Economic Crossroads: Navigating Policy Shifts and Market Resilience in 2025

Summary

• Concerns about a potential economic slowdown are rising, with recent data releases signaling possible headwinds for the U.S. economy. While fiscal policy shifts and government spending cuts introduce some contractionary pressures, the near-term economic picture remains broadly positive.
• Tariff policies will likely lead to higher consumer prices and moderating economic growth. However, based on current projections, these policies alone are unlikely to push the economy into recession.
• From a portfolio perspective, diversification has re-emerged as a key winner in 2025, with both bonds and international stocks outperforming US equities. Bonds played a stabilizing role amid heightened stock market volatility, reinforcing their role as an important building block. We were early in highlighting the improved return potential of fixed income over the past several years, though recent interest rate declines underscore bonds’ ability to act as a ballast in uncertain times. International stocks are capturing outperformance from a weaker US Dollar and multiple expansion. 

What is Happening

Recent headlines reflect growing uncertainty about the U.S. economy. Corporate layoff announcements are increasing, the Atlanta Fed’s GDPNow model projects a first-quarter GDP contraction exceeding 2%, and consumer confidence is trending lower. These shifts stem, in part, from evolving policy measures introduced by the new administration.

Since taking office on January 20, President Trump acted swiftly on campaign promises, issuing more than 70 executive orders, the highest number in a President’s first 100 days since FDR in 1933. 

Distribution of Trump Administration Executive Orders (through February 20, 2025)

Source: MUFG

Notably, key policies affecting investors include:

• Trade Policy: Newly imposed tariffs on Canada, Mexico, and China could trim U.S. GDP growth by 0.5% while adding to inflationary pressures.
• Government Spending and Department of Government Efficiency (DOGE): Reductions in federal expenditures may weigh on growth but could also counterbalance inflationary concerns. DOGE related layoffs of federal government workers will also slow growth. 
• Immigration Policy: A shifting course in the labor force that reduces its overall size and removes lower cost employees may elevate wage growth and slow economic growth.

While these policy shifts present challenges, the broader economic environment remains resilient, supported by ongoing health in labor markets (for now), consumer spending, and corporate investment.

What are the implications? 

The immediate impact of tariffs appears manageable, with economists forecasting inflation to rise by 0.5% and GDP growth to slow by 0.25%-0.5% per annum. While these factors are a drag on growth, they are not expected to trigger a recession. However, we remain watchful of evolving immigration policies, which could further impact the labor market and price stability. 

Stock Market

U.S. equities initially reacted negatively to tariff announcements, reflecting concerns over higher input costs and potential earnings compression. However, not all sectors are affected equally with supply chain disruptions likely impacting industrial and manufacturing companies more so than areas like utilities and healthcare. Despite near-term volatility, we maintain a constructive long-term outlook for equities, emphasizing that periodic selloffs are a natural part of market cycles. In 2024, the S&P 500 experienced a strong gain despite intra-year drawdowns of 5% in April and 8.5% in August. Investors should maintain a disciplined, long-term perspective.

Bond Market

An encouraging development in 2025 has been the return of fixed-income diversification. As stocks experience heightened volatility, bonds played a stabilizing role:

• Core bonds appreciated amid declining interest rates, satellite bonds performed strongly in each of the past two years and the addition of securities such as TIPS provide the ability to protect against inflation risk with limited duration exposure. 

We continue to believe parts of the bond market offer opportunities to lock in higher yields, particularly as economic uncertainty persists. 

Key Considerations Looking Ahead 

Investor sentiment and market narratives are evolving rapidly in response to uncertainty around tariffs, immigration and government spending policies. While the economy currently benefits from strong momentum, potential headwinds may emerge in the form of fiscal tightening, labor force constraints, and increased trade tensions. That said, long-term economic tailwinds remain in place:

• Productivity gains from artificial intelligence that may enhance corporate efficiency.
• Demographic shifts that support labor market growth, including a growing portion of the population between the prime working ages of 24-45.
• Healthy consumer and corporate balance sheets, which continue to support spending.

While market volatility is likely to persist based on continued policy changes, we encourage investors to remain focused on fundamentals and maintain a well-diversified, long-term strategy to navigate shifting economic conditions.