After a turbulent yet resilient first six months of the year, we wanted to share an updated macroeconomic perspective and investment outlook.
Overview
The U.S. economy has displayed stamina in the face of persistent monetary and fiscal policy uncertainty. While the Federal Reserve projects gross domestic product (GDP) growth of 1.4% for 2025 — reflecting a more cautious stance — unemployment has held steady at 4.2% and the recent easing of trade tensions with China has helped mitigate the most severe stagflationary risks. As a reminder, stagflation occurs when rising inflation and a stagnating economy occur at the same time, a hard-to-fight combination.
Still, despite lower severe stagflationary risks, inflation continues above the Fed’s 2% target, hovering near 3%. The Federal Reserve has maintained its policy rate at 4.25%-4.50% through June, but has signaled a more accommodative stance ahead. With two rate cuts anticipated this year, the central bank appears committed to supporting growth while managing inflationary pressures.
Following the sharp volatility in April, driven by tariff announcements, markets have rebounded impressively. Fueled by tech outperformance, the S&P 500 index rallied more than 24% from its April 8th bottom, finishing the first half of the year at an all-time high.
Looking ahead, economic activity should benefit from greater policy clarity and the prospect of fiscal stimulus from the One Big Beautiful Bill Act. While corporate earnings are set to post solid growth, particularly within the technology sector, trade anxieties could reestablish new headwinds.
How are Q2 Corporate Earnings Stacking Up?
The latest quarter presented a more challenging earnings environment for S&P 500 companies. Analysts are projecting the slowest earnings growth in two years amid widespread estimate revisions and heightened uncertainty around trade policies and economic conditions.
For Q2 2025, S&P 500 earnings are expected to grow 5.0% year-over-year, which would be the slowest pace since Q4 2023. This outlook dropped from an earlier estimate of 9.4% at the end of March, with all eleven sectors now projected to report lower earnings.
Among S&P 500 companies, 59 have issued negative earnings guidance, while 51 have issued positive guidance for the quarter. The index’s forward 12-month price-to-earnings (P/E) ratio stands at 21.9, above both its five- and ten-year averages. Higher P/E ratios can mean a company’s stock is overvalued or that higher growth is expected.
Despite earlier concerns, the technology sector’s earnings outlook has stabilized in recent weeks after initial downward revisions. The sector is expected to be a key driver of overall index performance, with analysts projecting approximately 21% earnings growth for the full year 2025. Major tech companies are benefiting from continued AI investment and infrastructure spending, though growth rates have moderated from previous quarters.
Economic Growth and GDP Outlook
The U.S. economy contracted in Q1 2025, with the final GDP estimate showing a 0.5% annualized decline. It was the first quarterly drop in three years, largely due to a surge in imports ahead of tariff hikes.
For Q2 2025, growth is expected to rebound to around 1.5% annualized, but this is a significant slowdown from previous years, with 3.2% growth in 2023, 2.5% growth in 2024.
The economy’s trajectory appears heavily dependent on tariff policies. Under the baseline scenario, real GDP growth is expected to be 1.4% in 2025 and 1.5% in 2026. The slowdown is due to weaker household and government spending, with consumption growth decelerating after an unsustainable surge in late 2024.
Manufacturing and Capital Spending Remain Sluggish
The manufacturing sector continues to contract. New orders weakened for the fifth straight month, while employment conditions deteriorated further. Increasing prices paid for inputs suggest that the tariffs on imported goods are hampering businesses’ ability to plan.
Business investment is also subdued, with capital expenditure expected to grow only 0.7% in 2025, down significantly from 3.7% in 2024. The Business Roundtable CEO Economic Outlook Index, which measures CEOs’ plans for hiring and capital spending, dropped 15 points to 69 in Q2 2025, well below its historic average of 83.
Productivity Is the Secret Sauce
Productivity is crucial for the economy because it is the main driver of long-term economic growth and rising living standards, enabling more (and better) goods and services to be produced with the same resources. Sustained productivity gains are essential for increasing GDP per capita and improving overall prosperity. U.S. productivity dipped 1.5% in Q1 2025, mainly due to higher labor costs and slower output growth.
Trade and Tariffs Headaches
The U.S. trade landscape in mid-2025 remains highly unsettled, with new tariffs and critical deadlines shaping economic and market conditions.
Currently, most imports face a 10% tariff, while Chinese goods are taxed at 30% after falling from a peak of 145%. Steel and aluminum imports carry a steep 50% tariff. These measures have triggered retaliation: China has imposed 10% tariffs on U.S. goods, and the EU is preparing renewed tariffs of up to 25% if talks fail.
In April, the U.S. trade deficit narrowed sharply to $61.6 billion as imports fell 16.3% and exports rose 3%. This reflected businesses rushing to bring in goods before tariffs increased and now adjusting their supply chains.
Negative Effects of Rising Costs
For 2025, tariffs and retaliation are expected to reduce real GDP growth by 0.5-0.6%, raise consumer prices by 1.5%, and increase unemployment by 0.3%.
The next three months will be critical. Several tariff pauses with the EU and other partners expire in July. The White House has signaled it may either extend negotiations or reinstate tariffs as high as 125% if talks collapse.
These decisions will have a direct impact on inflation, supply chains, and Federal Reserve policy. A breakthrough could ease tariffs and support lower inflation, paving the way for interest rate cuts. Renewed trade tensions could disrupt markets and delay monetary easing.
Staying Focused Amid Shifting Economic Currents
It’s been a wild quarter, with the major U.S. stock indices rebounding impressively from April lows.
Still, knotty issues continue to loom over the economy. These include ongoing trade policy dissonance, elevated expectations of inflation, and the increasing prospect of labor market softening.
While certain vital indicators are encouraging and point to economic resilience, the stagflationary mix of slowing growth, persistent inflation pressures, and policy uncertainty presents a challenging environment for both economic performance and financial market stability in the remainder of 2025.
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