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 third quarter of 2025.
• U.S. equities have rebounded from initial tariff-related volatility driven by rising earnings, with geopolitical risks and potential tariff reductions influencing market outlook.
• Inflation expectations remain high, with consumers anticipating short-term pressures and labor market dynamics potentially influencing longer-term trends; Core PCE inflation is forecasted between 3.0% and 4.0% for 2025.
• The Federal Reserve is divided on policy rates, balancing moderating growth conditions with tariff-induced inflation risks, with some members favoring rate cuts and others advocating a wait-and-see approach.
• The Trump Administration's fiscal policies have overshadowed tariffs, increasing U.S. national debt by $3.3 trillion over the next decade, leading to elevated long-bond yields.
• Fiscal policy is the primary driver of 10-year Treasury rates, projected to remain between 4.00% and 4.50% by year-end 2025, supported by persistent inflation and rising debt levels.
• Equity Market Outlook: Our updated S&P 500 forecast for 2025 ranges from -5% to +10%, reflecting high uncertainty amid geopolitical and economic factors.
• Economic Forecast Adjustments: Due to rapidly shifting economic influences, we have increased our forecasted ranges for inflation, Fed funds, and equity returns for the second half of 2025.
Market practitioners learned a lot during the second quarter of 2025 as the global trading platform was upended by the Trump Administration, but narrowing it down to more simplistic outcomes, we now know tariffs will not be as big and the fiscal spending bill will be even bigger. The result of all the trade turmoil was a roundtrip ticket for stock investors into bear-market territory and back in a matter of weeks. While equity investors were able to shake off the introduction of tariffs in the new world trade order, bond investors have become more and more wary about the levels of debt the U.S. has racked up. Not to mention, the ”Big Beautiful Bill” will be adding another $3.3 trillion to the national debt over the next decade. The result of all the fiscal finagling caused the U.S. long-bond to surpass the 5% yield level for the first time since 2023, when inflation was out of control. The backup in yields has been met with some resistance as economists have lowered their prospects for U.S. growth and foreign buyers have slowed their purchases of U.S. debt.
However, it’s only a matter of time before the U.S. has to increase the size of coupon issuance, and with fiscal spending on the rise globally, there is some concern that we could be in the early innings of elevated yield levels for government debt.
From the perspective of the Federal Reserve, they are currently stuck between a rock and a hard place as the desire to cut interest rates on moderating growth conditions is being offset by the risks of tariff-induced inflation. Despite May inflation data being rather benign, we think it’s too early for visible pass-through inflation from tariffs to show up. In fact, we are inclined to believe that a meaningful pickup of consumer prices is likely to occur in the coming months as inventory runs thin and suppliers are forced to restock at levels that accommodate newly implemented tariffs. Right now, the Fed committee remains divided on policy rates, with some favoring rate cuts as soon as July, while others have subscribed to a wait-and-see policy that would leave rates mostly unchanged through the end of the year. Either way, the path of inflation will continue to dictate the direction of policy rates as Chairman Powell will remain in his seat until the end of his term in May 2026, despite President Trump’s wishes, and rate policy decisions remain on a data-dependent course of action.
Overall, with handshake trade deals among global trading partners continuing to take place, a tax and spending bill on track for passage, and the world averting an escalation of geopolitical conflict, we appear to have avoided a recession, reached a new all-time high in equity prices, and positioned the U.S. economy into a much better spot than it was in immediately following “Liberation Day.” We continue to maintain concerns around the path of inflation and believe the interest rate environment will likely remain elevated.
Following “Liberation Day” tariffs, markets continue to wait for negative soft data readings (e.g., negative consumer/business sentiment surveys, higher inflation expectations, etc.), to start showing up in hard data readings (e.g., inflation, jobless claims, unemployment, corporate earnings, etc.). The disconnect has been driven by importers’ actions thus far to delay the full impact of 13.5% average effective tariff rates: stockpiling inventory in late Q4 ’24 and early Q1 ’25, changing supply chains, forcing exporters to bear some of the cost increases, and realizing lower product margins. The final lever for importers – to raise prices for customers/consumers – is now being pulled. This should result in hard data beginning to deteriorate. Q1 GDP was negative (-0.2%) due to abnormally high net imports in the quarter (+43%) that were driven by inventory stockpiling. Net imports should normalize in Q2, which should result in a positive GDP print for the quarter. For the back half of the year, GDP is expected to slow, giving rise to our full-year GDP forecast of -0.5% to +1.5%. The ultimate scope and magnitude of tariffs coupled with fiscal spending and tax cuts will drive the realization of the upper or lower bound of our estimate.
Navigating a precarious macroeconomic landscape, the Federal Reserve continues to exercise patience amid potential inflationary pressures from tariffs. A notable shift in the Fed's messaging since the March FOMC meeting suggests a recalibration of rate cut expectations, previously anticipated by year-end. Fed President Hammack's remarks illuminate this prudent approach: “For the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.” With inflation expected to surpass target levels in the second half of 2025, the bar for rate cuts has been elevated. Rising inflation expectations hint at a more enduring inflationary environment, potentially reducing the necessity for rate cuts this year. The Fed faces a difficult task of balancing its dual-mandate objectives, with the labor market conditions needing to deteriorate further before the Fed can overlook inflation impacts. Consequently, our target Fed policy rate has been adjusted to between 3.75% and 4.25%, implying approximately 1-3 cuts by the end of 2025.
The inflation narrative in the U.S. remains a contentious debate between transitory and entrenched forces. Despite the elevated inflation expectations reflected in survey-based measures, such as PMI and ISM input costs, the hard data has yet to substantiate these anticipations. Core CPI and Core PCE have delivered subdued monthly inflation prints for March and April, suggesting a benign inflation environment.
However, consumers are increasingly anticipating short-term inflationary pressures. A tariff-induced inflationary spike is projected to impart a one-time elevation of approximately 2% to core PCE inflation. Looking further ahead, the labor market dynamics could potentially play some role in shaping inflationary trends. Elevated job openings, coupled with low jobless claims and a declining labor supply due to restrictive immigration policies, could intensify wage pressures, thus influencing longer-term inflation. With these factors in play, we maintain our forecast for Core PCE inflation to hover within the 3.0% to 4.0% range for 2025, underscoring the complexity of the inflation trajectory amid evolving economic indicators.
Against the current macro backdrop, fiscal policy has emerged as the primary influence on the trajectory of 10-year rates, relegating monetary policy to a back-seat role. This is due to the Federal Reserve strategically positioning itself on the sidelines, while awaiting clarity on the inflationary impacts of tariffs. With recession fears abating, the probability of a recession has meaningfully declined, bolstered by the Atlanta Fed’s GDP nowcast projecting a robust growth for Q2, a payback from the negative print in Q1. Term premium continues to build, which is the additional yield investors are looking to get paid further out on the interest rate curve. The focus on fiscal drivers suggests that interest rates will remain elevated for an extended period, as the search for catalysts to drive rates lower continues. The rationale for maintaining a forecast for 10-year rates above the 4% threshold remains strong, supported by persistent inflation above the Fed’s target, raising debt levels. Consequently, the 10-year rate forecast for year-end 2025 remains between 4.00% and 4.50%.
Investors have largely shrugged off the initial negative reaction to the “Liberation Day” tariff announcements, with many market participants using the volatility as buying opportunities and driving up prices on dips. Although the outlook is hazy, earnings have continued to rise and have primarily been responsible for rising equity prices, as opposed to higher multiples. Although tariffs have yet to substantially impact U.S. industries, they have the potential to slow growth and increase consumer prices, both of which should be negative for U.S. equities. However, the possibility that tariffs are reduced – through trade deals, legal challenges, or simply waning political will – could boost equities. Geopolitical risks persist in the current economic environment, as highlighted by the recent military bombing in Iran, and these uncertainties reduce clarity going forward. Given the improved sentiment, we have updated our forecast for the S&P 500® to end within a range of -5% to +10% for 2025, maintaining a wider range due to high levels of uncertainty.
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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