Fitting the Puzzle Pieces Together

A pivotal week for economic data, earnings, trade and tariffs has provided support for our constructive medium-term view on the fundamentals of risk markets, although the second half of 2025 will pose challenges with some anticipated softening in the economy and lingering uncertainties around inflation, policy and geopolitical risk.

In our recent Asset Allocation Committee Outlooks, we projected that risk markets would begin to stabilize and modestly strengthen after a period of tumult and uncertainty from the U.S. administration’s trade and tariff policy. At the core of our thesis was the expectation that policymaking would somewhat normalize, and markets and economies would absorb and adjust to the trade and tariff effects, supported by strong economic fundamentals coming into Liberation Day in early April. These views had us leaning into risk assets at the start of the year, including an overweight to global equities in April as markets plunged and volatility spiked.

Four months later, some key pieces to the puzzle are coming together, both supporting our constructive view and highlighting continued risks to the U.S. economy. The non-farm payrolls on Friday, for instance, were materially lower than expected, suggesting some weakness in the labor market.

Looking forward, more surprises may come, but we believe most of the noteworthy headlines on issues such as trade and tariffs are now behind us. With U.S. large-cap equities sitting near all-time highs—buoyed by a generally solid round of second-quarter earnings—we look ahead to the remainder of the year. Focus will increasingly shift toward how the tariffs are being absorbed by companies and consumers and how that translates into hard data in terms of inflation, earnings and employment.

We expect the U.S. economy will grow at a similar rate in the second half of the year as it did in the first half, a pace significantly slower than the above-trend growth of prior years. However, we believe this more muted growth is not likely to approach recessionary levels, and the economy and risk markets will continue to demonstrate resilience through these macro policy risks.

Indeed, our view is that the longer-term outlook will be supported by solid liquidity, a healthy capital cycle driven by AI and other innovative investments, and a supportive fiscal and monetary policy backdrop around the world once the tariff noise is digested. Many of the hard data releases so far appear to support this thesis.

A Clearer Picture Begins to Emerge

A swathe of important data and events hit last week, including key trade agreements on the eve of the August 1 tariff deadline, corporate earnings results, and several key data points around employment, GDP growth and inflation—not to mention numerous central bank policy rate meetings, led by the Federal Reserve.

Overall, we would make three main observations.

First, we turn to the main cause of much of the uncertainty: trade and tariff negotiations. As we go to press on the August 1 deadline, the U.S. has already agreed deals with some of its largest trading partners, including the European Union, Japan, South Korea, the U.K., and Vietnam. While more trading partners remain to strike deals with, having agreements with some of the largest partners is important, moving us closer to a more definitive global trade environment. Average tariff rates on U.S. imports are now materially higher than they have been for decades, but they are more favorable than the punitive rates threatened on Liberation Day. How companies and consumers absorb these new higher tariffs will be watched closely in the coming months.

Second, economic growth fundamentals, despite the high policy uncertainty from the spring, remain in decent shape. According to U.S. Bureau of Economic Analysis (BEA) figures, annualized economic growth in the U.S. bounced back to 3% in the second quarter from a 0.5% contraction in the first three months, boosted by a modest pick-up in consumer spending and, more powerfully, a marked drop in imports.

Such growth is promising, but we think some caution is warranted. Overall underlying growth is slowing—the U.S. economy grew at a 1.1% annualized rate in the first half of 2025, down from about 2.9% in the second half of 2024—and is expected to further decelerate during the final two quarters.

Third, the labor market generally looks stable although there are some signs of weakness. On Friday, for instance, the Bureau of Labor Statistics reported that the U.S. added only 73,000 jobs in July—far lower than the 104,000 expected—and with substantial downward revisions to prior months. However, this contrasted with stronger figures earlier in the week when investors were heartened by stability in job openings (down slightly to 7.44 million from 7.71 million in May) and unemployment claims.

Corporate earnings are also showing further resilience as the majority of companies, led by three of the Magnificent 7, last week reported growth above expectations. Overall, these elements broadly signal the U.S. economy’s continued robustness, although pockets of weakness may be emerging.

This will be closely watched by the Federal Reserve, which, as expected, held rates steady last week. Further rate cuts are still expected to happen later this year, potentially hastened by labor market concerns. However, the Fed remains cautious on inflation. Pre-tariffs, inflation had generally been falling back toward the 2% target. In the coming months, the tariff impact is expected to increase inflation. The BEA’s Core Personal Consumption Expenditures price index seems to reflect this risk—marginally rising 0.3% from May and recording a rate of 2.8% on an annualized basis.

Uncertainties and Risks Remain

Although we believe there are good reasons to be constructive in our outlook on economic fundamentals and risk markets over the medium term, prudence is warranted in the coming weeks and months.

Indeed, U.S. markets remain expensive relative to global peers, so we continue to emphasize the importance of diversification—particularly toward high-quality companies in Europe, Japan and select emerging markets where valuations are more attractive.

History tells us that August and September can bring volatility, and a “hot” inflation report—especially if driven by tariff effects—could introduce meaningful turbulence as markets wrestle with what this would mean for the direction of policy rates. On the other side, and under its dual mandate, the Fed will also be closely watching for signs of any material deterioration in the labor market.

Similarly, we expect shifting fiscal policy in the U.S. and other developed economies, possible flare-ups in trade negotiations, and certain geopolitical risk events to persist as key risks, periodically provoking bouts of market volatility. Yet, beyond the short-term effects of these disruptions, we are optimistic in our medium-term outlook for the U.S. economy, global growth and risk assets.