Allianz Investment Management LLC Q4 2025 Market Outlook

U.S. GDP in Q2 showed modest strength, primarily driven by a decline in imports and resilient consumer spending, which helped offset headwinds from trade and inflation. However, a slowdown is expected in the second half of the year, which could reduce full-year GDP growth by 120 basis points sequentially. While the U.S. has resolved most tariff disputes, negotiations with China remain ongoing. Meanwhile, the Court of International Trade nullified the controversial tariffs under executive emergency powers, but the Appeals Court issued a stay on that ruling, leaving the tariffs in place for now. A final decision rests with the Supreme Court, sometime in Q4 of 2025. Although the President holds additional tariff authorities, these tools require time to deploy. If the Supreme Court eventually upholds the lower court’s ruling, the best-case scenario could see the trade-weighted tariff rate fall to 6.4%. In the meantime, sectoral tariffs are expanding: autos, auto parts, copper, steel, and aluminum are already affected, with new tariffs expected on commercial aircraft, lumber, pharmaceuticals, semiconductors, and trucks. As such, our 2025 real GDP growth is forecast between 0.0% and 2.0%, marking a 50-basis point improvement from earlier estimates, but reflecting a larger range.

The Federal Reserve cut policy rates by 25 basis points at its September meeting, as weakening labor conditions have shifted the focus from inflation to employment. While the Fed’s wait-and-see approach has lingered, a single soft labor report was enough to pivot Chair Powell toward a more dovish stance. In late July, Powell maintained that inflation was “a bit above 2 percent” and the economy wasn’t showing signs of policy being overly restrictive. Yet by the Jackson Hole event, his tone had shifted, suggesting the evolving risk balance could warrant policy adjustments. This dovish turn has fueled market expectations for additional rate cuts. Still, the Fed remains divided, with July’s meeting revealing clear dissent, highlighting the difficulty of managing its dual mandate. While inflation persists, employment now dominates the policy conversation. As a result, the expected terminal rate holds near 3.0%, with our forecast for the Fed policy rate moving to 3.75%-4.25%, implying 1-3 cuts by the end of 2025

U.S. inflation remains marginally higher, with early signs pointing to further increases, though the full impact of tariff-induced inflation may not appear in hard data until 2026. Soft data suggests upward pressure is building, and markets are closely watching the upcoming core CPI releases, expecting higher monthly prints of 0.3% or more. These prints will be key for gauging how the Fed might respond to inflation risks tied to ongoing trade tensions. While earlier concerns focused on service-sector inflation, attention has now shifted toward core goods inflation, which is more sensitive to tariffs and global supply chains. A repeat of July’s inflation surprise could complicate the Fed’s ability to communicate future rate cuts. Mathematically, monthly prints over 0.4% would be needed through year-end for core PCE to exceed 4%, which appears unlikely. Still, with core PCE at 2.9% in August, a marginal rise is expected, likely pushing the index above 3.0%. Thus, our outlook for 2025 Core PCE remains in the 3.0%–4.0% range.

We remain cautiously overweight on duration, with monetary policy continuing to drive rate direction – except at the long end of the curve, where other factors dominate. With the Fed’s rate-cutting cycle underway in September, a shift was already partially priced into the market as 10-year Treasury yields have declined 50 basis points year-to-date. While growth has stabilized and inflation has risen only slightly, further weakening in labor markets could apply additional downward pressure on 10-year yields. Nonetheless, our long-term view holds: We expect 10-year yields to remain elevated due to key structural risks. These include persistent inflation above the Fed’s 2% target, growing concerns around Fed independence, and unfavorable supply/demand dynamics driven by rising fiscal deficits. However, the primary risk to this outlook has shifted toward the potential for a more pronounced economic slowdown, particularly from continued weakness in job creation. Our forecast for the 10-year Treasury yield at year-end 2025 remains in the 4.00% to 4.50% range.