The Federal Reserve’s approach to inflation has long influenced the direction of financial markets. As its policies evolve, so does the environment in which investment decisions are made. In 2020, the Fed transitioned from a fixed strategy to a flexible strategy known as Average Inflation Targeting (AIT). This approach aims for inflation to average 2% over time, even if that means tolerating periods above 2% to offset earlier shortfalls.
While this shift may appear subtle, it reflects one of the most consequential shifts in Federal Reserve monetary policy in recent decades. For investors in 2025, this framework has a direct impact on inflation expectations, interest rates, and the broader investment landscape.
On September 17, the Fed announced its first interest rate cut of the year, lowering the Federal Funds interest rate by 0.25 percentage points to a range of 4.00% to 4.25%. The cut, which was the first made since December 2024, highlights the Fed’s balancing act between stabilizing a weakening labor market and managing persistent inflation. For investors, the decision serves as a clear reminder that the Average Inflation Targeting framework continues to shape today’s financial landscape.
What Changed in the Federal Reserve’s Inflation Targeting Policy?
Prior to AIT, the Fed treated 2% inflation more as a ceiling than an average. It often responded to inflation below 2% with looser monetary policy but did not aim to offset past undershoots. Even during much of the 2010s expansion, core inflation remained below 2%, prompting the Fed to hold interest rates at near-zero levels for years after the financial crisis. Rates gradually rose beginning in 2015, were cut again in 2019, and returned to zero in 2020 as the pandemic hit.
The Federal Reserve introduced Average Inflation Targeting in 2020 to provide more flexibility after persistent undershoots of its inflation target. Under AIT, the Fed can tolerate below-target inflation in some periods, with the expectation that future inflation will exceed 2% to balance the average. This gives the Fed more room to delay tightening monetary policy.
In 2025, following its five-year monetary policy review, the Fed released an updated Statement on Longer-Run Goals and Monetary Policy Strategy. The revision reaffirmed the 2% inflation goal while incorporating lessons from recent inflation spikes, labor market shifts, and supply chain disruptions.
Why the Fed’s Inflation Framework Matters for Investors
The Fed’s adoption of AIT is reshaping interest rate policy, market volatility, and global capital flows. For investors, understanding these changes is essential to navigating both opportunities and risks in today’s economy. Key areas of impact include:
Interest Rate Policy
Under AIT, the Fed is more willing to tolerate temporary inflation overshoots. In practice, this has often resulted in lower interest rates for longer, especially during periods of uneven recovery. The most recent example came on September 17, 2025, when the Fed cut interest rates by 0.25 percentage points, citing concerns about slowing job growth and softer economic conditions. While inflation remains above the 2% target, the decision reflects the Fed’s more flexible AIT framework, which allows it to balance inflation management with its mandate to support employment.
Inflation Dynamics
AIT was introduced during a period of low inflation, but the post-pandemic surge in prices tested its limits. In recent years, the Fed has focused on restoring price stability, while still operating within the AIT framework. The balance between short-term inflation management and long-term credibility remains central to investment strategy.
Market Volatility
Changes in inflation expectations and Fed policy have led to increased market volatility. Investors must adjust assumptions around earnings growth, discount rates, and long-term returns in response to evolving policy signals across both equity and bond markets.
Global Implications
Because U.S. monetary policy heavily influences global capital flows, the Fed’s framework also shapes the direction of the U.S. dollar and cross-border investment. These spillovers can have ripple effects across international equities, emerging markets, and global fixed income.
Ongoing Policy Evolution
The Fed’s 2025 policy review reaffirmed its 2% inflation goal but also incorporated insights from recent disruptions, including supply chain constraints and labor market changes. This highlights that the Fed’s strategy is adaptive, and its framework will continue to evolve with economic conditions.
Navigating Market Changes Under the Average Inflation Targeting Approach
What does AIT mean for investors? By allowing periods of above-target inflation, Average Inflation Targeting can create unexpected market swings and challenge traditional investment strategies.
In response to AIT, Boulay’s investment team has taken a proactive approach. They’ve explored a broader range of asset classes, such as commodities and other real assets, to help protect portfolios against inflation risk and enhance diversification. At the same time, the team is committed to long-term goals, balancing short-term market movements with disciplined strategies designed to keep clients positioned for stability and growth.
Managing Inflation and Market Risk with Boulay
Understanding the Federal Reserve’s monetary policy and Average Inflation Targeting (AIT) is critical for building a resilient investment portfolio. Changes in interest rates, inflation expectations, and market volatility can directly impact your investment strategy. At Boulay, we help you assess your portfolio, improve diversification, and manage inflation risk while keeping focus on long-term growth and financial stability. Connect with an advisor today to explore investment strategies that align with your wealth goals.