Economic Update: A Review of Second Quarter 2025

The U.S. economy has been navigating a complex set of factors including slowing growth, persistent inflationary pressures, changing monetary policy and uncertain global trade dynamics. Despite these lingering uncertainties, the U.S. stock market performed well in the second quarter, with the S&P 500 setting new highs during the last few days of June. 

At the beginning of July, the “Big, Beautiful Bill” was passed by Congress and signed into law by President Trump. It extends the 2017 tax cuts that were due to expire after this year while adding several new ones including bonus deductions for seniors through 2028, increased state and local tax deductions through 2029, new deductions for earned income through tips and overtime and a $1,000 credit for children born between 2025 and 2028.

The law is financed through a $5 trillion increase to the debt ceiling as well as cuts to Medicaid and federal food stamps to be phased in over the next decade. 

U.S. Economy

According to the Bureau of Economic Analysis, U.S. GDP shrunk at an annualized rate of 0.5% during the first quarter. This follows a 2.4% increase during the fourth quarter 2024. The contraction was primarily due to a sharp increase in imports as companies have been attempting to build inventories ahead of impending tariffs. Government spending also declined, while the rate of consumer spending slowed.

However, economists expect a rebound for economic growth in the second quarter that will likely help avoid a recession, which is defined by two consecutive quarters of negative growth. For the full year 2025, the Federal Reserve currently projects real GDP growth of 1.4%.

Inflation expectations have risen, with survey respondents’ year-ahead inflation expectations increasing from 3.3% in January to 5.1% in June, according to the University of Michigan’s consumer sentiment survey. This inflationary environment is contributing to tighter financial conditions and reduced consumer confidence overall.

On the other hand, the current Fed projections suggest that inflation will gradually ease but remain above the 2% target through the end of the year. Still, they remain cautious about cuts with tariff uncertainty still on the horizon. As of this writing, Fed rate cuts are not expected until 2026. 

Our strong labor market supports this cautious stance by the Fed. In June, the U.S. economy added 147,000 jobs, exceeding expectations. The unemployment rate also fell to 4.1%, down from 4.2%. This growth was largely driven by a surge in public education employment, particularly at the state and local levels.  

Recent income and spending data, however, tell a different story. Personal income fell by 0.4% in May 2025, according to the Bureau of Economic Analysis, which is a decrease of $109.6 billion. That same report also shows that disposable personal income declined by 0.6% ($125 billion). Not surprisingly, personal consumption expenditures also decreased by 0.1% ($29.3 billion). This decline in disposable income and consumption expenditure could have ripple effects across various sectors of the economy over the next few months.

The value of the U.S. dollar declined 10.8% during the first half of the year compared to a basket of currencies from America’s major trading partners. This is the biggest decline to start the year since 1973. Still, we are far from the historical lows seen just prior to the financial crisis in 2008. U.S. Treasury Secretary Scott Bessent publicly favors a strong dollar; however, it is worth noting that a weaker dollar could help fuel growth in exports, thereby helping shrink our trade deficit. 

International Economy

In its June report “Global Economic Prospects,” the World Bank projects the global economy to grow at a sluggish 2.3% overall during 2025. According to the report, the slowdown — expected to affect nearly 70% of all economies — is driven by high policy uncertainty, geopolitical instability and rising trade tensions particularly involving the U.S., China and the EU. Despite these challenges, the outlook for the second half of 2025 is slow growth, not recession, with some regions showing signs of stabilization.

Many central banks outside the U.S. are now pivoting toward easing. The European Central Bank and several emerging market central banks have already begun to cut rates, aiming to support growth with inflation seemingly slowing down. Recent estimates for inflation among the 38-member OECD countries are projected to average 4.2% during 2025. This is down from post-pandemic highs but up slightly from similar estimates taken earlier this year due to trade-related cost pressures. 

Markets

The U.S. stock market rebounded strongly during the second quarter 2025. U.S. large-cap equities, as represented by the S&P 500 Index, gained 10.94% during the quarter. That index is now up 6.2% year to date. Developed international equity markets, as represented by the MSCI EAFE Index, also posted a strong quarter, finishing with 11.78% gains. They are now up 19.45% for the year. The MSCI Emerging Markets Index also posted positive performance, finishing the quarter up 11.99% and the first six months of the year up 15.27%.

Bond returns were slightly positive. The Bloomberg U.S. Aggregate Bond Index was up 1.21%, the Bloomberg Hedged Global Aggregate Bond Index was up 1.61% and the Bloomberg U.S. Inflation-Linked Bond Index was up 0.48% during the second quarter. Year to date, they are up 4.02%, 2.81% and 4.67% respectively. 

Commodities pulled back a little during the quarter. The Bloomberg Commodity Index lost 3.08% during the period. It is still up 5.53% year to date. The Wilshire REIT Index was also down 1.24% for the quarter and is now down 0.24% during the first half of the year.

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Outlook            

The first six months of 2025 have demonstrated the value of holding diversified assets. The U.S. stock market has been so strong over the last few years that it has been tempting for investors to steer an outsized portion of their investments into the U.S. while avoiding the rest of the world. However, international stocks have outperformed so far this year and still look relatively attractive from a valuation perspective. 

Likewise, fixed income has been a poor performer over the previous five calendar years, as a rising interest rate environment made it virtually impossible for bonds to earn returns. However, this year has been much better. Assuming we are now in a flat or declining interest rate environment, we would expect bonds to continue to perform well.

The economic outlook for the remainder of 2025 remains uncertain. The Federal Reserve projects modest GDP growth, with inflation expected to gradually decline. However, risks remain including geopolitical tensions, tariff uncertainty and shifts in consumer behavior. As always, we recommend a diversified portfolio containing a reasonable amount of equity exposure for any investor with a long enough time horizon.