Assessing the Impact of Trump Tariffs and Core PCE Inflation on U.S. Equities and Fed Policy

The U.S. economy in late 2025 is navigating a complex interplay of inflationary pressures, trade policy shifts, and central bank policy uncertainty. With core PCE inflation at 2.9% year-over-year in July 2025—the highest since February—the Federal Reserve faces a critical juncture as it weighs the risks of persistently sticky inflation against signs of a cooling labor market [1]. Meanwhile, President Trump’s aggressive tariff policies, which have pushed the average effective U.S. tariff rate to 20.6%—the highest since 1910—have further complicated the Fed’s calculus [2]. For investors, the September 2025 FOMC meeting represents a pivotal moment, with markets pricing in an 87% probability of a 25-basis-point rate cut [3].

Tariffs, Inflation, and Sectoral Vulnerabilities

Trump’s tariffs have amplified inflationary pressures, particularly in sectors reliant on imported goods. The July core PCE data revealed a 3.6% annualized rise in services prices, driven by higher costs in healthcare, hospitality, and transportation, while goods prices rose modestly by 0.5% [1]. Goldman Sachs analysis underscores that U.S. businesses absorbed 64% of tariff costs in the first half of 2025, but this is expected to shift toward consumers as supply chains adjust [2]. Sectors like footwear and apparel—where tariffs have spiked to 50%—are experiencing margin compression, while service-oriented industries remain relatively insulated [4].

Equity markets have responded with mixed signals. The S&P 500 and Nasdaq Composite hit record highs in Q2 2025, fueled by AI-driven tech stocks, but defensive sectors like utilities and consumer staples have outperformed as investors hedge against volatility [5]. However, the broader market faces headwinds: Morningstar estimates that tariffs have added 1.6 percentage points to inflation and reduced real GDP growth forecasts by 0.7 percentage points over 2025–2026 [6].

Core PCE Inflation: A Sticking Point for the Fed

The July core PCE report underscores the Fed’s dilemma. While the 2.9% annual rate is a marginal improvement from June’s 2.8%, it remains well above the 2% target. The 0.3% monthly increase aligns with expectations but signals that inflationary momentum is not abating [1]. Services inflation, which accounts for 60% of core PCE, is proving particularly stubborn, with healthcare and housing costs rising faster than the Fed’s models anticipate [7].

The labor market, meanwhile, shows early signs of normalization. July’s nonfarm payrolls grew by 73,000—a sharp decline from June’s revised 14,000—while the unemployment rate edged up to 4.2% [3]. A shrinking labor force participation rate (62.2%) and rising long-term unemployment (1.8 million) suggest structural weaknesses are emerging [8]. These trends have emboldened Fed officials like Christopher Waller, who has signaled openness to a larger rate cut if labor data deteriorate further [9].

Investor Preparedness: Balancing Rate-Cut Optimism and Inflation Risks

Investors are adopting a dual strategy to navigate the Fed’s potential September move. Defensive equity sectors—healthcare, utilities, and consumer staples—are favored for their resilience during rate-cut cycles, while inflation-hedging assets like gold and Treasury Inflation-Protected Securities (TIPS) are gaining traction [10]. Fixed-income allocations are shifting toward short-duration bonds and active credit strategies to mitigate yield curve compression and duration risk [11].

Equity positioning is also tilting toward sectors poised to benefit from lower rates. Growth stocks in technology and industrials, particularly those tied to AI infrastructure and housing recovery, are attracting capital as discount rates decline [12]. However, the market’s optimism is tempered by concerns that a rate cut could reignite inflation, especially with tariffs still elevating import prices [13].

Hedging strategies are evolving to address September’s seasonal volatility. Investors are using VIX call options and inverse ETFs to protect against sharp selloffs, while diversifying geographically into Asian and European markets less exposed to U.S. trade tensions [14]. BlackRock and J.P. Morgan recommend a “belly” of the yield curve (intermediate-duration bonds) over long-term Treasuries, citing reduced demand for duration risk amid fiscal uncertainty [15].

The Fed’s Dilemma: Inflation Control vs. Labor Market Support

The September FOMC decision will hinge on a delicate balancing act. A rate cut could stimulate the labor market and avert a recession but risks entrenching inflation by signaling accommodative policy. Conversely, maintaining higher rates could deepen a fragile labor market, with unemployment potentially rising to 4.3% in August [16]. The Fed’s challenge is compounded by the fact that tariffs have created a “second-order” inflationary effect, with price pressures filtering through supply chains and consumer behavior [17].

Conclusion: A Prudent Path Forward

For investors, the key lies in adopting a dynamic, balanced approach. Defensive assets and inflation-linked securities provide downside protection, while growth-oriented equities and active credit strategies capitalize on rate-cut optimism. As the Fed navigates its policy crossroads, staying attuned to real-time data—particularly August employment and inflation reports—will be critical. The September rate cut, if it materializes, may offer a temporary reprieve for markets, but the broader economic landscape remains shaped by Trump’s tariffs and the stickiness of core PCE inflation.

Source:
[1] Core inflation rose to 2.9% in July, highest since February [https://www.cnbc.com/2025/08/29/pce-inflation-report-july-2025.html]
[2] Assessing the Impact of Trump's Tariffs and the Fed's Dilemma [https://www.ainvest.com/news/assessing-impact-trump-tariffs-fed-dilemma-inflation-equity-market-outlook-2508/]
[3] Positioning for an Imminent Fed Rate Cut: Tactical Fixed Income and Equity Strategies [https://www.ainvest.com/news/positioning-imminent-fed-rate-cut-tactical-fixed-income-equity-strategies-dovish-environment-2508/]
[4] US Tariffs: What's the Impact? | J.P. Morgan Global Research [https://www.jpmorgan.com/insights/global-research/current-events/us-tariffs]
[5] Q3 2025 Market & Economic Outlook [https://www.1834investmentadvisors.com/insights/market-economic-outlook/]
[6] Tariff Concerns, US Stock Rebound & Economic Indicators [https://global.morningstar.com/en-gb/stocks/recession-indicators-financial-advisors-cheat-sheet]
[7] PCE data paints a solid picture, but hidden cracks show ... [https://fortune.com/2025/08/29/july-pce-data-inflation-consumer-spending-income-hidden-cracks-trump-tariffs/]
[8] Employment Situation Summary - 2025 M07 Results [https://www.bls.gov/news.release/empsit.nr0.htm]
[9] Fed Rate Cuts & Potential Portfolio Implications | BlackRock [https://www.blackrock.com/us/financial-professionals/insights/fed-rate-cuts-and-potential-portfolio-implications]
[10] Positioning for an Imminent Fed Rate Cut: Tactical Fixed ... [https://www.ainvest.com/news/positioning-imminent-fed-rate-cut-tactical-fixed-income-equity-strategies-dovish-environment-2508/]
[11] Fed Rate Cut? Not So Fast [https://www.morganstanley.com/insights/articles/fed-rate-cut-september-2025-forecast]
[12] Navigating the Fed's September Rate Cut: Strategic Asset ... [https://www.bitget.com/news/detail/12560604939446]
[13] Positioning for a September Rate Cut and Seasonal Volatility [https://www.ainvest.com/news/positioning-september-rate-cut-seasonal-volatility-2508/]
[14] US Consumer Spending Rises Firmly Despite Stubborn Inflation [https://www.bloomberg.com/news/articles/2025-08-29/us-consumer-spending-rises-firmly-despite-stubborn-inflation]
[15] Fed Rate Cuts & Potential Portfolio Implications | BlackRock [https://www.blackrock.com/us/financial-professionals/insights/fed-rate-cuts-and-potential-portfolio-implications]
[16] US labor market cracks widen as job growth hits stall speed [https://www.reuters.com/world/us/us-labor-market-cracks-widen-job-growth-hits-stall-speed-2025-08-01/]
[17] Can the Market Stay Hot as Trump Turns Up the Tariff Heat? [https://www.mitrade.com/insights/news/live-news/article-8-1082195-20250830]