On December 19, 2024, we published our 2025 macro outlook, titled “Profiles of the Future.”

In it, we outlined our 2025 expectations for continued economic growth, a slowing labor market, moderating inflation, and dovish central banks lowering interest rates. 

The first half of 2025 was a rollercoaster ride in financial markets, with global trade policy uncertainty surging to its highest level since 1985. However, as markets digested the trade shock and negotiations began, economic policy uncertainty subsided from its peak in April (see Figure 1), and markets completely retraced the trade shock sell-off.

With the first half of the year behind us, below we grade our 2025 outlook so far and update as needed for the second half of the year. 

Macro Call #1: Inflation would moderate.

After a “hot” start to the year in January, core inflation measures cooled over the last three months. The monthly core PCE inflation reading in the previous three months averaged 0.14%, the slowest pace in the current disinflation cycle (see Figure 2).

Macro Call #2: Growth continues, but not at the pace put forth by the optimists at the beginning of the year, nor a contraction as feared by most after April 2nd.

We expected continued, trend-like growth to start the year, not a Trump-driven acceleration of above 2% growth as some forecasters had predicted.

As the year progressed, trade and fiscal policy surprises quickly led to a deterioration in growth expectations. Again, we’ve preached calm.

For example, investors feared that layoffs and Federal spending cuts would derail U.S. growth. We also counseled that DOGE was overhyped. As it turns out, the DOGE process resulted in just $9.4 billion in “rescission" cuts being submitted to Congress, or merely 0.14% of total Federal spending in FY 2024. Federal employee layoffs have ebbed since March, and Federal spending in FY 2025 is on track to beat 2024 by 25%.

Then, with the tariffs announced on April 2nd, some famous analysts and pundits deemed a recession “inevitable,” or at least placing “a 95% chance” of one occurring in 2025. We acknowledged the rising risks to growth as tariffs impose a nasty “tax” on businesses and consumers, but we still thought the U.S. could avoid a downturn in 2025. We pushed back against concerns that negative consumer sentiment would drag growth as much as forecasters had touted, and advised that a solid labor market would still support consumer spending. 

Since then, cooler and calmer heads have prevailed, both in Washington (through negotiations, reductions, and a tariff pause) and among analysts.  

While headline GDP contracted due to a drag from surging imports, underlying GDP growth expanded at a slower but healthy pace in Q1 after controlling for volatile components, such as trade and government spending. 

Macro Call #3: The unemployment rate could rise above 4.4%.

The unemployment rate remained stable at 4.2% at the start of the year and fell to 4.1% as of June. However, job growth has slowed (see Figure 3). So, what gives?

A shrinking labor force has kept the unemployment rate steady even as hiring has slowed somewhat. Labor force participation rate is declining due, at least in part, to immigration restrictions and deportations. But even before deportations began, labor force growth was already slowing (see Figure 4).

Macro Call #4: Rates would move lower in 2025.

U.S. monetary policy remained restrictive at 4.25-4.50% for the first half of the year, as potential tariff threats and a stronger-than-expected labor market kept the Fed on the sidelines. 

However, despite the monthly volatility, falling growth expectations drove both the 2-year and 10-year Treasury yields lower year-to-date.

Globally, the story has been one of disinflation as well (see Figure 5). 

Specifically, the euro area saw a cycle-low services inflation print in May 2025, allowing the ECB to cut rates by another 100 basis points in 2025, as we expected at the beginning of the year. 

Core inflation in Australia also dipped within its target range of 2-3% for the first time since 2022 in the first quarter of 2025. Argentina, well known for its struggles with hyperinflation, saw its softest monthly inflation rate in the last five years. It’s almost as if a common global event and policy responses triggered this inflation, which has since subsided with a lag.

Macro Call #5: The dollar would remain well bid. 

Our biggest miss so far in 2025 was the U.S. dollar. As of July 14th, the USD had declined by 10% year-to-date compared to its peers' index, primarily due to the U.S. trade policy shock.

Macro Call #6: Stocks had more scope to rally, and credit spreads can remain tight for an extended period of time.

Equity markets had a volatile first half of the year.

As is often the case, investors grasp for just-so explanations when the market swoons. For example, a February sell-off was pinned on DeepSeek. We argued that, if anything, there was not enough computing, casting doubt on the explanation for the sell-off.

Following the April 2nd announcements, the S&P 500 index dipped a total of 19% from its peak, fueling recession narratives. However, we still advised that equities could find their footing as long as the economy avoids a recession.  

As of July, the stock market has completely retraced its tariff-driven sell-off. U.S. corporate high-yield spreads, too, widened by 166 basis points before narrowing to their tightest level of the year in recent weeks.

With the year half over, what about our outlook for the next six months?

Outlook Call #1: Inflation can still moderate despite tariff threats.

While we acknowledge the risk of an inflation pick-up due to tariffs, one has yet to materialize. Even if goods prices pick up over the summer, services prices carry a heavier weight in consumer price indices, and the trend is our friend. Softer core inflation by year-end remains achievable.

The main counterarguments to our view relate to inflation expectations. On the one hand, some analysts say the tariff-driven inflation shock will arrive with a delay. We’ve accounted for that in our inflation outlook for goods inflation, and we still think services softening could offset it. On the other hand, others have suggested that inflation expectations from businesses and households will delay rate cuts, as the Fed prioritizes “what is in consumers' heads,” rather than just the actual data. We believe household inflation expectations follow actual inflation or high-frequency purchase prices (see Figure 6).

Outlook Call #2: Sub-trend GDP growth—not a recession, not a re-acceleration.

We expect the trend in Q1 and Q2 to continue for the remainder of the year as consumer spending slows but remains at a solid pace. However, we don’t expect a recession as long as the job growth remains positive. 

How likely is a re-acceleration in growth? With Q2 real GDP tracking at a 2.6% annualized quarterly rate, for real GDP to pick up to above 2.5% year-over-year in 2025, growth needs to increase at an annual rate of 4% in Q3 and Q4—a pace of growth we haven’t seen since the Covid re-opening recovery in 2021. We think such a scenario is unlikely. We also don’t expect the recent passage of the One Big Beautiful Budget Act to be a material boost to growth.

Outlook Call #3: The unemployment rate trajectory is still higher.

The unemployment rate has been steady for more than a year, but such periods of stability are rare, as unemployment typically falls slowly or rises quickly. 

Weakness in the labor market is accumulating. Downward revisions to past data suggest a further slowdown in hiring ahead. We are also seeing a rise in continuing claims for unemployment insurance, a sign that it’s taking longer for workers to find new employment. 

As a result, we still think downside risks to job growth will outweigh the upside pressure from the shrinking labor force, leading to a gradual rise in the unemployment rate.

Outlook Call #4: The Fed could still cut rates more than the market currently expects.

With four policy meetings left on the calendar, we think it’s likely the policy rate could be 75 basis points lower by December, a slight change of 100 basis points of cuts we expected at the beginning of the year. Note that this is not a material change to our view, but rather a reflection of the labor market staying stronger for longer than we had expected, allowing the Fed to be more patient.

And yes, we are aware that the median policymaker expects only two 25-basis-point cuts by year-end, according to the latest set of Summary of Economic Projections (SEP) released in June. Mainly because the median policymaker expects core PCE inflation to top 3.1% year-over-year by December, compared to our expectation of just 2.5% (see Figure 7).

However, if inflation remains muted OR the unemployment rate exceeds 4.3%, the Fed will return to cutting mode. At the very least, the market should factor in more cuts as more data becomes available over the summer.

We’d also like to remind investors that the Fed’s “dot plot” is very fluid, especially in the first half of the year. For example, in 2024, the median “dot” moved from implying three cuts in March to only one cut in June. The Fed eventually cut the fed funds rate by 100 basis points by year-end 2024, following softer job growth last summer (see Figure 8). A similar situation could also unfold in 2025.

Outlook Call #5: Rates can still move lower across the curve. 

We acknowledge that the term premium investor demand for holding U.S. Treasuries has increased due to fiscal concerns. Further, we expect the term premium to remain elevated as the U.S. federal budget deficit may still linger around 6-7% of nominal GDP for 2025 and 2026. However, inflation expectations and fed funds rate play a much larger role in yields than the term premium. Therefore, even with a higher term premium, we still expect the 10-year Treasury yield to decline as inflation moderates and the Fed cuts interest rates. 

Globally, we remain dovish on rates, especially in the euro area. While the ECB indicated that it's nearing the end of its cutting cycle, we expect rates to go lower as inflation may undershoot the ECB’s target, and the growth boost from Germany’s fiscal spending might fail to alter the euro area’s growth trajectory meaningfully. 

Outlook Call #6: With the Fed leading rate cuts, the dollar could remain weak in H2 2025, but the trade is crowded.  

In general, a dovish Fed leads to a weaker dollar, as long as the U.S. avoids a recession. Given that other major central banks, such as the ECB and the Bank of Canada, are already nearing the end of their cutting cycle, we expect the U.S. to cut rates more aggressively among the major central banks this year, leading to a weaker U.S. dollar. 

However, be careful about your reasons for expecting a weaker USD. We don’t think a capital flight from the U.S. is underway. Further, despite the recent volatility in Treasury yields, there are no alternatives to the U.S. Treasury market. 

The bottom line is that moderating inflation with continued growth is a scenario underpriced in markets and underappreciated among policymakers. If our disinflation view pans out, the Fed will likely cut rates faster than markets currently anticipate. Even if inflation remains somewhat sticky, the Fed could still resume rate cuts if the unemployment rate rises above 4.3% in the next six months.

Best of luck in the second half of 2025,

The Payden Economics Team