Core PCE Trends and the Fed’s September Rate Cut Decision: Assessing the Implications of a Modest but Persistent Inflation Uptick on USD and Equity Markets

The Federal Reserve faces a delicate balancing act in September 2025 as it weighs the implications of a modest but persistent inflation uptick against a softening labor market. Core PCE inflation, the Fed’s preferred gauge of price stability, rose to 2.9% year-over-year in July 2025, up from 2.8% in June and remaining above the central bank’s 2% target [1]. While this increase is not a sharp spike, its persistence—driven by services inflation in housing and healthcare—has kept policymakers on edge [1]. The Fed’s response will shape not only the trajectory of U.S. monetary policy but also the performance of the dollar and equities in a global market increasingly attuned to the interplay of inflation and rate expectations.

The Fed’s Dilemma: Inflation Moderation vs. Labor Market Softness

The July core PCE data underscores a key tension in the Fed’s decision-making. On one hand, inflation remains elevated, with services prices continuing to outpace goods inflation due to structural bottlenecks and policy-driven distortions like U.S. tariffs [1]. On the other, the labor market has shown signs of strain, with July job creation slowing to 73,000 and prior months’ figures revised downward [3]. This duality has led to a shift in Fed rhetoric. Governor Christopher Waller, for instance, has advocated for preemptive rate cuts to “prevent further labor market deterioration” [3], while Chair Jerome Powell has emphasized a data-dependent approach, noting that “the FOMC will make its decisions based solely on economic data” [6].

The market has priced in a 82% probability of a 25-basis-point rate cut at the September meeting, with traders anticipating a more aggressive easing path if inflation shows signs of peaking [1]. This expectation is rooted in historical precedents: the 50-basis-point cut in September 2024, for example, was followed by a 1.7% rally in the S&P 500 and a 10% decline in the USD Index [5]. The Fed’s September 2025 decision, therefore, is not just a technical adjustment but a pivotal signal about the central bank’s tolerance for inflation and its prioritization of employment stability.

Implications for the U.S. Dollar

A rate cut in September would likely exacerbate the dollar’s recent weakness. The USD Index has already fallen nearly 10% in 2025, pressured by divergent global monetary policies and trade policy uncertainty [4]. A 25-basis-point reduction in the federal funds rate would further erode the dollar’s appeal, particularly as other central banks, such as the European Central Bank and the Bank of Japan, maintain tighter policy stances [6]. This dynamic is evident in the 2024 precedent, where the Fed’s rate cut coincided with a shift in capital flows toward higher-yielding emerging market assets [5].

However, the dollar’s response may be tempered by the Fed’s forward guidance. If policymakers signal a measured easing path—such as a single 25-basis-point cut in September followed by a pause—market volatility could be contained. The key variable will be the Fed’s ability to reconcile its dual mandate: a rate cut aimed at supporting employment could be offset by a stronger-than-expected inflation print in August, which might limit the dollar’s decline.

Equity Market Reactions: Sectoral Winners and Losers

Equity markets have already priced in much of the Fed’s anticipated easing, but a September rate cut could still drive sectoral rotations. Historically, lower rates have favored sectors with high sensitivity to borrowing costs, such as real estate, consumer discretionary, and technology [6]. For example, the 2024 rate cut spurred a 1.7% gain in the S&P 500 the following day, with growth stocks outperforming value equities [5]. A similar pattern could emerge in 2025, particularly if the rate cut is accompanied by a decline in Treasury yields, which would reduce the discount rate for future earnings.

Conversely, financial institutions and insurance companies may face headwinds. Lower rates compress net interest margins for banks, while insurers could see the present value of future cash flows decline [6]. Investors may also rotate into intermediate-duration bonds or credit-sensitive assets, as BlackRock has advised, to capitalize on the falling-rate environment [2].

The Path Forward: A Shallow Easing Cycle?

The Fed’s September decision must also be viewed through the lens of its long-term inflation projections. Professional forecasters expect core PCE inflation to remain at 3.0% in 2025 before moderating to 2.5% in 2026 [5]. This suggests a shallow easing cycle, with the Fed unlikely to pursue a rapid rate reduction akin to 2024. Such a scenario would limit the magnitude of dollar depreciation and equity market rallies, as investors adjust to a prolonged period of modest inflation and gradual policy normalization.

In this context, the Fed’s credibility will be paramount. If policymakers can credibly anchor inflation expectations while supporting the labor market, the September rate cut could serve as a stabilizing force. However, any miscalculation—such as a rate cut that fails to curb inflation or a delay that exacerbates unemployment—could trigger renewed market turbulence.

Conclusion

The Fed’s September 2025 rate decision is a microcosm of its broader challenge: managing a modest but persistent inflation uptick while navigating a fragile labor market. For investors, the implications are clear. A rate cut will likely weaken the dollar and buoy equities, but the extent of these effects will depend on the Fed’s communication and the data it receives in the coming months. As the central bank inches closer to its September meeting, the markets will be watching not just for the size of the cut, but for the clarity of its path forward.

Source:
[1] Core inflation rose to 2.9% in July, as expected, key Fed ... [https://www.cnbc.com/2025/08/29/pce-inflation-report-july-2025.html]
[2] Fed Rate Cuts & Potential Portfolio Implications | BlackRock [https://www.blackrock.com/us/financial-professionals/insights/fed-rate-cuts-and-potential-portfolio-implications]
[3] Assessing the Impact of July PCE Data on Fed Policy and USD Dynamics [https://www.ainvest.com/news/assessing-impact-july-pce-data-fed-policy-usd-dynamics-2508/]
[4] Dollar edges higher ahead of PCE; monthly fall likely [https://www.investing.com/news/forex-news/dollar-edges-higher-ahead-of-pce-monthly-fall-likely-4216079]
[5] Fed Rate Cut Looms: Positioning Clients for Success, [https://get.ycharts.com/resources/blog/fed-rate-cut-advisor-strategies/]
[6] Fed Eyes September Rate Cut Amid Weakening Jobs Market [https://markets.financialcontent.com/wral/article/marketminute-2025-8-28-fed-eyes-september-rate-cut-amid-weakening-jobs-market-inflationary-concerns-linger]