The Economy
After several quarters of gains in Gross Domestic Product (GDP), the economy contracted during the first quarter at an annualized rate of -0.5%. Decreases in GDP reflected an increase in imports as retailers sought to build inventories following Trump’s announcement of higher tariff rates. There was also a decline in government spending. These effects were partially offset by increases in investment and consumer spending. (Second quarter GDP data will be released July 30.)
Employment numbers remained healthy as nonfarm payrolls rose by 147,000 in June. The unemployment rate was 4.1%, and wages grew at an annualized rate of 3.7%.
Recent data from the University of Michigan’s Surveys of Consumers have shown a decline in consumer sentiment on inflation, personal finances, and the economy. While June reflected a 16.3% increase in sentiment over May’s Surveys, consumers are still more negative on inflation and personal finances than they were one year ago, with a decline of 11.0% in overall sentiment.
The Consumer Price Index (CPI) increased 0.3% in June, after rising 0.1% in May. CPI increased at an annualized rate of 2.7%. The rate reflected increases in prices for household furnishings, medical care, recreation, clothing, and personal care. Core CPI, which includes all items less food and energy, saw a smaller rise, up 0.2% in June. Core CPI increased by 2.9% over the last 12 months. The Fed’s preferred measure of inflation is the Personal Consumption Expenditures Index (PCE). The Fed is currently targeting a 2% rate of inflation by this measure. In May, Core PCE inflation grew at an annualized rate of 2.7%, and consumer spending decreased $29.3 billion from April.
Fixed Income Markets
After 1.0% of rate cuts in the latter half of 2024, the Fed has continued to hold rates steady at a target of 4.25% - 4.50%. The next Fed meeting will occur on July 29 and 30; however, few economists expect a rate cut announcement at that meeting.
The yield on 2-year U.S. Treasuries was 3.72% at quarter end, and the yields on 5- and 10-year maturities stood at 3.79% and 4.24%, respectively. The yield on 30-year Treasuries was 4.78%. The yield on 3-month Treasury Bills was 4.41% as of June 30, up 0.09% from 3 months ago.
For the quarter, fixed income market returns by sector were positive, except for Long Government/Credit, down 0.2%. Developed International Bonds led returns, up 7.6%.
Equity Markets
While there was a wide variance in returns between sectors, the broad market S&P 500® Index was up 10.9% in the second quarter. Information Technology led performance, up 23.7%, Communication Services and Industrials also went up strongly, at 18.5% and 12.9% respectively, while Energy was down 8.6%. Healthcare also significantly underperformed, down 7.2%.
Growth stocks outperformed Value stocks across the investment style spectrum; the variance was wide, with a return difference of 14.0% between Large Growth and Large Value. There was also a wide divergence in returns by market cap, as Mid Growth led returns at 18.2% while Small Growth posted a return of 12.0%.
For the quarter, both Developed International and Emerging Markets (EM) bested the return of the broad U.S. market Russell 3000® Index. Developed International Markets were up 12.3% and Emerging Markets were up 12.2%. On a regional basis, EM Latin America outperformed all other regions with a return of 15.4%. The lowest return for the quarter was in the European, Middle Eastern, and African countries represented by the EM EMEA Index, up 7.7% for the quarter.
For the one-year period ended June 30, Developed International and EM also posted gains versus the U.S. Equity Market. Developed International Markets were up 19.3%, outperforming the Russell 3000® Index by 4.0%. EM markets were up 16.0%, besting the Russell 3000® Index by 0.7%.
Outlook
Most tariffs have been paused until August 1 as the White House continues negotiations with key trading partners, including the Eurozone, China, and Japan. With second quarter earnings being announced over the coming weeks, Wall Street is expecting to see the early impacts of trade tariffs on corporate financial results.
There is tension between the Federal Reserve and the White House on the timing and depth of rate cuts. The Fed remains cautious as it evaluates the effects of tariffs on inflation and the U.S. economy. The Fed is also monitoring the impact of immigration policy changes on labor markets and inflation. Treasury futures trading implies a low likelihood of cuts at the July meeting but holds open the possibility of two to three rate cuts later in the year.
Congress passed Trump’s tax and spending bill in early July. Initial assessments indicate that the Bill’s provisions could increase the federal deficit by up to $3.3 trillion over the next ten years. A deficit increase could discourage international investors who are concerned about the sustainability of increasing government deficits.
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