U.S. Inflation Expectations Cool: Fed's Soft Landing Gains Momentum

The University of Michigan's June 2025 survey revealed a significant shift in consumer inflation expectations, dropping to 5.0% from May's 5.3%—marking the lowest reading in six months and undershooting forecasts of 5.1%. This decline signals a pivotal moment for Federal Reserve policy and investment strategies, as markets parse whether the U.S. economy is finally nearing a sustainable “soft landing.”

The Data: A Turning Point?

The Michigan 1-Year Inflation Expectations survey, a critical gauge of consumer sentiment, reflects households' belief in future price trends. A 5.0% reading suggests a moderation from the post-2022 peak of 5.5%, but remains elevated compared to the Fed's 2% target. The drop was driven by easing energy costs (gasoline prices fell 2.2% month-over-month in May) and stabilizing shelter inflation, which accounts for roughly one-third of the core PCE basket.

However, core inflation—excluding food and energy—remains stubbornly elevated. The May 2025 core PCE inflation rate held at 2.7% annually, slightly above the Fed's preferred 2.4% path for 2026. This divergence underscores a key challenge: while headline inflation is cooling, persistent service-sector costs (e.g., healthcare, education) and tariff-driven goods inflation could prolong the Fed's caution.

Why This Matters for the Fed—and Investors

The Fed has emphasized that “data dependence” will guide policy, and this survey reinforces its case for pausing rate hikes. With the federal funds rate at 3.9%—its highest since 2001—the central bank faces a delicate balancing act: maintaining restrictive policy to quell inflation while avoiding a recession.

Key Takeaways for Policy:
- A dovish tilt is likely: The Fed will likely keep rates steady at July's meeting, awaiting further clarity on wage growth (average hourly earnings rose 4.3% in May, still above the 3% needed to hit 2% inflation).
- Tariffs as a wildcard: President Trump's import taxes, now averaging 15.8%, risk reigniting goods inflation. Analysts estimate tariffs could add 0.3–0.6% to core PCE in 2025.

Sector-Specific Investment Implications

The Michigan data has reshaped market narratives, rewarding sectors insulated from inflation while penalizing those exposed to margin pressures.

Winners: Transportation & Utilities

• Transportation Infrastructure: Lower energy costs and steady demand for freight services have driven a +8% gain in the sector over 60 days (e.g., companies like CHRW and JBHT).
• Utilities: Regulated utilities (e.g., DUK, EIX) benefit from stable demand and inflation-indexed pricing.

Losers: Chemicals & Industrials

• Chemical Producers: Firms like DOW and LXK have seen -6% declines over 22 days as input costs (plastics, fertilizers) remain elevated due to tariffs.
• Industrial Equipment: Investors are pricing in weaker demand amid softening manufacturing PMIs.

Investment Recommendations

Overweight Transportation Infrastructure:
- Rationale: Eases inflation fears reduce refinancing risks for infrastructure projects.
- Top Picks:
- C.H. Robinson (CHRW): Logistics leader with exposure to e-commerce demand.
- Kansas City Southern (KSU): Railway operator benefiting from cross-border trade.

Underweight Chemicals:
- Rationale: Margin pressures persist as input costs outpace pricing power.
- Avoid: Dow Inc. (DOW), LyondellBasell (LYB).

Risks and the Road Ahead

While the Michigan data is encouraging, two critical risks loom:
1. Service-sector inertia: Shelter inflation (rent) is cooling but remains elevated at 4.2% annually.
2. Geopolitical tailwinds: Iran-Israel tensions could disrupt oil markets, reigniting energy inflation.

Investors should monitor August's CPI report and the September Fed meeting for clues on rate paths. For now, the Michigan survey's cooldown offers a green light for risk-on trades—but don't ignore the Fed's “data-dependent” mantra.

Final Take: The Michigan inflation surprise reinforces the Fed's soft-landing narrative. Capitalize on sectors benefiting from demand stability while avoiding those vulnerable to margin squeezes. Stay nimble—this inflation saga isn't over yet.