July 2025 U.S. Core PPI and the Roadmap for Sector Rotation: Navigating Disinflation in Equities and Fixed Income

The July 2025 U.S. Core Producer Price Index (PPI) report delivered a critical signal for investors: disinflation is gaining momentum. With annual growth at 2.6%—below the 2.7% forecast and the lowest since July 2024—the data underscores a broad deceleration in inflationary pressures at the wholesale level. This shift has profound implications for sector rotation strategies, particularly in equities and fixed income markets, as investors recalibrate portfolios to align with a changing macroeconomic landscape.

Disinflation Unfolds: A Tale of Two Sectors

The core PPI's flat monthly performance (0.1% decline in June) and annual slowdown highlight divergent sector dynamics. Trade and distribution sectors, including infrastructure and aerospace, are thriving. Companies like 3M and Honeywell are leveraging stable demand and lower input costs to expand margins. Conversely, chemical producers such as Dow and DuPont face margin compression due to oversupply and falling raw material prices. This duality reflects a broader theme: sectors with pricing power and diversified supply chains outperform in disinflationary environments, while those reliant on narrow cost structures struggle.

Equity Sector Rotation: Favoring Resilience, Hedging Weakness

Historical patterns from 2020 to 2025 reveal a clear playbook for sector rotation during disinflationary PPI periods. Aerospace & Defense and Technology have historically outperformed, with the former gaining +4.2% on average over 41 days following disinflationary surprises. This is driven by reduced cost pressures and stable demand for capital-intensive goods. Meanwhile, Building Materials and Utilities have underperformed, with the former declining -2.5% in similar periods due to weaker construction activity.

Investors should consider overweighting industrial conglomerates (e.g., Caterpillar, Honeywell) and tech enablers (e.g., semiconductor firms) while reducing exposure to materials-heavy sectors. For hedging, short positions in chemical ETFs (XLB) or sector-specific derivatives can mitigate near-term risks.

Fixed Income: Extending Durations in a Low-Rate World

The Federal Reserve's pause on rate hikes—now the second-longest in modern history—has created a tailwind for long-duration fixed income assets. Disinflationary PPI data historically correlates with increased demand for Mortgage-Backed Securities (MBS) and utility bonds, which offer stable yields in a low-inflation environment. For example, MBS with yields around 4.5% (vs. 3.2% for 10-year Treasuries) have become increasingly attractive, though investors must guard against prepayment risks.

A laddered MBS portfolio—mixing short- and long-dated securities—can balance yield capture with risk mitigation. Similarly, utility bonds, which typically underperform in high-inflation periods, now present value opportunities as the Fed's rate-hike pause reduces pressure on high-yield defensive sectors.

Policy Outlook and Strategic Rebalancing

The July PPI data strengthens the case for a Fed rate cut by year-end, potentially accelerating from the current September forecast. This would boost equities and Treasuries while pressuring cash-heavy portfolios. Investors should prepare by:
1. Extending fixed-income durations to capitalize on bond market rallies.
2. Positioning in rate-sensitive sectors like real estate and utilities.
3. Monitoring August CPI for confirmation of a sustained disinflationary trend.

Conclusion: A Disinflationary Inflection Point

The July 2025 core PPI report marks a pivotal shift in inflation dynamics, favoring sectors with macroeconomic resilience and hedging against vulnerabilities. By aligning portfolios with historical disinflationary patterns—favoring aerospace, technology, and long-duration fixed income while hedging materials sectors—investors can navigate the transition to a lower-inflation world. As the Fed inches closer to easing, strategic rebalancing will be key to capturing returns in a market poised for transformation.