Representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets, and economic releases such as inflation, GDP, consumer confidence, housing, retail sales, and job unemployment news. Here is their outlook for second quarter of 2025.
Reflecting back on the many lessons I learned early in my career, I can recall one lesson that stood out and pertains to the market environment today, and that is the reality that markets are fast and can move much faster than the economy. This is exactly what we have been witnessing since we were all “liberated” in early April by the Trump Administration’s reciprocal tariff policy. Despite all the uncertainty leading up to and surrounding U.S. tariff policy, market participants appear to be certain of two things: First, tariffs inevitably lead to lower output or growth of the U.S. economy as companies delay their decisions on capital expenditure, freeze their hiring plans, or even experience supply chain constraints. Second, tariffs are widely considered inflationary and while one could argue that not all costs will be passed on to the end consumer, there is a direct incentive for companies to do so to preserve future profit margins. While it may take longer for economic data to reflect the slowing economy accompanied by higher inflation, markets reflected this with lightning speed, as the S&P 500® Index incurred its fourth largest two-day sell-off ever, with a decline of 10%. The last time the market experienced a sell off of this velocity was the market crash of 1987. The sharp decline in equity prices was a direct reflection of increased recession risks resulting from a tariff policy that appeared to be much larger than anticipated.
Fortunately for the U.S., we started from a position of strength with equity markets already rich, GDP was growing close to 3%, and inflation, while stubborn, had been on a downward trajectory. Starting from a strong position helps soften the blow as President Trump attempts to upend the world trade order, but the extreme changes in asset price levels are a sharp reminder of the risks embedded within equity investments.
Under normal circumstances, we would likely see the white knight of the Federal Reserve ride in with rate cuts to shield the U.S. economy from recession. However, the lurking risks of inflation resulting from U.S. tariff policy have turned the Fed into a spectator of, rather than a participant in, the sport of changing economic conditions. In turn, we have seen some dramatic moves in U.S. interest rate markets, with the front-end of the curve bouncing around on Fed rate cut expectations, but more concerning was the swift rise in long-term interest rates, as the global investment community appeared to be bent on selling U.S. assets or at least refraining from adding new investments at this time. As a result, the effectiveness of long-duration U.S. Treasuries as a hedge remains an outstanding question and leaves investors seeking other alternatives to mitigate risk.
So here we are in a 90-day limbo with “tariffied markets” leading the way, a strong expectation for slowing economic growth accompanied by recession risks on the horizon, and the potential for another cycle of inflation for the Fed to carefully manage through.
There is not much debate on the directional view of the U.S. economy as growth is widely expected to slow, but the timing and magnitude of the slowdown is where the picture become less certain. We expect consumption to take a hit from higher inflation as additional costs get passed along to consumers. We have already entered an environment where delayed business investment has occurred. Softer, survey-based measures of economic activity point to a significant slowdown, and it remains to be seen if hard economic data line up to the projected weakness. Most notably, we have yet to see cracks in the labor market, which would further push up the odds of recession, but we are watching a leading indicator, such as jobless claims, for any sign of weakness. With higher outright levels of tariffs expected to remain in place, we are adjusting our GDP forecast for 2025 to reflect a wider range of outcomes, and we now expect U.S. GDP for 2025 to be in a range of -0.5% to 1.5%.
If influencing markets was a sport, the Fed would clearly be a spectator at this juncture, as Chairman Powell has reiterated that the wait-and-see policy stance introduced back in December of last year remains tactically in place. Despite the rhetoric from the White House to pressure the Fed into lowering interest rates, Federal Reserve independence remains in place as the committee has been unwavering to President Trump’s demands. Knowing that this Fed historically has been very data-driven in making policy decision, we are not surprised by the extended pause in the rate cycle, as a resilient U.S. economy was the only narrative leading up to “Liberation Day.” Moreover, given the potential influence rising inflation will have on policy decisions, we think the bar still remains elevated for the Fed to pursue additional rate cuts from here. Consequently, we are leaving our Fed policy forecast unchanged with the expectation that the Fed will cut rates two to three times later this year, leaving Fed funds within a range of 3.50% to 4.00%.
When we set our view on inflation back at the beginning of the year, we knew inflation was going to be the wild card to our economic outlook, but none of us were expecting a tariff increase of this magnitude to take place. The problem with inflation is that, albeit meaningful progress was made, the Fed was never able to fully bring inflation back down to their stated 2% target. As such, the woes accompanying the recent high levels of inflation are fresh on Chairman Powell’s mind. However, we should note that core goods have been in a deflationary environment in recent years, and most of the lingering inflation has been a wage-driven, service-induced inflationary environment. So even with an elevated and lengthy tariff policy in place, we are only expecting a marginal increase in the level of inflation. For one thing, it’s not entirely clear that all tariff-related costs will be passed along to consumers, and we should remember the U.S. economy is driven nearly 70% by service activity. Thus, we are marginally increasing our inflation outlook with core PCE inflation to end the year between 2.55 and 3.5%.
“Steep and cheap” is the decided narrative for the U.S. Treasury market as conditions have deteriorated since the announcement of tariffs. With the Fed posturing on the sidelines through the tariff-induced equity sell-off, and due to the risk of higher inflation, traditional safe-haven trades in U.S. Treasuries failed to materially develop. Normally, we would see a stronger bid to duration during market sell-offs of that magnitude, but that was not the case this time around. The market continues to be influenced by elevated deficits, raising inflation expectations and lowering confidence in U.S. assets. Along with the near perfect storm surrounding the Treasury market came volatility, notably on the intra-day range on the Monday following “Liberation Day,” when the 10-year Treasury was 34 basis points, the largest since March 17, 2020. Despite slowing growth, we find several reasons – including rate cuts being on hold, higher inflation, and elevated deficits – to keep term premium elevated and the 10-year Treasury yield to remain above 4%. Overall, we expect the 10-year yield to end 2025 between 4.00% and 4.50%..
With regard to equity markets, we feel like much of the damage has been done, as markets have moved much faster than the economy. Given the uncertainty, however, we are open to a wider range of risks. Rapidly changing tariff policy has not led to a straightforward view on the business environment. Obviously, lower growth and higher inflation induces us to lower our U.S. equity forecast for the S&P 500® Index, but should the economy slow into recession, we see a chance for more downside risk. The starting point for the sell-off helps dampen the risk going forward, as the concentration risk we noted in the past surrounding the Magnificent 7 was a significant driver of the market correction. Lastly, there are potential tailwinds that the market has largely ignored, including deregulation and tax cuts, that potentially offset tariff angst. Therefore, we have updated our forecast for the S&P 500® to end within a range of -10% to +5% for 2025.
Table Columns
Previous – Observation as of the end of the prior month
Survey – Economist survey prediction for current month’s observation
Actual – Actual observation as of the end of the current month
Next – Date of next period’s observation
ISM Manufacturing Index
Based on a survey from the Institute for Supply Management, this index indicates a positive growth in the manufacturing sector when the figure is above 50 and a contraction of the sector when it is below 50. An increase in the figure indicates either slowing contraction or accelerating growth. The index represents underlying figures in employment, inventories, new orders, production levels, and deliveries. (Source: Bloomberg)
Unemployment rate
Based on a monthly survey of households, the unemployment rate is one of many figures in the Current Population Survey that move markets by indicating what portion of the population is at work, looking for work, what they are getting paid, and how many hours they work. The unemployment rate is the percentage of workers unable to find work who are actively seeking a job. The survey is conducted by the Bureau of Labor Statistics.
Retail sales
Retail sales measure the total amount of purchases by consumers in stores that sell merchandise, food, and other services to end consumers. This measure is a significant indicator of trends in consumer spending, which moves markets because consumer spending accounts for over two-thirds of U.S. economic output. Data is compiled by the U.S. Bureau of the Census.
Consumer Price Index (CPI)
The Consumer Price Index measures the prices of a fixed basket of goods that reflect an average consumer’s cost of living. CPI is a popular indicator of inflation, driving prices on U.S. inflation-linked bonds, and is used to adjust tax brackets and Social Security payments. CPI is compiled by the Bureau of Labor Statistics monthly.
Home Price Index
The S&P CoreLogic Home Price Index is the seasonally adjusted average price of residential homes in 20 major cities in the U.S. Data is published with a two-month lag (numbers available in March reflect price changes from January). Housing prices affect consumer wealth and consumers’ ability to borrow and spend, which in turn affects U.S. economic growth.
Gross Domestic Product (GDP)
Gross Domestic Product is the sum of the value of all goods and services produced in the economy. It is one of the most comprehensive benchmarks for economic performance. Real GDP measures economic productivity adjusted for inflation, which measures growth that is not due to goods getting more expensive. GDP is published by the Bureau of Economic Analysis.
University of Michigan Consumer Sentiment Index
The index is derived from surveys of 500 households by the University of Michigan on consumer finances and attitudes regarding the economy. The index is set to 100 as of 1966, reached a high of 107.3 in June of 1999 and a low of 56.4 in June of 2008. High consumer confidence levels lead to robust consumer spending, whereas low consumer confidence levels lead consumers to pull back on spending.
S&P 500® Index
The S&P 500® Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
Chicago Board Options Exchange (CBOE)
Volatility Index® (VIX® Index)
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index®, or VIX®, is a real-time market index that represents the market’s expectations of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500® index options, it provides a measure of market risk and investors’ sentiments.
The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of the date of publication. This document is provided for informational purposes by AIM LLC, a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. These views may change as interest rates, market conditions, tax rulings, and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. This report does not constitute a solicitation or an offer to buy or to sell any security, product, or service. It is not intended and should not be used to provide financial advice as it does not address or account for an individual's circumstances. Consult with your advisor and tax professional before taking any action based upon the information contained in this document. Past performance does not guarantee future results and no forecast should be considered a guarantee. Any investment and economic outlook information contained in this document has been compiled by AIM LLC from various sources, including affiliated entities. AIM LLC takes reasonable steps to provide up-to-date, accurate, and reliable information, and believes the information to be so when provided, but no representation or warranty, express or implied, is made by AIM LLC as to its accuracy, completeness, or correctness.
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