The Implications of Stable PCE Inflation for Equity Market Momentum

The U.S. Personal Consumption Expenditures (PCE) price index, the Federal Reserve's preferred inflation gauge, has stabilized in 2025, hovering near 2.7% year-over-year for core PCE inflation. This moderation, while still above the Fed's 2% target, has created a unique inflection point for equity markets. Investors are recalibrating strategies as inflation stabilization reshapes sentiment and sector dynamics, with implications for both risk tolerance and capital allocation.

Inflation Stabilization and Investor Sentiment

Stable PCE inflation has tempered the volatility that characterized 2024, fostering a more measured approach to equity investing. According to a report by the 2025 Natixis Global Survey of Individual Investors, only 35% of respondents expect the market's robust performance of 2023–2024 to continue, reflecting a shift from exuberance to cautionStock Market Rotation in 2025: What Investors Need to Know^[1]. This sentiment is reinforced by Vanguard's Investor Pulse survey, which notes that while investors still anticipate a 6.4% return for U.S. stocks in 2025, they also foresee an average inflation rate of 3.2% for the yearThe 2025 Stock Market Rotation: What it Means for Investors^[3].

The stabilization of inflation—particularly in goods sectors, where tariffs have introduced controlled volatility—has allowed investors to focus on structural trends rather than short-term shocks. For example, the Russell 1000 Value index has outperformed growth benchmarks, gaining 8.2% year-to-date through September 2025Stock Market Rotation in 2025: What Investors Need to Know^[1]. This shift underscores a broader reallocation toward sectors with durable cash flows and pricing power, such as energy and healthcare, which are less sensitive to interest rate fluctuations.

Sector Rotation: Winners and Losers in a Stable Inflation Regime

The equity market's rotation in 2025 has been driven by divergent sector responses to inflationary pressures. Defensive sectors like utilities, healthcare, and consumer staples have benefited from their resilience to rate hikes and their role in providing essential services. For instance, healthcare stocks have risen 7% in Q1 2025, buoyed by stable demand and limited margin compression despite core PCE inflation remaining at 2.8%How Core PCE Inflation Affects Markets in 2025^[4].

Conversely, growth-oriented sectors such as technology and consumer discretionary have faced headwinds. The Nasdaq Composite, heavily weighted toward AI-driven tech firms, has underperformed the S&P 500 by 4.5 percentage points in Q1 2025How Core PCE Inflation Affects Markets in 2025^[4]. This underperformance reflects investor concerns over profit margins in a high-rate environment, where elevated borrowing costs and cautious consumer spending constrain growth. Meanwhile, energy and industrials have gained traction, with energy stocks rising 10% year-to-date as commodity prices stabilize and demand for inflation-linked assets growsThe 2025 Stock Market Rotation: What it Means for Investors^[3].

International equities have also attracted renewed interest. The MSCI EAFE index surged 11% through early March 2025, as investors sought diversification and undervalued assets in markets like Europe and Asia-PacificStock Market Rotation in 2025: What Investors Need to Know^[1]. This trend aligns with the Fed's projected rate cuts, which have weakened the U.S. dollar and made foreign stocks more attractive.

Fed Policy and the Path Forward

The Federal Reserve's response to stable PCE inflation will be pivotal in shaping equity momentum. With core PCE inflation projected to remain at 3.1% in 2025 but decline to 2.0% by 2028FOMC Summary of Economic Projections, September 2025^[2], the Fed has signaled a cautious path of rate cuts. Markets currently price in an 88% probability of a 25-basis-point reduction at the October 2025 meetingPCE Inflation Data Will Clarify Fed Outlook (Live Coverage)^[5], which could provide a near-term boost to risk assets. However, the Fed's reluctance to overcommit to aggressive easing—given the stickiness of services inflation, particularly in housing and healthcare—suggests a measured approachHow Core PCE Inflation Affects Markets in 2025^[4].

This policy environment favors sectors that thrive in a low-volatility, low-growth setting. Financials, for example, have benefited from higher interest rates, with net interest margins expanding in Q2 2025The 2025 Stock Market Rotation: What it Means for Investors^[3]. Conversely, highly leveraged sectors like industrials face challenges if rate cuts are delayed, as borrowing costs remain elevated.

Conclusion

Stable PCE inflation in 2025 has acted as a double-edged sword for equity markets. While it has reduced the immediate risk of runaway inflation, it has also created a landscape where sector differentiation is critical. Investors are prioritizing defensive positioning, international diversification, and sectors with inflation-resistant cash flows. As the Fed navigates its dual mandate, the interplay between inflation stability and monetary policy will remain a defining theme for equity momentum in the remainder of 2025.