Steering Through Shifting Storms
While the year began with ever-shifting winds of change from the second Trump administration, these have settled into a more modest headwind as 2025 nears its close. The initial tariff tsunami has subsided with the administration pulling back on some of the more extreme measures with negotiated bilateral agreements. Uncertainty surrounding fiscal policy has also moderated with the passage of the One Big Beautiful Bill Act (OBBBA) and follow-up rescission package, although concerns about long-term US fiscal sustainability remain. Although the policy uncertainty index has receded, it remains historically elevated. While the administration has successfully negotiated bilateral agreements, progress has been bumpy, hitting some notable snags. In addition, many of the tariffs are on shaky legal ground. The US Supreme Court is scheduled to fast-track a review of these tariffs in early November.
While there was little evidence that elevated uncertainty introduced by tariffs was impacting the wider economy last quarter, cracks are now beginning to emerge. The July US labour report disappointed, with significant downward revisions to the May and June data. Moreover, the Bureau of Labor Statistics (BLS) announced in a preliminary benchmark revision in early September an overestimation of employment growth by nearly one million jobs from March 2024 to March 2025, suggesting a weaker labour market than previously understood.
Although recession sentiment has improved, investors and consumers remain concerned about the threat of higher inflation, particularly in the short term due to tariff risks. Core CPI remained elevated in August, rising 3.1% year-over-year, with moderating shelter costs offset by upward pressure on core goods inflation. With increased downside risks to the labour market and elevated inflation, the US Federal Reserve (Fed) faced a difficult decision at its mid-September meeting. Ultimately, concerns over labour market risks won out, and the Fed cut its target policy rate range by 25bps to 4.00%-4.25%. Following its mid-September meeting, the Fed’s Summary of Economic Projections (SEP) indicates two more rate cuts this year, followed by one in 2026 to reach a target range of 3.25%-3.50%.Even so, the anticipated faster pace of cuts may not be sufficient to quiet the aggressive cut drumbeat from the Trump administration.
Political turmoil has not been isolated to the US: The French Prime Minister lost a vote of confidence and was ousted due to a poorly received budget plan; the Deputy Prime Minister in the UK resigned over a tax scandal, prompting a cabinet reshuffle; and the Japanese Prime Minister resigned following defeat in the July upper house election.
Domestic and external policy turmoil has contributed to volatility in European economic data. Eurozone GDP saw solid growth in Q1, supported by robust business investment and exports in advance of implementation of US tariffs. However, a pullback in Q2 brought first-half GDP growth to approximately 1.4% annualised, consistent with the Eurozone’s modest pre-COVID growth trajectory. Unlike the US, the Eurozone is closer to its inflation target, providing the European Central Bank with greater flexibility to resume cutting rates in the months ahead. The Japanese economy has been relatively resilient compared to Europe. Second-quarter GDP growth was revised upward, marking an increase of more than 2% for four of the past five quarters. However, the economy faces mounting challenges as tariffs are expected to have a greater impact on the economy going forward, and rising inflation continues to squeeze households. Although China has largely been spared the domestic political challenges seen in Europe and Japan, it remains a primary focus of the Trump administration’s tariff policy. The US and Chinese governments have agreed to a temporary trade truce, extended by 90 days in mid-August.
CALMER WATERS AHEAD?
Financial markets were in risk-on mode during Q3, recovering from the turbulence of Q2 triggered by the announcement of reciprocal US tariffs. US Treasury yields benefited from growing expectations of rate cuts throughout the quarter. Earlier in the quarter, yields faced upward pressure from concerns about deficits following passage of the OBBBA and President Trump’s heightened criticism of Fed Chair Powell. Later, rising expectations for rate cuts combined with inflation data showing minimal signs of tariff pass-through and a more dovish tone from the Fed Chair drove yields lower. Stocks surged from their April lows, gaining over 5% quarter-to-date (as of September 10) and setting fresh all-time highs in late summer, with US small-cap stocks besting large caps on rate-cut optimism. International equities also delivered solid gains. Commodities saw ongoing interest as an inflation hedge, with gold hitting record highs above $3,600/oz. The US administration’s fiscal policy efforts to encourage economic growth and specifically, investment spending, have been key drivers of asset class performance.
Tariffs continued to take centre stage for markets during the quarter, with President Trump extending the initial 90-day deadline from July 9 until August 1. However, a flurry of agreements with key trade partners helped ease trade policy uncertainty. Overall, the current backdrop remains supportive of risk assets. While global growth expectations have been revised lower since the start of the year, improved clarity on tariffs and reduced trade uncertainty are likely to put a floor on deterioration in growth expectations.
Corporate earnings have continued to surprise on the upside, defying fears of tariff-related impacts. Second-quarter earnings growth for the S&P 500 surged to around 13% year over year, more than double the earlier tariff-adjusted forecasts, bolstered by solid 6% revenue growth. US earnings exceptionalism persists relative to other developed markets, where growth is expected to range between 6-8%. Meanwhile, earnings in Emerging Markets have been revised lower over the past year, particularly in Asia, reflecting a more challenging outlook.
In fixed income markets, global government bond yields, particularly on the long end, have remained under pressure, driven by policy uncertainty surrounding tariffs and fiscal spending concerns. Outside the US, government yields are also under pressure. Even in Japan, where the BoJ is expected to continue its rate hike path, yield curves are steepening as longer-term Japanese Government Bonds (JGB) face declining demand amid prospects of rising interest payments and widening deficits.
Amid trade war concerns, commodity supply is increasingly concentrated in geopolitically sensitive regions such as the Middle East, Russia, China, and the US, raising the risk of supply disruptions. Despite OPEC+ efforts to normalise supply, declining spare capacity heightens the risk of oil shocks. Structural trends such as rising defence spending and moves toward dollar diversification support sustained demand for commodities. Putting it all together, despite recent signs of a slowing US labour market, we remain in a risk-on macro environment, even as persistent policy uncertainty heightens the potential for tail risks.
Source for all data points: PGIM, September 2025.
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