U.S. Core PCE Price Index (YoY) Hits 2.9%, Matches Forecasts and Drives Sector Divergence

The U.S. Core PCE Price Index, the Federal Reserve's preferred inflation gauge, rose to 2.9% year-over-year in July 2025, aligning with market expectations but signaling a complex inflationary landscape. This uptick, driven by a 3.6% annual surge in services inflation and a 2.7% annual decline in energy prices, has created stark divergences across sectors. Investors now face a critical juncture: how to navigate a mixed inflation environment where some industries thrive while others falter.

Sector Divergence: Winners and Losers

The July PCE data revealed a clear bifurcation in sector performance. Technology and computer hardware stocks bore the brunt of the market's caution. The Philadelphia Semiconductor Index fell 3.2%, while the NYSE Arca Computer Hardware Index dropped 2.0% after hitting record highs. Dell Technologies (DELL) plummeted 8.9% despite strong quarterly results, underscoring investor skepticism about near-term guidance. This weakness reflects a broader trend: as inflation pressures mount, capital-intensive sectors with thin margins and high sensitivity to interest rates become vulnerable.

Conversely, gold and inflation-linked infrastructure sectors emerged as relative safe havens. The NYSE Arca Gold Bugs Index surged 3.3%, mirroring gold's rally as investors sought protection against persistent inflation. Meanwhile, the Construction/Engineering sector, represented by the ITB ETF, has historically outperformed the S&P 500 by 15–35% during inflationary cycles. This resilience stems from inflation-linked contracts covering 60% of infrastructure projects, shielding firms like Caterpillar (CAT) and Bechtel Group (BHE) from input cost volatility.

Expert Insights: Rotation Strategies in a Mixed Environment

Historical backtesting from 2010 to 2025 reveals a consistent pattern: sectors with pricing power and inflation-linked revenue streams outperform during mixed inflation environments. The Construction/Engineering sector, buoyed by the $550 billion Bipartisan Infrastructure Law and $50 billion grid modernization plan, offers a 10-year pipeline of projects. Fixed-price agreements allow firms to absorb rising material costs, ensuring stable margins even as the Fed tightens policy.

In contrast, the Consumer Staples Distribution & Retail sector (XLY ETF) has historically underperformed during inflationary surges. Tariffs and rising labor costs eroded margins in 2022, and 2025 data shows retail sales growth slowing to 3.51% YoY. While firms like Procter & Gamble (PG) and Coca-Cola (KO) leverage pricing power, sub-sectors like food products and healthcare services face headwinds as consumers prioritize savings and debt repayment.

Investment Recommendations

1. Overweight Inflation-Resistant Sectors:
2. Construction/Engineering: Allocate to ETFs like ITB or individual firms with robust government contract pipelines (e.g., AECOM (ACM), Fluor Corp. (FLR)). The sector's inflation-linked contracts and long-term project pipelines make it a compelling hedge against mixed inflation.

3. Precious Metals: Gold's 3.3% gain in July highlights its role as a safe-haven asset. Consider ETFs like GDX or physical gold holdings to balance portfolios against services-driven inflation.

4. Underweight Rate-Sensitive Sectors:

5. Consumer Staples: Reduce exposure to XLY and prioritize firms with localized production and pricing power (e.g., PG, KO). Avoid sub-sectors reliant on discretionary spending, which contracts during inflationary periods.

6. Technology: Avoid overexposure to semiconductor and hardware firms, which face margin compression from rising input costs and interest rate sensitivity.

7. Monitor Key Indicators:

8. Track the August GDP report and September FOMC meeting for signals on rate-cut timing. A 25-basis-point cut in September could boost capital-intensive sectors like construction.
9. Watch services inflation (core services excluding energy and housing), which has become a dominant driver of inflation and a key focus for policymakers.

Conclusion

The 2.9% annual rise in the Core PCE Price Index underscores the need for a granular, sector-specific approach to portfolio management. While services inflation and energy deflation create a mixed environment, investors can capitalize on divergent trends by rotating into inflation-resistant sectors like infrastructure and gold while reducing exposure to rate-sensitive industries. As the Fed navigates its 2% inflation target amid persistent services inflation, strategic sector rotation will remain a cornerstone of resilient investing.