Executive Summary
Economic Outlook
- The initial volatility from the second Trump administration has eased, with bilateral trade agreements reducing economic policy uncertainty. However, legal challenges to tariffs and fiscal sustainability concerns persist.
- The Supreme Court will review the legality of 2025 tariffs, potentially invalidating over 70% and reducing the effective rate from 17.4% down to 6.8%. This could significantly alter trade dynamics.
- Recent jobs data disappointed, with flat non-farm payrolls since April and a major downward revision to employment growth. The Bureau of Labor Statistics overestimated job gains by nearly one million from March 2024-2025.
- Despite hiring stagnation, layoffs remain low and real wage growth is steady. Layoffs can be a lagging indicator of recessionary conditions. Our real private wage bill growth calculation, a more coincident measure of the economy, remains roughly consistent with the post-GFC/pre-COVID trend.
- Consumer balance sheets are in good shape and delinquency rates are stable. Ongoing investment in data centers as well as fiscal stimulus from the One Big Beautiful Bill Act (OBBBA) and deregulatory reforms from the Trump administration are also supporting economic growth.
- PGIM Quant’s sentiment indicator shows reduced recession fears. The Federal Reserve’s (Fed) Q3 Survey of Professional Forecasters projects 1.6% GDP growth over the next year— slower, but not recessionary.
- Core CPI rose 3.1% year over year in August. Inflation remains a public concern, with proprietary indicators showing elevated media attention despite a decline from 2022 peaks.
- The Fed lowered rates by 25bps in September to 4.00-4.25%, prioritizing labor market risks. Further cuts are expected through 2026, though political pressure for deeper easing is mounting.
- Leadership changes in France, the UK, and Japan have contributed to bond market volatility and policy uncertainty across major economies.
- A temporary US-China trade truce is in place, but elevated tariffs are dampening Chinese retail and industrial activity, posing risks to global growth.
Market Outlook
- Financial markets shifted back to risk-on mode in Q3, with volatility easing significantly. The VIX averaged 16, down from 24 in Q2, while the MOVE index fell to 83 from 104, reflecting a calmer environment for risk assets.
- US Treasury yields were supported by rising rate cut expectations, despite deficit concerns following the passage of OBBBA. Fed Chair Powell’s dovish stance at Jackson Hole helped reinforce market confidence.
- Global bond markets faced pressure due to fiscal developments. Germany’s stimulus-heavy budget, UK welfare reversals, and Japan’s election outcomes contributed to rising yields and fiscal uncertainty across regions.
- Equities rallied strongly, with US small caps outperforming large caps. International stocks posted solid gains, and commodities— especially gold—attracted interest as inflation hedges, with gold reaching record highs above $3,600/oz.
- Trade policy uncertainty eased after President Trump delayed tariff deadlines and secured deals with key partners. OBBBA's fiscal measures are expected to push the US deficit to 7% of GDP by 2026, supporting growth but raising long-term risks.
- Corporate earnings exceeded expectations, with S&P 500 companies posting 13% year-over-year growth in Q2. Positive revisions suggest continued strength, with an improvement in the broader market earnings, while Magnificent Seven growth has started to moderate from its earlier scorching pace.
- Bond yields may decline in the short term due to rate cut prospects, but long-term rates face upward pressure from inflation and supply concerns. Credit remains appealing amid moderate growth and attractive nominal yields.
- Commodities and real assets typically thrive during inflation. Commodities have stabilized, but geopolitical and inflationary risks have risen. Structural trends including rising defense spending and dollar diversification support sustained demand for commodities.
- While the macro environment remains pro-risk, persistent policy uncertainty and tail risks underscore the importance of diversified portfolios. Low stock-bond correlations are diversifying, and equity-commodity links may enhance inflation protection.
