Equity markets continued to climb in the third quarter, building on momentum from the post-Liberation Day rebound. The S&P 500 gained 8.1%, fueled by easing trade uncertainty and expectations that the Federal Reserve would resume cutting interest rates. Corporate earnings, which had initially been revised lower amid heightened uncertainty around trade policy, came in well above expectations and alleviated concerns that tariffs would materially impact profits. A wave of deals and partnerships among companies in the artificial intelligence space highlighted that enthusiasm for AI continues to run high, as investors drove up stock prices in response. The Information Technology sector led the rally as risk-on sentiment returned to the market, followed by Communication Services and Consumer Discretionary. Investors largely looked past higher valuations, elevated inflation, and a softening labor market to keep stocks on an upward trajectory through quarter-end. Small-cap stocks were a notable outperformer during the period, with the Russell 2000 rising 12.4% on a total return basis.
The Bloomberg Aggregate Bond Index returned 2%, as investors anticipated the resumption of monetary easing. After holding rates steady throughout the year, the Fed cut the federal funds rate by 0.25% in September, pointing to signs of a weakening labor market. Significant downward revisions to monthly job numbers have shifted the Fed’s focus toward the employment side of its dual mandate. And while inflation remains above the 2% target, there is a growing view that the effects of tariffs on prices may prove less pronounced than initially expected. Updated projections now show the potential for two more rate cuts this year and additional easing into 2026, though Chair Jerome Powell said the Fed was now in a “meeting-by-meeting situation”. At the same time, the central bank faces increasing political scrutiny, with renewed debate over its independence as the White House pushes for more aggressive easing and seeks to replace senior officials. With a labor market weaker than previously thought, inflation still elevated, mounting political pressure, and limited data releases due to the government shutdown, the Fed is navigating a particularly complex environment heading into the remainder of the year.
After months of uncertainty surrounding U.S. trade policy, recent tariff agreements have brought much-needed clarity to the global economic landscape. The Trump administration reached deals with major trading partners, including Japan and the European Union, establishing a baseline tariff rate of 15% and signaling a framework that could extend to other nations. The two deals marked a turning point in trade negotiations, providing clarity on the types of agreements the U.S. would be willing to accept with other countries. While the U.S. average effective tariff rate has risen considerably this year, the reduced risk of an escalating trade war has eased investor anxiety and helped support the equity rally during the quarter. That said, negotiations with China remain ongoing, and financial markets are likely to react quickly to any new developments on this front. Investors are cautiously optimistic about the prospect of an agreement being reached, but the unpredictability of trade negotiations continues to pose a potential source of market volatility.
So far this year, the economy has demonstrated surprising resilience and investor risk appetite remains high. Expectations for lower interest rates alongside solid corporate earnings have for now pushed aside mounting concerns about the labor market’s strength and the trend in inflation. These will be key focus points heading into year-end, but the longer the government shutdown continues, the less visibility investors will get into the state of the economy as data releases are either delayed or halted altogether. Under such conditions, maintaining a disciplined yet flexible approach will be vital for the remainder of 2025.