Q3 2025 Summary – Cut, Shut, and Rally

Cut, Shut, and Rally

3Q25 was marked by the intersection of policy and markets. A government shutdown capped the quarter after partisan gridlock over spending priorities, while the Federal Reserve delivered its first rate cut in nine months. Equities extended their rally on the back of resilient earnings and an unusually strong September, a month that has historically been weak for U.S. stocks. Abroad, activity was supported by fiscal and monetary accommodation, and global ex-U.S. equities built on their year-to-date leadership. Yet beneath the surface, stretched valuations, persistent inflation, and elevated policy uncertainty left investors with plenty to weigh as the quarter closed.

U.S. Policy and Economy

The U.S. bull market extended in 3Q as steady economic activity and ongoing enthusiasm for AI helped offset anxieties around trade policy and stubborn inflation. The overall effective U.S. tariff rate was estimated at 17%, according to the Yale Budget Lab, the highest level since 1935. While some companies have absorbed the costs, the effects are increasingly visible in certain sectors, such as consumer staples, where margins have come under pressure. Several lower courts have ruled that the president overstepped on specific tariffs (including reciprocal duties and China fentanyl-related retaliation), with the final decision expected from the Supreme Court later this year.

Trade policy uncertainty was soon eclipsed by the federal budget standoff, which ended in a government shutdown. At the center of the dispute were disagreements over spending priorities, including health care subsidies. The shutdown has forced several government agencies, including the Bureau of Labor Statistics, to suspend publishing and collecting economic data—an important input into Federal Reserve decision-making. For context, the longest prior shutdown began in late 2018 during President Trump’s first term and lasted roughly five weeks.

The Federal Reserve approved a quarter-point cut to the Fed Funds Rate in September, its first reduction in nine months. The new target range of 4.00%–4.25% marked the lowest level in nearly three years, as officials judged that labor market softness outweighed still-stubborn inflation. Eleven of twelve Fed governors supported the move, with newly appointed governor Stephen Miran dissenting in favor of a larger half-point cut. The FOMC’s updated dot plot indicated expectations for one to two additional cuts by year-end, though one member projected as much as 125 basis points of further easing. Markets welcomed the cut, with equities extending their rally into quarter-end and Treasury yields easing modestly along the curve.

Both headline and core inflation remained sticky in 3Q25, staying above the Federal Reserve’s 2% target. The Fed’s preferred measure, core PCE, rose 0.2% in August and 2.7% year-over-year, little changed from prior months. CPI-U also ticked higher, with headline inflation up 2.9% year-over-year and core CPI up 3.1%. Goods prices firmed across several categories, reflecting tariff pass-through and labor shortages tied to tighter immigration policies. Meanwhile, consumer spending stayed resilient, rising 0.6% in August after a 0.5% gain in July, highlighting that demand may have yet to meaningfully cool despite elevated prices.

The labor market continued to soften across multiple indicators. Job growth slowed and the unemployment rate climbed to 4.3%, its highest level in four years. The BLS Job Openings and Labor Turnover Survey (JOLTS) showed slower hiring and fewer voluntary quits, which is consistent with easing labor demand. Consumer sentiment weakened further as the Conference Board’s Confidence Index fell in September to its lowest reading since April with respondents citing persistent concerns over job availability. Retail sales, however, surprised to the upside, rising 0.6% in August and beating expectations, signaling that household spending capacity has not yet been exhausted. The Atlanta Fed’s GDPNow model revised its 3Q25 growth estimate upward to 3.9% annualized, compared to 3.1% earlier in the month. Meanwhile, the BEA’s final estimate confirmed that 2Q25 real GDP had expanded at a 3.8% annualized pace.

Global Macroeconomics

The OECD upgraded its global growth outlook in September, reflecting stronger-than-expected resilience in the first half of 2025. It now projects G20 GDP growth of 3.2% for 2025, up from its 2.9% forecast in June, citing front-loaded demand ahead of tariff measures and AI investment activity. Looking ahead, the OECD expects growth to moderate, projecting G20 GDP easing to 2.9% in 2026 as labor markets soften in advanced economies and private consumption slows.

Monetary policy remained divergent across major developed economies. The ECB held its policy rate at 2.15% in September, after eight consecutive cuts since June 2024. President Christine Lagarde reiterated that inflation is expected to stabilize at the 2% target over the medium term. The Bank of England also kept rates steady at 4.0% following a series of five quarter-point cuts this year, cautioning that inflation could temporarily rise before trending back toward target. Meanwhile, the Bank of Japan maintained its policy rate at 0.5%, pausing to assess the impact of U.S. tariffs and broader global demand on Japan’s export sector.

Political instability in France and Japan added to global uncertainty. In France, President Emmanuel Macron appointed his fifth prime minister in under two years, tasking him with delivering a 2026 budget and a credible path to deficit reduction. Fitch downgraded France’s sovereign rating to A+ from AA-, citing the country’s high debt burden and persistent political gridlock that has hindered fiscal reform. In Japan, Prime Minister Shigeru Ishiba’s resignation deepened political turmoil, marking the nation’s third leadership change in five years. Despite the upheaval, Japan’s economy showed resilience. 2Q GDP expanded at a 1.0% annualized rate, following 0.6% growth in 1Q, supported by robust auto exports as automakers partially offset U.S. tariff headwinds by absorbing costs rather than passing them to consumers.

China entered 3Q under pressure from weakening manufacturing, mounting deflationary concerns, and continued property-sector stress. Manufacturing PMI contracted for a sixth consecutive month, underscoring persistent weakness in industrial activity. Deflationary signals also lingered, with consumer and producer prices declining year-over-year. In September, Beijing announced plans to deploy RMB 500 billion (~$70 billion) in policy-based financial tools to accelerate infrastructure and investment projects, alongside new measures to curb overcapacity in key industries, reflecting policymakers’ attempt to stabilize growth and shore up confidence.

Global Equities

U.S. equities extended gains for the year and advanced to record levels as investors looked through policy uncertainty and focused on earnings and Fed easing prospects. The S&P 500 rose 8.1% (+14.8% YTD), led by Information Technology (+13.2%) and Communication Services (+12.0%) on continued enthusiasm for the AI-trade and digital platforms. The Magnificent Seven stocks were propelled further as they reached approximately 35% of the S&P 500’s market capitalization. Consumer Discretionary (+9.5%) also posted strong gains, while Consumer Staples (–2.4%) was the weakest sector reflecting a rotation into cyclical names as well as a weaker outlook stemming from increased margin pressures on consumer staples companies. Small caps (Russell 2000: +12.4%) outperformed large caps (Russell 1000: +8.0%), and growth stocks (Russell 3000 Growth: +10.4%) continued to lead value (+5.6%).

Market valuations grew further into focus as the Schiller P/E ratio for the S&P 500 ended the quarter at roughly 40x, reaching a level that has only been exceeded by the rally prior to the Dot-Com Bubble. Similarly, the market-cap-to-GDP Ratio, also known as the Buffett Indicator, surged past 200% in September, signaling that market gains have far outpaced U.S. economic growth.

Non-U.S. equities extended their year-to-date lead over U.S. markets as the MSCI ACWI ex-USA Index rose 6.9% (+26.0% YTD). The currency tailwind abated during the quarter as the U.S. dollar stabilized (DXY: +0.9%) after a tumultuous 1H25 (-10%). Developed market equities (MSCI World ex-USA: +7.3%) advanced as the ECB paused its easing cycle and the BOJ maintained its accommodative stance. Financials (+8.6%) were the strongest performers as European banks posted solid 2Q earnings, while Health Care stocks (+0.7%) faced pressure from newly announced U.S. tariffs on imported pharmaceuticals. Japanese equities (+8.0%) rallied, led by autos and semiconductors, as a U.S.-Japan trade deal was reached in July and finalized in September, helping boost investor sentiment on exporters.

Emerging market equities delivered strong gains (MSCI EM: +10.6%), led by Chinese equities (+20.7%). Despite signs of economic deceleration, investor sentiment was lifted by potential government intervention to address overcapacity in the Chinese economy, easing in trade tensions with the U.S., and progress on AI and chip technology. South Korean (+12.7%) and Taiwanese equities (+14.3%) also surged ahead in 3Q, benefiting from strong semiconductor demand.

Global Fixed Income

Fixed income markets posted broad-based gains in 3Q25. The U.S. Treasury yield curve steepened modestly as the front end fell more sharply in anticipation of Fed cuts, while the long end shifted marginally lower but remained elevated. The Bloomberg US Aggregate Bond Index advanced 2.0% (+6.1% YTD) as yields declined. Investment grade corporate bonds outperformed securitized (MBS, CMBS, ABS) on a like-duration basis as corporate option-adjusted spreads continued tightening and reached levels last seen in the pre-GFC period. Within leveraged finance, spreads also continued to grind tighter as the Bloomberg US High Yield Index rose 2.5% and the Morningstar LSTA Leveraged Loan Index advanced 1.8%, supported by strong CLO demand. The Bloomberg TIPS Index gained 2.1% (+6.9% YTD) as the 10-year breakeven increased and implied 10-year real yield declined. Municipals generated solid returns (Bloomberg Muni: +3.0%), aided by favorable technicals and strong demand.

Global bonds delivered mixed performance as 10-year bond yields rose across most G7 nations and U.S. dollar strength was a headwind to unhedged investors. The Bloomberg Global Aggregate Index (USD Hedged) gained 1.2%, while unhedged returns were nearly flat (Bloomberg Global Agg: +0.5%). Emerging market debt outpaced developed market peers, with the hard-currency (JPM EMBI Global Diversified: +4.8%) and local-currency (JPM GBI-EM Global Diversified: +2.0%) indices both advancing.

Listed Real Assets

Liquid alternatives posted positive returns in 3Q25, with strength concentrated in precious metals. The S&P GSCI rose 4.1%, though performance across underlying sectors diverged. Precious metals surged (S&P GSCI Precious Metals: +17.4%), with gold up roughly 45% YTD as elevated uncertainty bolstered its appeal as a safe-haven. In contrast, energy prices remained under pressure as oil markets faced ample supply. Global natural resource equities advanced (S&P Global Natural Resource Equities: +9.4%), lifted by strong gains in metals and agriculture that offset weakness in energy. REITs also posted gains (FTSE Nariet: +4.8%), supported by a modest decline in long-term yields.

Closing Thoughts

This quarter reinforced that we are living in “interesting times.” Some celebrate policy shifts, others cheer an unprecedented bull market, and many are simply navigating the constant churn of news. Yet markets, and people, move forward by adapting and finding common ground. With Thanksgiving around the corner, it’s a fitting reminder that engaging across perspectives can broaden understanding, whether in policy debates, investment outlooks, or around the dinner table. As always, but especially in periods of stretched valuations and safe-haven rallies, we encourage investors to keep a long-term perspective and a prudent asset allocation with appropriate levels of diversification.

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