Q3 2025 Review

Summary

The economic outlook at the close of Q3 2025 is marked by significant fiscal and geopolitical uncertainty. The One, Big, Beautiful Bill (OBBBA) is projected to add $4.1–$5.5 trillion to the national debt, potentially pushing debt-to-GDP over 130%. Inflation is expected to rise to 3.0–3.5% by Q4 2025, driven by the current 15.8% effective tariff rate (the highest since the 1930s). Geopolitical conflicts in the Middle East are keeping a risk premium on oil, delaying the first Fed rate cut until Q4. Meanwhile, the U.S. Dollar is down ~10% YTD, signaling a breakdown in the traditional correlation between rising U.S. rates and dollar strength, and fueling outperformance in non-U.S. equities.

U.S. Economy: Clouded by Uncertainty

The U.S. economic outlook is currently clouded by a trio of key themes: unpredictable trade policy (tariffs), geopolitical tensions (specifically the Middle East), and ongoing immigration constraints.

Growth and Labor Market Forecasts:

• Real GDP Growth is forecasted to slow, with 2025 expected at 1.7% and a further deceleration to 1.1% by Q4 2025.

• Unemployment is anticipated to peak around 4.6% by mid-2026 as payroll gains fall below 100K per month, partly due to federal job cuts (DOGE layoffs).

Inflation, Tariffs, and the Fed Funds Rate:

• Core Inflation is projected to climb to 3.0–3.5% by Q4 2025 as the full impact of tariffs feeds through inventory restocking.

• Fed Funds Rate projections for end-2025 are 3.75–4.00%, declining to 3.00–3.25% by end-2026.

The Fiscal Earthquake: Analyzing the OBBBA

The "One, Big, Beautiful Bill Act" (OBBBA) is the most significant fiscal event of the quarter, combining extensive tax cuts with limited long-term offsets.

Key Provisions:

• Tax Relief: Up to $10,900 in additional take-home pay for the middle-income household, a 12% tax cut for households earning less than $100,000, and no tax on tips/overtime.

• Job Impact: Projected to protect and create up to 7.2 million jobs.

• Social Programs: Locks in and boosts the Child Tax Credit (to $2,200) and the Standard Deduction (to $31,500 for families).

• Reductions: Eliminates $500 billion of Green New Deal subsidies.

Debt-to-GDP Projections:

The bill's long-term impact on the national balance sheet is concerning:

• Total Debt Increase: The final legislation is projected to add $4.1–$5.5 trillion to the national debt through 2034.

• Debt-to-GDP: Current debt at ~100% of GDP is forecasted to rise to 127%–130% under the bill, potentially reaching 133% if interest rates remain elevated.

Tariffs: The New Reality of Global Trade

Trade policy has shifted dramatically, with a new baseline of high tariffs complicating economic forecasts.

• Universal Baseline: Since April 2025, a 10% universal baseline tariff applies to nearly all imports.

• Country-Specific Rates: China faces a 30% tariff. Over 60 countries are subject to reciprocal tariffs (ranging from 20% to 40%).

• Effective Rate: The effective U.S. tariff rate is now 15.8%, the highest since 1936.

• Upcoming Threats: Proposed tariffs include a 50% rate on copper and a massive 200% tariff on pharmaceuticals.

Interest Rates and Geopolitical Risks

Federal Reserve policy is caught between sticky inflation and geopolitical risks, particularly from the Middle East.

Fed Policy & Market Outlook:

• Current Rates: The Fed held rates steady at 4.25%–4.50% in June.

• Cut Expectations: The first rate-cut is now expected to be delayed until Q4, possibly a 50bps reduction in December, due to inflation risks added by the tariff impact and geopolitical events.

• Longer-Term Path: The rate path could move to 3.25% by mid-2026 following rapid easing once inflation and trade damage fully take hold.

Middle East Conflict Impact:

• Inflation Risk: The Israel–Iran conflict raises the energy risk premium, with Brent crude expected to stay in the $65–70/bbl range. A potential oil price shock ($90+) would raise inflation by 0.2–0.3 points.

• Escalation: A Strait of Hormuz blockage (30% of global seaborne oil) remains a tail risk, with prices potentially spiking to $120/bbl.

• Eurozone Stagflation: Escalation presents a major risk of stagflation for the Eurozone, further complicating the ECB’s already-cautious path toward easing.

Global Equities and the Weakening Dollar

Non-U.S. equity markets have strongly outperformed, a trend driven by structural policy shifts and the rapid decline of the U.S. dollar.

U.S. Dollar Breakdown:

• YTD Decline: The U.S. Dollar Index (DXY) is down ~10% YTD.

• Broken Correlation: The dollar has fallen even as U.S. interest rates have risen, a worrying signal that "markets are no longer buying U.S. yield as a safe bet."

• Reserve Diversification: The dollar's share of global FX reserves has dipped to 57.7%, with gains flowing to the Euro, Swiss Franc, and select Asian currencies.

International Outperformance:

• Key Drivers: Structural policy changes in Europe (€500B infrastructure fund) and Japan (NISA reform) are boosting foreign markets.

• Valuations: International equities offer an attractive entry point; for example, Japan's P/E ratio is 15x compared to the U.S.'s 22x.

Strategic Takeaway for Investors

Global diversification is strengthening. International equities offer policy and valuation upside, and U.S. investors should consider enabling sectors like banks and infrastructure. Key things to watch are the final tariff deals, the anticipated Fed cut in Q4, and further currency realignment opportunities.

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The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.