President Trump’s first actions in his second term revoked his predecessor’s executive order setting a high target for new EV sales. How could this affect EV leader Tesla and other automakers? I talked with Seth Goldstein. He’s a strategist for Morningstar Research Services and covers Tesla.
Thanks for being here, Seth.
Seth Goldstein: Of course. Hi, Ivanna. How are you?
How Trump’s Policy Shift Could Affect Tesla and Other Automakers
Hampton: I am doing well. Well, let’s get right into it. President Trump has issued an executive order on electric vehicles to roll back one from former President Joe Biden. Biden set a target for half of new-car sales in the US to be electric by 2030. Trump has also criticized the $7,500 federal tax credit given to shoppers for buying an EV. What do these policy shifts mean for Tesla and other automakers?
Goldstein: Well, for other automakers, it means that they can respond to what vehicles they produce more based on market demand rather than regulations. But in the long term, we see electric vehicles reaching cost parity and functional parity with the buildout of high-powered chargers throughout the country. And that will be the demand boost from consumers who want to switch to an electric vehicle once they find the cost and function suitable for them. So, the impact of changing automaker regulations in the future, we don’t really see as a big driver of electric vehicles, so we see very little impact of this Trump policy change.
Now, the Inflation Reduction Act, if that $7,500 subsidy is reversed, we could see a temporary impact on demand. But there are automakers, such as Tesla and GM GM, coming out with more affordable electric vehicles that are at cost parity with their internal combustion engine counterparts without the subsidy upfront. So, we think those new, more affordable vehicles will be a growth driver for EVs, even if there is a slight reduction in subsidies for other more expensive vehicles. So net-net, we still see a very positive future for electric vehicles.
Is It Still Possible for EVs to Hit Their Accelerated Growth Forecast?
Hampton: We’ve spoken before about Morningstar’s electric vehicle forecast. It predicts EVs will see accelerated growth in the second half of the decade. Is that target still possible with a shift in the US?
Goldstein: Yes, and globally EVs are still growing. They grew in 2024, looking like another year of growth in 2025. The US is still a relatively smaller contributor globally, but even if we just look at the US market. Long term, we expect electric vehicles will grow as more affordable long-range vehicles hit the market and consumers find the convenience of being able to charge at home and being able to have a lower operating cost just due to fewer moving pieces in the vehicle itself. So, we think that eventually, these models will make the case to win consumer demand regardless of subsidies once there’s the availability of affordable models and the availability of high-powered chargers built out along highways and in cities so that consumers feel confident they can take a road trip in an EV. So, regardless of any Trump policy impacts, we still see a very bright outlook for EV growth.
Why Tesla May Have a Comeback in 2025
Hampton: Tesla missed its vehicle delivery target for 2024, but you’re predicting the company can turn it around in 2025. Talk about why, Seth.
Goldstein: Well, we see deliveries growing in 2025 after they fell in 2024. One of the first times vehicle deliveries ever fell in company history. And the reason is Tesla plans to launch a new, more affordable model in about the middle of the year. As that model ramps up production, that should accelerate delivery growth. Now, we don’t think that Tesla will be able to hit management’s target of 20% to 30% delivery growth this year, but we ultimately still see a return to growth.
What to Look for in Tesla’s Upcoming Earnings
Hampton: Tesla is scheduled to report its earnings on Jan. 29. Give us some insight into what you want to hear from Elon Musk and his team.
Goldstein: First, we want to hear about the new, more affordable vehicle. Is it still on track to be produced in the middle of this year? For the past few quarters, that has been the timeline, and they’ve stuck to it. So, we want to hear an update on that vehicle. And then we want to hear an update on the full self-driving, autonomous-driving software. Tesla is investing heavily in the development of this software as a way that consumers will choose a Tesla over other automakers. We think this software will be successful, but we want to hear updates on it. How are the miles per intervention going? Is the software getting better? And what is the planned rollout for the unsupervised version, which is a level 3 software where the car does most of the driving itself? What is the rollout timeline for that to enter California and Texas, which is where Tesla wants to start that version of its software this year?
We want to hear an update to see if that’s still on track because ultimately when investors are looking at Tesla, they’re hoping that someday Tesla will be able to launch a robo-taxi service with fully autonomous cars. And so when we’re looking at that, we’re looking to see if they are making progress. Is the software still getting better? And can we make the launch to the level 3 software where the car does most of the driving in 2025? Or is this going to be another year of delays like we’ve seen many years before from Tesla?
Morningstar’s Outlook on Tesla Stock
Hampton: Let’s close out our conversation with what you think about Tesla stock.
Goldstein: We view Tesla stock as very overvalued, shares trade at about double versus our fair value estimate. So, right now we’d say there’s a lot of growth, a lot of success priced in for Tesla’s deliveries getting back on track, for the autonomous driving software to continue to develop and eventually roll out the robo-taxi product. But we think that investors may be getting a little carried away. The market is overly enthusiastic. And a lot of the upside or bull case is starting to be priced into the stock, which means there’s not a great margin of safety in current shares.
Hampton: Well, Seth, thank you for joining me today. I know you’re going to be very busy next week when Tesla reports earnings. Great to see you.
Goldstein: Thanks for having me, Ivanna.
Hampton: Thanks, Seth, for joining me today and sharing an update on Tesla.
That wraps up this week’s episode. Thanks for watching and making this show part of your day. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to senior video producer Jake VanKersen and associate multimedia editor Jessica Bebel. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Take care.