Assessing the Impact of July S&P Global US Flash PMI on the Fed's Policy Path and USD Strength

The July 2025 S&P Global US Flash PMI data has painted a starkly divergent picture of the U.S. economy, with the manufacturing sector contracting for the first time since December 2024 while the services sector continues to expand. This split in performance raises critical questions about the Federal Reserve's policy trajectory and the future strength of the U.S. dollar. For investors, understanding how these sector-specific trends influence inflation, employment, and monetary policy is key to positioning portfolios in the coming months.

Manufacturing Contraction: A Breath of Relief or a Warning Sign?

The manufacturing PMI fell to 49.5 in July 2025, a sharp drop from June's 52.0 and below forecasts of 52.6. This contraction marks the first deterioration in factory activity since late 2024 and signals a cooling in a sector that had previously driven much of the economy's momentum. Production growth slowed, new orders declined, and employment and inventories fell for the first time since April 2025. However, supplier delivery times improved significantly, pointing to easing supply chain pressures—a positive development for inflation.

The contraction in manufacturing may be partly attributed to inventory adjustments. Firms had accumulated significant stockpiles in anticipation of potential tariff hikes, and this activity appears to have front-loaded growth. If true, the sector's near-term weakness could represent a temporary correction rather than a structural slowdown. That said, the persistent rise in input and output prices—driven by tariffs—suggests that inflationary pressures in this sector remain embedded.

Services Sector Resilience: A Double-Edged Sword

In contrast, the services PMI is expected to rise to 53.0 in July 2025, reinforcing its role as the economy's anchor. The sector has reported sustained growth, strong hiring, and elevated price pressures, though inflation has eased to its lowest level in nearly four-and-a-half years. This combination of expansion and inflationary resilience complicates the Fed's calculus.

Services employment has accelerated at the fastest rate in months, which is typically a positive sign for labor markets. However, the sector's elevated price pressures—though moderating—could prolong inflationary concerns. Services account for roughly 80% of the U.S. economy, so its performance heavily influences the Fed's inflation and employment mandates. A services sector that continues to expand while adding to wage growth could delay the central bank's pivot to rate cuts.

Divergent Sectors and the Fed's Dilemma

The Fed's primary challenge lies in reconciling these divergent signals. A contracting manufacturing sector may ease headline inflation by reducing supply chain bottlenecks and lowering commodity prices. Yet the services sector's growth and hiring could offset this by sustaining core inflation and wage growth.

The Composite PMI, which combines both sectors, remains above 50 at 52.9, indicating overall economic expansion. However, the narrowing gap between manufacturing and services activity suggests a shift in the economy's drivers. If the Fed interprets this as a structural move toward services-led growth, it may prioritize inflation control over employment support, particularly if services inflation remains stubborn.

Implications for Policy and the USD

The Fed's September 2025 meeting will be pivotal. A strong services PMI print in July, coupled with a weak manufacturing reading, could lead to a “soft landing” narrative: a slowdown in goods production without a broad economic downturn. This scenario would likely see the Fed maintain rates and signal a cautious approach to cuts in 2026. Conversely, if manufacturing weakness deepens and services inflation eases meaningfully, the Fed may feel emboldened to cut rates in Q3 to support demand.

The U.S. dollar's strength will hinge on these outcomes. A Fed that appears committed to its inflation-fighting mandate would bolster the dollar, while any hints of dovishness could trigger a sell-off. The dollar's performance in recent months has already reflected this tension, with volatility tied to trade policy uncertainties and sector-specific data.

Investment Strategy: Navigating the Divergence

For investors, the key is to hedge against both scenarios. If the Fed delays cuts, growth-sensitive sectors like consumer discretionary and technology could outperform. Conversely, a rate cut would likely benefit high-yield bonds, real estate, and rate-sensitive equities.

In the foreign exchange market, a long USD position could be justified if the services PMI surprises to the upside and manufacturing weakness proves temporary. However, given the risks of prolonged services inflation, investors should also consider short-term USD hedges or allocations to USD-weak assets like emerging market equities.

Conclusion: A Tug-of-War Between Sectors

The July PMI data underscores the U.S. economy's complexity. While manufacturing's contraction may offer a reprieve for inflation, the services sector's resilience could delay the Fed's pivot. Investors must remain agile, monitoring granular data on price pressures and employment trends. The Fed's September decision will likely reflect a balancing act between these forces, with the dollar and broader markets poised to react sharply to even minor shifts in policy expectations.

As the July 24 flash PMI release approaches, all eyes will be on whether the services sector's growth is sustainable—or if the manufacturing slump signals a broader slowdown. For now, the Fed's cautious stance and the dollar's strength remain on life support, hanging in the balance of these divergent economic narratives.