U.S. ISM Manufacturing Prices Signal Persistent Inflation, but Sector Rotation Gains Clarity as Fed Policy Nears Pivotal Point

The U.S. ISM Manufacturing Prices Paid Index for November 2025 hit , . This 14th consecutive month of expansion underscores stubborn inflationary pressures in the manufacturing sector, driven by , steel and aluminum price surges, and supply chain bottlenecks. Yet, beneath the headline numbers lies a nuanced story: the pace of price increases has stabilized, and broader inflation metrics—such as the CPI and PPI—suggest a softening trend. For investors, this creates a critical inflection point for sector rotation strategies, as the Federal Reserve's policy trajectory inches closer to a potential pivot.

Inflation Moderation: A Two-Track Reality

The ISM data paints a sector-specific picture. While 12 of 18 manufacturing industries reported higher raw material prices in November, the net index of (derived from 27.2% of respondents citing price hikes vs. 10.2% citing declines) reflects a narrowing spread compared to earlier in the year. This contrasts with the broader CPI, which fell to annualized in December 2025, , and core PCE projections of for 2026. The disconnect highlights a key insight: input inflation remains elevated, but consumer price pressures are easing, creating a window for sector-specific opportunities.

Fed Policy: Caution Over Certainty

The Federal Reserve's December 2025 Summary of Economic Projections (SEP) signals a measured approach. While the median FOMC participant expects core PCE inflation to reach in 2026—a 0.1% improvement from September—the policy rate is projected to remain at through 2026. This suggests the Fed is prioritizing inflation control over aggressive rate cuts, even as growth forecasts are revised upward (2026 GDP now at ). The narrowing range of individual participant forecasts (3.4%–3.9% for 2025) indicates growing consensus, but the wide 2026 range (2.1%–3.9%) underscores lingering uncertainty.

Sector Rotation: Navigating the Inflation-Interest Rate Tightrope

The interplay between input costs and Fed policy creates a clear framework for sector rotation:
1. Defensive Sectors (Energy, Materials):
- Steel and aluminum producers (e.g., Nucor, Alcoa) have benefited from tariffs and elevated prices, but further gains are capped as the ISM index plateaus.
- Energy firms (e.g., ExxonMobil, Chevron) remain resilient due to sticky fuel prices, but a Fed pivot could pressure long-duration assets.

1. Growth Sectors (Technology, Consumer Discretionary):
2. Semiconductors and AI infrastructure (e.g., NVIDIA, AMD) are poised to outperform as inflation moderation reduces input costs and Fed easing lowers discount rates.

3. Auto manufacturers (e.g., Tesla, Ford) face mixed signals: while steel prices remain high, a shift in consumer demand toward EVs and AI-driven efficiency could offset cost pressures.
   

4. Cyclical Sectors (Industrial, Transportation):

5. Machinery and transportation equipment (e.g., Caterpillar, Deere) have seen consistent price increases but may face margin compression if input costs stabilize without a corresponding rise in demand.
6. Logistics firms (e.g., FedEx, UPS) could benefit from a Fed pivot, as lower interest rates reduce borrowing costs and boost consumer spending.

Investment Strategy: Positioning for the Fed's Next Move

The key takeaway is timing. While the Fed is unlikely to cut rates aggressively in 2026, the risk-reward balance is shifting:
- Short-term (Q1 2026): Overweight sectors insulated from input costs (e.g., software, healthcare) and underweight long-duration assets (e.g., utilities, real estate).
- Mid-term (H2 2026): If CPI falls below 2.5% and the Fed signals cuts, rotate into rate-sensitive sectors (e.g., financials, housing).

Conclusion: A Calculated Pivot Awaits

The U.S. manufacturing sector remains a bellwether for inflation, but the broader economy is showing signs of moderation. Investors should adopt a : hedge against persistent input inflation in industrial sectors while positioning for a Fed pivot in growth areas. As the December 2025 CPI data confirms a slowdown and the Fed's SEP hints at a cautious pivot, the next six months will be pivotal for sector rotation. Those who act now—leveraging the ISM index as a leading indicator—will be best positioned to capitalize on the shifting landscape.