U.S. Long-Term Inflation Expectations Cool to 3.9% as Growth Sectors Face Pressure

The U.S. inflation landscape in August 2025 presents a nuanced picture. While long-term inflation expectations, as measured by the University of Michigan Surveys of Consumers, rose to 3.9% from 3.4% in July, this figure marks a cooling trend compared to the peaks seen earlier in the year. This shift reflects a delicate balance between persistent near-term inflationary pressures and a gradual reanchoring of long-term expectations. For investors, the implications are clear: sector rotation and defensive positioning strategies must adapt to a market where growth sectors face headwinds, while inflation-linked assets and yield-sensitive allocations gain traction.

The Cooling of Long-Term Inflation Expectations

The 3.9% reading in August 2025, though higher than July, signals a moderation in long-term inflation expectations after a three-month decline. This cooling aligns with the Federal Reserve's broader narrative of stabilizing inflation, as outlined in its June 2025 Monetary Policy Report. While the University of Michigan survey remains volatile—rising from 3.4% in July—other indicators, such as the New York Fed's Survey of Consumer Expectations, show five-year-ahead inflation expectations at 2.9%, closer to the Fed's 2% target. This divergence underscores the importance of distinguishing between short-term volatility and long-term trends.

The rise in August expectations, however, cannot be ignored. Consumers are increasingly factoring in the impact of aggressive tariff hikes and global supply chain disruptions, which have introduced uncertainty about future price stability. This dynamic creates a dual challenge for investors: managing exposure to near-term inflationary shocks while capitalizing on the Fed's long-term credibility in maintaining price stability.

Sector Rotation: From AI-Driven Growth to Defensive Reallocation

The interplay between inflation expectations and yield dynamics has reshaped sector rotation in 2025. J.P. Morgan Research highlights a pronounced shift toward AI and technology-driven sectors, which have dominated equity performance. The AI data center basket, for instance, has historically led the S&P 500, with peaks occurring earlier than the broader index. This trend is expected to continue, as AI remains the primary engine for equity growth in the second half of 2025.

However, traditional growth sectors like consumer discretionary and industrials are losing momentum. These industries, once key drivers of the S&P 500, now face pressure from tariff-related costs and a sentiment shock that has dampened business confidence. The front-loading of activity in goods-producing industries is fading, creating a drag on growth. For example, shows that AI and infrastructure accounted for 79% of returns, while energy and materials lagged.

Investors are also recalibrating their fixed-income strategies. The bond market's shift toward stagflationary expectations—characterized by weaker growth and higher inflation—has led to a flattening yield curve and a preference for short-duration assets. Long-term U.S. interest rates have risen, driven by eroding U.S. exceptionalism and declining foreign demand for Treasuries. illustrates this trend, with the spread narrowing to reflect heightened inflation risks.

Defensive Positioning: Balancing Growth and Stability

Defensive positioning in Q2 2025 has evolved from a purely risk-off stance to a more nuanced approach. The passage of the $1.2 trillion infrastructure and AI stimulus package reinvigorated investor confidence in long-term growth, but concerns about inflation and trade policy have kept defensive allocations in focus. Sectors like utilities and consumer staples, which offer stable yields and inflation-linked cash flows, have gained traction. For instance, Dominion Energy and Procter & Gamble have been highlighted for their resilience in an inflationary environment.

Private equity has also emerged as a defensive asset class. The “Big Four” firms—Blackstone, Apollo, KKR, and Carlyle—have seen a resurgence in investor sentiment, with Apollo's 21% asset under management growth and Carlyle's 26.4% stock return in Q2 2025 underscoring their appeal. The anticipated opening of 401(k) accounts to private equity investments is expected to redirect trillions in retirement savings toward long-duration, high-yield assets.

Emerging markets and Canadian equities have also become focal points for defensive capital. The weakening U.S. dollar has boosted local currency returns in emerging markets, with India and Brazil showing mixed inflation trends. Canadian financials, such as Brookfield Corp and Bank of Montreal, have attracted inflows due to their exposure to stable sectors and favorable macroeconomic conditions.

Investment Advice: Navigating the New Normal

For investors, the key takeaway is to adopt a diversified strategy that balances structural growth with inflation hedges. Overweighting AI and infrastructure sectors remains critical, as these industries are insulated from short-term economic volatility. However, hedging with utilities, consumer staples, and high-quality fixed-income assets is essential to mitigate risks from persistent inflation and trade policy uncertainty.

In commodities, gold and copper warrant close attention. Gold, driven by central bank demand and ETF inflows, is projected to reach $3,700 by year-end. Copper, sensitive to trade policy and potential 232 tariff actions, could see volatility but offers exposure to industrial demand.

Finally, monitoring Federal Reserve signals is paramount. While a September rate cut is anticipated, any surprise inflation spike could trigger a selloff. Investors should remain agile, adjusting allocations based on evolving macroeconomic data and policy developments.

In conclusion, the cooling of U.S. long-term inflation expectations to 3.9% in August 2025 signals a stabilization in the inflation narrative but does not eliminate the need for defensive positioning. A strategic approach that combines growth-oriented AI and infrastructure investments with inflation-linked yields and diversified fixed-income allocations will be key to navigating the dynamic market environment of 2025.