Risk and Rates: Growth, Easing, and Repricing in Q3
Third Quarter, 2025
John R. Sides, CFA
The third quarter was characterized by a continued run-up in both risky asset classes and traditional safe havens. Equities, corporate credit, and securitized products all performed admirably, as did U.S. government bonds and precious metals like gold and silver. Despite a broad easing of financial conditions, the Federal Reserve took a dovish turn. At the annual Jackson Hole symposium in August, Chairman Powell indicated that the committee was more concerned about a weakening labor market than the recent creep higher in inflation readings. As a result, the Fed resumed their easing cycle in September. The Federal Funds rate was lowered by 25 basis points, the first cut since 2024. Importantly, at quarter end, the market was pricing in another 48 basis points of rate cuts by the end of 2025.
Economic growth rebounded from a contraction in the first quarter, with second quarter real GDP growth coming in at 3.8% annualized (above the consensus estimate of 3.3%), and the Atlanta Fed predicting 3.9% real GDP growth in the third quarter. The economy is seeing an “investment-led growth” pattern, with AI and tech infrastructure investment becoming a disproportionately large driver of the overall growth picture. Inflation data, both CPI and the Fed-preferred gauge PCE, remain firmly above the Fed’s 2% target. The last three readings of Core PCE were 2.81%, 2.85%, and 2.91%. With the Fed cutting rates into the latest 2.91% inflation print, the upside risks to inflation remain firmly in place. Conversely, non-farm payrolls underwhelmed versus expectations with some significantly lower recent revisions. Over the past three months payrolls have averaged +29,000 per month, the lowest 3-month average in the post-COVID era.
The shape of the risk-free U.S. Treasury yield curve is paramount for bond investors. As we entered the back half of the year, many bond investors were positioned for a steepening curve. The rationale being that continued economic growth – particularly when combined with fiscal stimulus and resurging inflationary pressure – should keep long-dated yields elevated. On the front end, easier monetary policy would drag short-dated yields lower. While the curve drifted steeper through August, some September flattening took out much of the move. However, the difference between the 5-year Treasury yield and the 30-year Treasury yield ended the quarter at 99 basis points, up from 40 basis points at the beginning of the year. Absent a recessionary shock, we believe this trend should continue, and we are positioned accordingly.
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