Insights Economic & Market Perspective: October 2025

Financial markets continued to post strong gains in the third quarter despite persistent economic and policy headwinds, as investors focused on resilient corporate earnings and expectations that the U.S. Federal Reserve would begin easing short-term interest rate policy.

Market Performance

The S&P 500^® Index rose 8.1%, its strongest third quarter since 2020, while the Russell 2000^® Index gained 12.4%, signaling early signs of a broadening of equities beyond the mega-cap leaders. International stocks also advanced, with the MSCI EAFE up 4.8% for the quarter and a robust 25.1% year to date. Gold climbed 16.8% as investors sought safety amid political uncertainty and expectations of further U.S. interest rate cuts.

Market leadership remains concentrated among the Magnificent 7 and other AI related stocks but improving earnings among small- and mid-cap stocks suggest participation is beginning to widen. Continued strength in earnings across sectors will be key to sustaining momentum into year end.

Economic Growth

U.S. growth remained firm through the second quarter. The Bureau of Economic Analysis revised the Gross Domestic Product (GDP) to a strong annual rate of 3.8% from 3.3% previously and 3.0% initially. First quarter GDP was revised down to –0.6%, reflecting a weaker start to the year. One key measure of domestic demand is final sales to private domestic purchasers, which rose to a 2.9% growth rate from a previous estimate of 1.9%, suggesting underlying strength in the economy despite trade-related uncertainty.

Labor Market

On the labor market front, conditions are tight but gradually cooling. Nonfarm payrolls rose by just 22,000 in August, and June’s figures were revised to a loss of 13,000 jobs, the first monthly decline in jobs since late 2020. With official payroll data delayed by the most recent government shutdown, which officially shut down at midnight on October 1, investors have turned to alternative indicators, such as ADP employment, Indeed postings, and the Job Openings and Labor Turnover Survey (JOLTS) data, all of which suggest slower hiring momentum.

Labor supply remains constrained by an aging workforce, fewer younger workers entering into full-time roles and reduced immigration. With softer labor supply, the economy now requires only about 75,000 to 100,000 new jobs each month to keep unemployment steady—since May 2024, the unemployment rate has remained between 4.0% and its current 4.3%. Although hiring has slowed, wage gains and steady employment continue to support spending among higher-income households. In contrast, lower-income households are starting to show signs of financial pressure.

Inflation

As for inflation, progress toward the Fed’s 2.0% target rate has stalled. The Fed’s preferred measure of inflation, Core PCE—the Personal Consumption Expenditures price index, which strips out volatile prices of food and energy—remains at 2.9%. The more commonly reported figure, Headline CPI—which measures the overall inflation rate for a basket of consumer goods and services, including food and energy—rose to 2.9% in August (from 2.7%). The combination of sticky inflation and softening labor data highlights the Fed’s competing priorities of stabilizing prices while sustaining employment.

Federal Reserve and Policy Outlook

In September, the Fed cut the federal funds rate by 25 basis points for the first time since 2024, bringing the target range to 4.0%-4.25%. Markets expect one or two additional cuts before year end, though several policy makers remain cautious as inflation remains above target. The pace of Fed rate cuts will influence whether the economy transitions smoothly toward steady growth or faces renewed inflation pressure.

Credit and Fixed Income Markets

Credit markets remained stable, with investment-grade spreads narrowing to their tightest levels since early 2022. Long-term Treasury yields eased modestly with the 10-year Treasury yield ending the quarter near 4.15%, after peaking at 4.48% in July.

Short-term instruments continued to offer attractive income as the Fed began easing policy. Despite equity market volatility, bond returns were stable, with the 10-year yield declining only 7 basis points during the quarter. We expect yields to stay in a narrow range through year-end, although volatility could return if growth slows or Treasury issuance remains elevated. Rising deficits and large borrowing needs continue to influence long term rates.

Global Markets

Looking overseas, international equities moved higher alongside U.S. markets, supported by improving growth in Europe, Japan and the U.K., and a weaker dollar. Europe continues to benefit from fiscal investment and defense spending commitments, while Japan’s corporate reform and wage gains are supporting equity performance. That said, the U.S. remains well-positioned due to strong earnings and greater exposure to global growth sectors.

Earnings and Valuation

Earnings growth for businesses expanded beyond large-cap tech. Small-cap profits improved, with forward estimates rising and valuations steady around 20 times earnings. Small caps still trade at a 25% discount to large caps, leaving room for gains if earnings momentum continues. Broader profit growth among smaller companies suggests market leadership may begin to widen if interest rate cuts proceed as expected.

AI and Market Leadership

Artificial intelligence spending remains a major driver of capital investment for businesses. Companies across multiple sectors are benefiting from rising investment for data centers, semiconductors and automation. While valuations in AI-related sectors are still high, earnings growth tied to AI is becoming more visible in corporate earnings results.

We see AI as a long-term driver of productivity and investment across industries. The key for investors is identifying where AI is strengthening business fundamentals rather than just inflating valuations, especially as capital spending data continues to surprise on the upside.

Tariffs and Consumers

Recent tariff policies by the U.S. government are starting to affect prices in categories like electronics, appliances and apparel, though the full impact is still unclear. Import costs are rising, and companies are deciding how much to absorb versus pass through to consumers. Inflation pressures are modest overall but more noticeable among lower-income households, which spend a greater share on everyday necessities. High-income consumers continue to spend at a solid pace, supported by equity market gains and a rising net worth which has offset softer middle- and lower-income demand.

Outlook

The third quarter ended with steady economic growth, stalled progress on inflation relative to the Fed’s 2.0% target, and unemployment near 4.3%. The government shutdown delayed some data, but this is unlikely to affect the overall outlook for the U.S economy. Looking ahead, the balance between inflation pressures and maintaining growth will shape market trends. Government spending, productivity gains and AI investment should continue to support growth, while rising deficits and trade tensions pose longer-term risks.

We remain optimistic about the overall health of the economy and financial markets, while staying attentive to potential signs of stress in areas such as the labor market. In this environment, we believe investors should continue to prioritize quality companies with reasonable valuations and maintain broad diversification.