The economy could slow, speed up and then slow down again over the next 18 months
Looking through tariff distortions, economic momentum appears to be fading and the U.S. economy could slow significantly in the coming quarters. The passage of the reconciliation bill should inject stimulus into the economy, boosting activity in early 2026. However, as the effects of fiscal stimulus fade and higher tariffs and lower immigration persist, growth could slow again in the second half of 2026.
Despite slower job growth, restrictive immigration policies should keep the unemployment rate low
A slower-growing U.S. economy will mean slower job growth, with average monthly payroll gains likely to fall below 100,000 for the rest of 2025. However, with the administration successfully reducing illegal immigration and ramping up deportation efforts, weaker labor force growth could limit any meaningful increase in the unemployment rate.
Tariff impacts, while not apparent in recent inflation data, are coming
Elevated inflation could allow the Fed to cut rates just once in 2025
Elevated policy uncertainty left the Federal Reserve on pause during the first half of 2025. With tariff impacts yet to take hold and the outlook for fiscal policy still unknown, it will likely remain on pause until it gains more clarity. If inflation climbs higher and the unemployment rate rises only modestly, the Fed could deliver just one rate cut this year.
Mega-cap U.S. equities still look expensive relative to the rest of the market
AI enthusiasm has helped propel U.S. equity markets higher, but has had an outsized impact on U.S. mega-cap tech companies. However, these companies’ market performance has outpaced their earnings growth, leaving their valuations elevated relative to the rest of the market. Long-term investors should consider increasing allocations to other parts of the market in case any headwinds arise that could turn the mega-cap U.S. equity boom into a bust.
Higher starting yields point to solid returns from core bonds
Despite signs that the economy is slowing, higher inflation, a patient Fed and the rising likelihood of fiscal stimulus could put a floor under long-term interest rates in 2025. For investors, there is not a strong argument for making a bet on either duration or credit. However, higher starting yields today suggest that high quality bonds could deliver solid returns in the years ahead.
Slower economic growth and portfolio rebalancing should weigh on the dollar
The U.S. dollar has fallen sharply since the beginning of the year, hindered by a high starting valuation, mounting concerns about global investor concentration in U.S. assets and U.S. government policy. With other global central banks more willing to cut interest rates than the Federal Reserve, further dollar weakness could be limited in the short run. However, in the long run, slower economic growth and a still high trade deficit should lead to a dollar decline.
Despite the recent rally, international equities still trade at a discount to their U.S. counterparts
International stocks outperformed their U.S. counterparts by a wide margin during 1H25, with local currency outperformance boosted by dollar weakness. Even after this rally, international stocks continue to trade at a discount vs. the U.S. With the dollar expected to weaken further and most U.S. investors likely still overweight domestic equities, international markets should continue to see strong performance as investors recalibrate portfolios to a more appropriate long-term asset allocation.
Portfolio drift may have left many investors overweight the most expensive assets
The last five years, while filled with plenty of headwinds, have, on balance, boasted
strong investment gains. However, these gains have been uneven, and investors
without a disciplined rebalancing strategy have likely seen their portfolios grow riskier. With the outlook still uncertainty, investors should consider rebalancing portfolio and ensure that they are properly diversified to weather any storms that may arise.
