The Impact of Upcoming Inflation Data on Equity and ETF Market Sentiment

The U.S. equity and ETF markets are at a pivotal juncture as inflation data and Federal Reserve policy signals converge to shape investor sentiment. With core PCE inflation rising to 2.9% year-over-year in July 2025—above the Fed’s 2.0% target—markets are increasingly pricing in a 25-basis-point rate cut at the September 16-17 FOMC meeting, with probabilities now exceeding 85% [4]. This expectation reflects a delicate balancing act: while inflation remains stubbornly elevated due to sticky services costs and tariff-driven supply chain disruptions [1], Fed officials like Christopher Waller have signaled a preference for easing policy to align rates with a “neutral” level of around 3% [3].

Inflationary Pressures and Market Reactions

The July 2025 inflation data underscores the Fed’s dilemma. Core PCE inflation climbed 0.3% month-over-month, driven by surging housing and healthcare costs, while headline inflation remained tempered by falling energy prices [5]. This divergence has created a mixed signal for markets. On one hand, the S&P 500 has reached record highs, buoyed by expectations of lower borrowing costs and robust corporate earnings [1]. On the other, rising 10-year Treasury yields have narrowed the equity risk premium, raising concerns about overvaluation [4]. Analysts warn that while rate cuts typically stimulate growth, the current environment—marked by a tight labor market and political pressures from figures like Donald Trump—introduces uncertainty [2].

Historically, equity markets have performed well during Fed easing cycles. Since 1980, the S&P 500 has averaged 14.1% returns in the 12 months following the first rate cut [2]. However, context matters: cycles during economic expansions (e.g., 2015-2018) have delivered stronger returns than those during recessions [3]. For ETFs, the relationship is equally nuanced. Cooling inflation data, such as a weaker-than-expected core CPI report, has historically triggered gains in both equity and bond ETFs. For example, the SPDR S&P 500 ETF (SPY) and iShares 20+ Year Treasury Bond ETF (TLT) rose 1.8% and 1.7%, respectively, after a surprise inflation slowdown in 2024 [3].

Strategic Positioning for Rate Cuts

As the Fed edges closer to a rate cut, investors must consider how to position portfolios for both the near-term and long-term. Key strategies include:

1. Long-Duration Equities and Growth Sectors: Lower discount rates from rate cuts typically benefit growth stocks, particularly in tech and AI-driven industries [1]. The S&P 500’s concentration in these sectors has already driven gains, but overreliance on a few names poses risks [4].
2. High-Yield Bonds and International Credit: A steepening yield curve and dovish central bank policies make high-yield bonds and emerging market debt attractive [3]. Japan and emerging markets, in particular, could benefit from global liquidity shifts.
3. Quality Fixed Income and Gold: Medium-duration government bonds and gold serve as hedges against rate volatility and inflation [1]. Gold’s non-interest-bearing nature makes it especially responsive to rate cuts, while central bank purchases reinforce its appeal [3].
4. Real Assets and TIPS: Real estate investment trusts (REITs) and Treasury Inflation-Protected Securities (TIPS) offer inflation protection without overexposure to short-duration fixed income [5].

Risks and Uncertainties

Despite the case for optimism, risks persist. Morgan Stanley cautions that robust GDP growth and low unemployment may delay cuts, with the September rate cut now seen as a 50-50 proposition [2]. Additionally, political interference in Fed independence—such as Trump’s public criticism of Jerome Powell—adds a layer of unpredictability [4]. For ETFs, rising tariffs and policy uncertainty could disrupt global supply chains, dampening returns in international and alternative asset classes [6].

Conclusion

The upcoming inflation data and potential September rate cut present both opportunities and challenges. While historical patterns suggest equities and ETFs will benefit from easing policy, investors must remain vigilant about valuation risks and macroeconomic shifts. A diversified approach—balancing growth equities, quality bonds, and real assets—offers the best path to navigating this complex environment. As the Fed’s easing cycle unfolds, agility and strategic rebalancing will be critical to capturing returns while mitigating downside risks.

Source:
[1] Fed's Waller sees rate cuts over next 3-6 months, starting in September [https://www.reuters.com/business/finance/feds-waller-sees-rate-cuts-over-next-3-6-months-starting-september-2025-08-28/]
[2] Fed Rate Cut? Not So Fast [https://www.morganstanley.com/insights/articles/fed-rate-cut-september-2025-forecast]
[3] How Do Stocks Perform During Fed Easing Cycles? [https://www.lpl.com/research/blog/how-do-stocks-perform-during-fed-easing-cycles.html]
[4] US core PCE inflation set to rise 2.9% YoY in July amid rising bets of Fed rate cut in September [https://www.fxstreet.com/news/us-core-pce-inflation-set-to-rise-29-yoy-in-july-amid-rising-bets-of-fed-rate-cut-in-september-202508290600]
[5] The Fed's Pivotal Shift: Timing and Implications of Rate Cuts [https://www.ainvest.com/news/fed-pivotal-shift-timing-implications-rate-cuts-2025-2508/]