U.S. Private-Sector Growth Slowdown Amid Tariffs and Policy Uncertainty: Strategic Sector Rotation and Inflation Hedging

The U.S. economy is navigating a treacherous path as tariffs, trade policy shifts, and policy uncertainty conspire to compress corporate margins and slow GDP growth. With the Manufacturing PMI contracting for the third consecutive month in May 2025 and the Services PMI dipping into negative territory for the first time since mid-2024, the private sector faces mounting headwinds. Investors must pivot toward sectors insulated from global trade shocks and positioned to thrive in an inflationary environment. Here's how to navigate the turbulence.

The Tariff Drag on Growth and Margins

The Institute for Supply Management's May Manufacturing PMI of 48.5 reflects a sector struggling with rising input costs, delayed supplier deliveries, and weaker demand. Tariffs on imported goods—particularly those targeting China, Canada, and Mexico—have driven input cost inflation to a 31-month high, squeezing profit margins. The Services sector's May PMI decline to 49.9 underscores the spillover into broader economic activity, with businesses citing tariff-related cost pressures and consumer caution as key drags.

S&P Global's Q2 2025 forecasts underscore the fragility: GDP growth is expected to slow to 1.9% for the year, with risks skewed toward further deceleration. The Federal Reserve's wait-and-see stance on interest rates—holding the federal funds rate near 4.5%—adds to the uncertainty, as businesses grapple with elevated borrowing costs and shifting trade policies.

Inflationary Pressures and Policy Whiplash

While the Fed aims to curb inflation, tariffs are pushing prices higher. The ISM Services Prices Index hit 68.7 in May—the highest since late 2022—driven by cost pass-through to consumers. S&P projects core PCE inflation to peak at 2.9% in Q3 before moderating, but the path remains fraught with risks. Policy uncertainty has spiked to near-record levels, with daily reversals in trade measures eroding business confidence.

Strategic Sector Rotation: Where to Deploy Capital

To navigate this environment, investors should focus on sectors shielded from trade disruptions and positioned to benefit from domestic demand or inflation protection:

1. Consumer Staples: A Safe Harbor

Domestic consumer staples—food, beverages, and household goods—are insulated from import tariffs and benefit from stable demand. Companies with strong pricing power, such as Procter & Gamble (PG) or Coca-Cola (KO), can pass rising input costs to consumers while retaining market share. S&P notes that consumer spending on staples remains resilient, even as discretionary spending cools.

2. Energy: Geopolitical Tensions and Inflation Resistance

Energy stocks, including oil majors like ExxonMobil (XOM) and Chevron (CVX), offer inflation hedging and geopolitical tailwinds. Supply constraints and Middle East tensions support prices, while energy companies benefit from dollar depreciation—a byproduct of Fed rate cuts. S&P's Q2 report highlights energy as a sector poised for modest outperformance.

3. Financials: Rate Cuts and Structural Resilience

Financials, particularly banks like JPMorgan Chase (JPM) and Bank of America (BAC), could benefit from a gradual Fed pivot toward rate cuts. While loan demand may soften, strong capital positions and fee-based income streams provide stability. S&P's analysis notes that financials' price-to-book ratios remain below historical averages, offering value.

Short the Trade-Exposed: Autos, Tech, and Materials

Conversely, sectors exposed to global trade flows face heightened risks:

• Automotive: U.S. automakers reliant on imported parts, such as Tesla (TSLA) or Ford (F), face margin pressure from tariffs and retaliatory measures.
• Technology Hardware: Sectors tied to global supply chains, like semiconductor firms (e.g., Intel INTC), are vulnerable to trade disputes and inventory overhangs.
• Materials: Steel and aluminum producers (e.g., Nucor NUE) face headwinds from both tariffs and weak industrial demand.

Inflation Hedging Beyond Equities

Alongside sector rotation, investors should allocate to inflation-linked assets:

• TIPS (Treasury Inflation-Protected Securities): Provide principal adjustments for inflation, mitigating real returns erosion.
• Gold: A classic hedge against policy uncertainty and dollar weakness, with ETFs like GLD offering accessible exposure.
• Real Estate Investment Trusts (REITs): Property sectors with inflation-indexed leases, such as industrial or apartment REITs (e.g., PSB or EQR), offer defensive income streams.

Conclusion: Prioritize Resilience and Inflation Protection

The U.S. private-sector slowdown is real, driven by tariffs and policy uncertainty. Investors must avoid trade-exposed sectors and pivot to domestic staples, energy, and financials. Inflation hedging is critical, given the near-term upside in price pressures. With S&P's GDP growth forecast at 1.9% and recession risks rising, the mantra is clear: protect capital in defensive sectors and short the vulnerable.

The path forward demands vigilance—monitoring tariff developments, Fed policy, and PMI trends will be key to adjusting allocations. In this environment, strategic sector rotation and inflation hedging are not just advantages but necessities.