2025 Quarter 2 Commentary

“Oh, I’ve seen fire and I’ve seen rain"

-James Taylor, “Fire and Rain”

It is fair to say that investors have been put through the wringer in the second quarter of 2025. The announcement of reciprocal tariffs in early April sparked a two-day selloff that ranked among the top 10 worst two days of selloffs since 1950ⁱ. The panic caused by these large, proposed tariffs led not only to sharp declines in the stock market, but also high volatility in long-term Treasury rates.

Within a short time, the 10-year U.S. Treasury rate moved from 4.38% on March 27 down to 4.01% on April 4 and then back up 4.48% on April 11. That amount of movement was symptomatic of the high degree of uncertainty caused by the administration’s trade policy proposals. It was enough to lead President Trump to call an audible and delay implementation of tariffs for 90 days while the U.S. negotiates directly with its trading partners. A welcome recovery in markets in May and June followed the initial announcement.

By the end of the quarter, the Russell 1000 Index (large cap U.S. stocks) was up 6.1% year to date, while the Rusell Midcap Index was up 4.8%. International stocks, as measured by the MSCI All Country World Index ex-U.S., were up 17.9% as the U.S. dollar depreciated against other currencies. Only the Russell 2000 Index (U.S. small cap) ended the quarter lower than the start of the year, down 1.8%.

Once investors got past the shock of the initial reciprocal tariff announcements, the news since “Liberation Day” has not been as bad as feared. While “soft” data, which includes indexes such as consumer sentiment surveys, has shown deterioration, “hard” data points, such as unemployment and payrolls, have remained steady. Soft data attempts to quantify the qualitative, which can be tricky. For example, the University of Michigan’s Index of Consumer Sentiment is designed to capture how U.S. consumers are feeling by asking questions about personal finances, business conditions and economic activity. The index showed a plunge upon the tariff announcement in April. And while the index showed some recovery in May and June, it still sat well below the reading from December 2024.

On the other hand, hard data such as the Bureau of Labor Statistics’ nonfarm payrolls attempts to measure the total number of paid workers in the U.S., excluding specific categories such as farm workers and active military personnel. The chart to the right specifically examines the monthly change in the level of nonfarm payrolls. Although the first five months in 2025 appear to show a lower overall level of new jobs being created than in some months of previous years, these 2025 payroll numbers have been slightly better than economists had expected, thus supporting the narrative that the situation is not as bad as was feared in April.

Summing up this outlook at a recent Milwaukee Business Journal Mid-Year Outlook eventⁱⁱ, the Federal Reserve Bank of Chicago President Austan Goolsbee, a former economic adviser to President Obama, said, “Somewhat surprisingly, thus far, the impact of tariffs has not been what people feared.”

While volatility has declined during the quarter, it may return, so maintain vigilance. Much uncertainty remains around the direction of trade policy. Many of the announced reciprocal tariffs were delayed while the U.S. negotiates with other trade partners, but nearly all the negotiations have yielded no results so far (with the exception of the U.K.). In addition, the baseline 10% tariff will remain in effect. The open conflict between Israel and the U.S. on one side and Iran on the other appears to have abated with no real effect on oil prices, yet concern remains about future outbreaks of conflict in the region.

Stock markets continue to recover from the dramatic selloff in the first week of April. First quarter’s earnings, which are reported during the months of April and May, came in better than expected. This continues the theme – the economic picture is not as bad as feared. Looking ahead, analysts have trimmed their estimates for corporate earnings over the next four quarters, mostly due to trade policy uncertainty. However, analysts still expect growth in earnings in each of the next four quarters.

Notably, estimates for profit margins among S&P 500 companies have not been negatively impacted by tariffs. The chart below shows the reported operating profit margin for the S&P 500 in blue. Operating profit margin is the percentage of revenue that is retained before income taxes. The most recent level is 12.9%, which means that for every dollar in revenue generated, S&P 500 companies made 12.9 cents in operating profit. The red line is a forward-looking estimate for the operating profit margin, and it implies an expectation of continued growth.

As noted earlier, long-term rates were quite volatile in the days before and after the tariffs announcements, but that has not been the only period of rate volatility. This year alone has seen the 10-year U.S. Treasury rate peak near 4.8% in mid-January, then decline to almost 4% with the reciprocal tariff announcements, then rise again to 4.6% in mid-May before finally settling around 4.2%. Interestingly, the Fed Funds Rate, which is the rate set by the Federal Reserve that governs overnight interbank lending, now sits at 4.375%. That is higher than nearly every part of the Treasury yield curve. In other words, only two- to three-month Treasury bills and Treasury bonds maturing in 20 years or longer have higher yields than the Fed Funds Rate.

This implies that the market believes that the Fed is a step slow and should consider cutting the Fed Funds Rate. The next Fed meeting is set for late July, and although Chairman Jerome Powell’s comments have been interpreted as against a rate cut in the near term, he has recently begun hedging his language. However, we continue to monitor any developments.

Thank you and stay cool!