Outlook: May 2025

Economy

The pace of growth has moderated and there is uncertainty in the outlook. Consumer confidence and sentiment indicators have fallen as the implementation of new tariffs and federal budget cuts are likely to serve as headwinds to growth. Tariffs are also expected to increase inflationary pressure. Given these factors, the consensus estimates for this year’s GDP growth have declined while inflation estimates have increased. 

Despite the weakening tone, the Federal Reserve has not changed its policy this year. However, they have lowered rates by 100 basis points since last September. Changes in monetary policy work with a lag, which means last year’s cuts are still working through the system. Currently, their policy is data-dependent, meaning they are waiting to see more evidence regarding the trajectory of inflation and growth before taking additional action. In their most recent statement of economic projections, they provided guidance suggesting two rate cuts this year.

Our base case remains that the economy will expand at a modest pace this year, with growth hovering around 1.0 to 1.25 percent. However, the odds of an economic downturn have increased, given the declining confidence and uncertainty around trade policy. This is a fluid situation, and much of the recent weakness relates to a softening of sentiment, which can change quickly. Accordingly, we are monitoring developments and reassessing our views as necessary.   

Inflation

Inflation remains above the Federal Reserve’s 2.0 percent target, but the annual inflation rate has been falling steadily since January of this year. The latest reading of the Consumer Price Index (CPI) indicated that inflation is running at a pace of 2.3 percent, which is the lowest annual reading since 2021. 

We have not yet seen any broad impact from the new tariffs, but prices are expected to increase as we progress through the summer. In fact, the Federal Reserve recently raised its estimate for this year’s inflation rate from 2.5 to 2.7 percent, which is consistent with our expectation for upward pressure on prices as we progress through the year.

U.S. dollar

The U.S. dollar has been volatile, with a significant increase in the fourth quarter of last year followed by a reversal this year. The recent weakness was driven by expectations for a moderation in growth in the U.S. and relative improvement in the economic outlook for Europe. Looking forward, we expect the dollar to remain volatile but trade within its recent range, given the heightened level of uncertainty around government policy and the future pace of growth in the U.S.  

Asset class

CASH/MONEY MARKET INSTRUMENTS

The outlook for U.S. short-term interest rates points to a gradual decline through 2025 but at a slower pace than earlier expectations. While the Federal Reserve is expected to implement rate cuts, the timing, extent, and frequency remain uncertain. The Federal Reserve is maintaining a cautious approach amid rising inflation expectations and global trade uncertainties. Ongoing concerns include the impact of recent tariffs, potential retaliatory measures, and a slowdown in quantitative tightening. Despite a strong labor market, the Federal Reserve is watching for signs of softening as it balances efforts to control inflation with the need to support future economic growth.

INTERMEDIATE GOVERNMENT/CREDIT BONDS

The U.S. bond market is showing signs of investor caution, as reflected by lower yields and moderately wider credit spreads. Investors remain wary due to economic and policy uncertainty surrounding tariffs and concerns about inflation, which could affect interest rates. Our caution is reflected in a strong preference for high-quality, investment-grade bonds and diversification across sectors and issuers. Market conditions are stable but fragile and could shift quickly with new economic data or trade developments.

TAX-EXEMPT MUNICIPAL BONDS

Municipal bonds have not escaped the recent market volatility, as concerns about tariffs and the potential loss of their tax-exempt status rattled the market. Although the threat of Congress removing this exemption to fund tax cuts has diminished, some risk remains, particularly for specific sectors like hospitals and private universities. Despite the uncertainty, municipal yields remain attractive, and they are especially appealing to investors in high tax brackets. The recent market volatility, tax-related selling, and high ETF redemptions pressured prices and created buying opportunities. We continue to focus on high-quality bonds and broadly diversified portfolios while being cautious of vulnerable areas. With strong credit fundamentals across most states and the ability of municipalities to raise revenue, we like municipal bonds as a diversifier within balanced investment portfolios.

U.S. EQUITY 

The S&P 500 Index generated a total return of approximately 25 percent in 2023 and 2024. Growth stocks drove the market to a record high, led by strong gains in the “Magnificent 7.” However, in the first four months of this year, stocks were volatile, and the Index declined approximately five percent. In addition, the Magnificent 7 stocks underperformed the S&P 500. Investors took profits in technology, rotating into stocks with lower valuations and earnings that are less sensitive to the pace of economic growth. 

Corporate earnings have been growing rapidly, increasing by approximately ten percent last year. In 2025, profits are expected to continue to grow, but there is heightened variability in the estimates given the wide range of policy outcomes. Assuming earnings growth of eight percent, stocks are trading at approximately 22x forward earnings, which is above their long-term average. Accordingly, earnings growth is critically important to justify the current valuations and to serve as a potential catalyst for higher stock prices as we progress through the year. 

Our base case remains that stocks will continue to be volatile, but equity prices will increase at a moderate pace, driven by the completion of some trade deals, the ongoing economic expansion, increasing earnings, and initiatives aimed at deregulating some industries. However, there is a heightened level of uncertainty, and we will continue to monitor developments closely, reassessing our views as necessary.

INTERNATIONAL EQUITY

Foreign stocks generated solid returns year-to-date, given a decline in the U.S. dollar and the implementation of stimulus programs in Europe. A shift towards greater fiscal stimulus has the potential to be transformative, with Germany and the European Commission announcing spending programs intended to boost economic growth. The U.S. dollar has also been a significant driver of returns as it has declined against many of the major currencies. 

Going forward, we expect greater symmetry in the returns between U.S. and foreign stocks, given the adoption of the stimulus measures in many countries and a weaker tone to the U.S. dollar. In addition, foreign stocks have attractive valuations with P/E multiples that are below their long-term average. 

COMMODITY

Most commodities have increased year-to-date, with prices rising for gold, industrial metals, and many agricultural products. Gold has been a top performer, with prices driven by concerns related to the long-term impact of rising government debt and the heightened level of uncertainty in the outlook. Oil has been an outlier this year, with prices falling given abundant supply and a moderation in the outlook for economic growth.

We maintain our positive long-term view on commodities but anticipate some pockets of weakness. To the extent tariffs are implemented, we anticipate upward pressure on prices. We also expect the heightened level of uncertainty to continue to support demand for gold. However, the uncertainty is also likely to weigh on cyclical commodities, and any moderation in global economic growth will put downward pressure on the prices of those products.

Potential opportunities & risks

OPPORTUNITIES

The emergence of artificial intelligence and other innovative technologies—The convergence of cloud computing, significant increases in computing power, and the advent of the smartphone have created a connected world in which new technologies change how we live. This convergence has created investment opportunities centered around long-term themes such as the growth of artificial intelligence, Big Data, quantum technologies, and cloud computing. 

A productivity boom—The advancements in technology noted above, coupled with a persistent shortage of skilled labor and rising costs, are leading companies to invest in new technologies to automate processes and boost productivity. Higher productivity allows for a faster pace of economic growth without a sustained increase in inflation.

The evolution of finance—Technological advancements are disrupting the financial services industry. We are experiencing a global shift from paper currency to electronic payments fueled by the popularity of credit and debit cards and the emergence of cryptocurrencies. Online payment systems facilitating money transfers, e-commerce, and electronic bill-paying services are also experiencing strong demand. This shift is still in its early stages and has a long runway as it is occurring across both developed and developing economies. In the coming years, blockchain technology may become a significant disruptor in the finance industry, creating opportunities for new entrants and risks for the firms currently dominating this space.

Expansion of robotics—5G communications, sensors, and artificial intelligence are facilitating technological advancements to expand robotics in healthcare, restaurants, construction, and other industries. Some estimates project that global robotics spending will jump from $40 billion in 2023 to $260 billion in 2030. 

Personalized healthcare—Advancements in technology support tailoring treatments to each patient, streamlining the drug discovery process, providing continuous data analysis in real-time, and improving clinical trials through digitization. Investment opportunities across the healthcare spectrum will be enhanced as artificial intelligence and machine learning increasingly result in better healthcare experiences.

RISKS

Deglobalization/protectionism—The globalization trend that has been in place since the fall of the Berlin Wall is now being reversed. A renewed priority to ensure independence by securing access to commodities, promoting domestic manufacturing, and a race to establish global dominance in certain technologies have led to a reversal of the free trade movement. We expect this development to be coupled with a sustained increase in geopolitical tensions, upward pressure on inflation, a rising cost structure for some industries, and the potential for moderation in economic growth.

Rising government debt—Sovereign debt levels were rising before the outbreak of COVID-19. However, in the wake of the virus, they have increased significantly. In the U.S., government debt outstanding has increased 66 percent since the end of 2019. While the short-term implications of higher debt levels are manageable, the long-term impact may be substantial as rising interest costs burden taxpayers.

Geopolitical risks—Conflicts in many parts of the world have escalated or have near-term catalysts that may result in a change in dynamics. We are closely monitoring the wars in Ukraine and the Middle East and the relationship between the West and China.

Inflation—Given the implantation of new tariffs, persistent federal budget deficits, a high level of government debt, reduced investment in production capacity for some commodities, the trend towards deglobalization, and a shortage of labor, there is a risk that inflation may return to a sustained upward trend and remain above the average of the last thirty years.

Cybersecurity—Cybersecurity remains a significant issue, evidenced by persistent attacks on governments, businesses, and individuals worldwide. 

^{Originally posted on May 14, 2025}

^{Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable. However, Badgley Phelps cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Badgley Phelps does not provide tax, legal, or accounting advice, and nothing contained in these materials should be taken as such.}