Hello, everyone. And welcome to the June Market Compass. Believe it or not, we are now headed towards the second half of 2025. We thought this would be a good time to reflect on how the economy and markets did in the first half and what we're watching for in the second half of 2025. In this episode, we take a look back at key economic data and a look forward into the second half of 2025 and discuss where we see opportunities in portfolios and investments heading into year end.
Overall, economic data has delivered in the first few months of the year, despite the uncertainties around tariffs, trade, and taxes. First, economic growth remained above trend. Now, while US GDP was soft in the first quarter, driven in large part by a huge spike in inventories, it is on pace to exceed 3% in the second quarter. This is driven by solid household consumption figures of about 2.5%.
Second, the US labor market has held up despite worries of a slowdown. Now, while job growth is cooling, we continue to see an unemployment rate of around 4.2%, well below the long-term average in the US of about 5.5% Notably, wage gains of around 3.9% continue to outpace inflation, which means consumers are benefiting from real positive wages.
Finally, inflation has remained contained thus far in 2025. Headline CPI inflation remains around 2.4% while core inflation is around 2.8%. In our view, tariffs have not yet impacted goods prices, perhaps because companies had built inventories and continue to do so even during this 90-day pause. This should help alleviate pricing pressure even as we head to the back half of 2025.
Some of this better data has been reflected in recent stock price movements, after falling nearly 20% from the mid-February highs. The S&P 500 has since rebounded and recovered over 20%. In our view, this reflects both solid economic and earnings data, as well as the US administration walking back some of the higher tariff rates. Now, as we head to the second half of 2025, we are, of course, watching a few key variables.
First, tariff and trade negotiations this summer-- in our view, it is likely that tariff rates will move substantially higher from about 2% rate we saw at the beginning of the year to perhaps 10% plus and even potentially higher on China and other select sectors. Now, this could weigh on both inflation and economic growth, but it is important to keep in mind that the US is a services-driven economy, with around 70% of GDP coming from the services sector. So while tariffs could impact goods pricing and demand, they may not have as broad of an impact on a service-led US economy.
Second, the US tax bill is likely in mid-July. We will also be watching for how the US tax bill unfolds and what the final details in this bill include. In our view, while there are some marginally stimulative measures being proposed in the potential tax bill, the biggest component is the extension of the Tax Cut and Jobs Act. This, however, is a status quo to the current tax backdrop and may not alter corporate spending or behavior meaningfully.
Finally, Fed rate cuts likely towards the end of 2025. Now, we would expect the Fed to cut interest rates in the back half of the year as well. As of June 12, 2025, the Fed funds rate is about 4 and 1/4 to 4.5% and remains well above inflation rates of around 2 and 1/2 to 3%. And thus the Fed has some room to move rates lower. Now, if the economy or labor market softens, the Fed is more likely to cut rates. Thus far, we see one or two rate cuts in 2025 likely.
Overall, economic data held up well in the first half of 2025, despite uncertainty around trade and tariffs. After a strong run in stock markets, we could see bouts of volatility emerge as investors digest news on tariffs as well as a US tax bill. However, as we head into the back half of 2025 and into 2026, investors may have a better setup. The Fed may be cutting rates. We should have more clarity on tariffs and the tax bill.
Now, there is a potential for corporate earnings growth to reaccelerate next year as well. In this environment, we believe bouts of volatility can be used as opportunities to add quality investments at better prices. We continue to favor diversification and broadening leadership as key investment themes. We recommend overweight positions in both US large cap and mid-cap stocks. From a sector perspective, we favor financials, health care, and exposure to growth sectors. And within investment-grade bonds, we see value in the 7 to 10-year maturity space, with yields still favorable around 4.5%.
Now remember, for long-term investors, strategies like dollar-cost averaging to gradually and consistently add exposure to markets have historically been a strong approach to meeting long-term financial goals. And with that, I thank you. Hope you're enjoying the start of the summer season, and we'll see you right back here next month for the Market Compass.