Market volatility. U.S. government debt. Tariffs. How will these issues play out over the remainder of 2025? Coming up, we have some expert predictions.

From Thrivent Asset Management, welcome to Advisor’s Market360^™, a podcast for you, the driven financial advisor.

At the end of each year, many dictionaries offer up a “word of the year.” Based on the first six months of 2025, the word “volatility” will probably make many short lists. That’s because volatility has impacted investors, consumers, inflation and the overall economy. In this mid-year market outlook, we address volatility and many other economic issues. As usual, we have assembled an outstanding team of Thrivent Asset Management experts: Steve Lowe, Chief Investment Strategist; David Spangler, Vice President, Model and Mixed Portfolios; and Kent White, Vice President, Fixed Income Mutual Funds.

Let's get into it…

As mentioned earlier, volatility was a dominating force over the first six months of 2025. One of the biggest issues with volatility is that it injects a lot of uncertainty into the markets, consumer behavior and the economy overall. We will let Lowe explain:

Lowe: So, the issue is that uncertainty can slow economic activity as consumers and companies don't know the rules. And it makes it very hard to plan. If you look at CEO confidence, it's low. And that could be very correlated with not necessarily layoffs but less hiring that they pull back. And we have seen hiring slow and consumer confidence was low already and it decreased further. It's starting to improve a little bit as you know, tariffs unwind, or policy gets more clear. But consumer confidence for many years now has been heavily influenced by your political leanings and depends on who controls the administration or not. And the interesting thing is low consumer confidence isn't very predictive of actual spending. Spending has softened a little bit, was actually held up pretty well. So how consumers say they feel, what they do are often two different things. But historically, the longer uncertainty stays around, the greater chance of downside risk of slowing the economy.

Another word that has the potential to make many “word of the year” lists is “tariffs.” The Donald Trump administration has imposed, revoked and modified a variety of tariffs with our trading partners—which has led many to believe these tariffs will spark inflation. But has it? White has some thoughts…

White: We're likely to see some higher inflation. Well, we've seen some recent softening in the inflation data. We've seen very little of the actual impact from tariffs beginning to show up yet. The next few months are going to be really critical to see how that begins to flow through. And we should see those effects in Q3 and Q4 if we're going to see them. Where I disagree with these consumer surveys is on the duration of the inflation uptick. The tariff should only have a one-time increase in the inflation rate but will have a lasting impact on the absolute level of prices as long as the tariffs remain in effect. So, we're still just like the Fed. We're in kind of wait and see mode and kind of see exactly what the impact will be on the economy and consumer behavior.

Lowe had this to add about consumer behavior:

Lowe: Consumers have reason to worry about prices because inflation is up, but they consistently overestimate the level of inflation. You know, University of Michigan does a well-watched survey and they show very high expectations. You know, partly because of the impact of of tariffs. You know, one year inflation expectations have hit 7%. I don't think we're going to have 7% in inflation. That seems too high. And we really don't know the impact yet. You're seeing some increases but so far, it's more muted. That may change over time. And what the Fed is really worried about is embedded inflation expectations because that can change behavior. When people start to hoard, they buy forward, and they can push up prices. And companies raise prices because people expect them to go up. And so what the Fed is most concerned about is that they don't become embedded high inflation expectations.

With U.S. tariffs and policy uncertainty, many economists have been lowering their global growth forecasts. We asked Spangler what his expectations are—focusing specifically on Europe and China:

Spangler: I would expect a slower global growth overall as a result of more de-globalization and higher tariffs overall, regardless of where they end up settling out, if they're higher, it's going to restrain growth to some extent. I think that tariffs are bad for everybody, but they may be worse for Europe and worse for China overall relative to the U.S. Remember, U.S. is some 70% services, and we actually have quite a bit of exports, if you will, from services. We talk a lot about imports from manufacturing and our lack of manufacturing in the United States. But we shouldn't forget also that we have a lot of services that we actually do export. We're a services-oriented economy, so tariffs are going to have less of an effect on us than other economies that are much higher in terms of their manufacturing reliance. One example, of course, is Germany. Germany is very reliant on manufacturing and export.

If China continues to overproduce and export out to other countries, that will hurt those countries. Again, Germany is an example. The auto industry is in stress there because of Chinese EVs coming in. China is also exporting out quite considerably to the emerging markets. The emerging markets, they don't have a way of fighting back as well. So that's going to hurt the emerging markets. I think that overall, there's a long term secular reasons why growth would be a little slower.

Returning to tariffs, we asked White how interest rates have been affected. Here’s his explanation:

White: Tariffs on their own have a definite inflationary impulse as they increase the cost of important goods. And sequentially, this inflationary impulse would show up first in higher interest rates, which is exactly what we saw when the tariffs were first announced. Interest rates adjusted higher because we need to be compensated for higher expected inflation in the future. And this combination of higher inflation and higher interest rates is likely to have a dampening effect on consumer and business spending. So, a secondary impact from the tariffs would likely be slower growth. I think once we've seen the initial inflation bump, we're likely to then see a modest drag on growth as the tariffs run through the economy. It's important to keep in mind, though, that there are other potential things that may offset this growth drag, one of which is the tax and spending bill that's making its way through Congress. There's initial a front loaded tax cut, which could offset some of the tariff impact, too. We're really, really just in this a little bit more in an uncertain environment where we need to see. We haven't seen this before, tariffs like this, so we need to see how it just plays out, and we'll get a good sense of that soon.

In our last episode, we did a deep dive on the U.S. debt. We won’t go into as much detail, but the U.S. appears to be on an unsustainable path right now with rising debt levels. So what are the consequences of that? We asked Lowe:

Lowe: You know, debt to GDP is about 100%. It's expected to go up to 120%. And that would be a record level higher than where we were coming out of World War II after financing the war. And that's really a consequence. Right now, we're running budget deficits of 6 to 7% of GDP, you know, versus what used to be kind of 2 to 3%. And markets are starting to pay more attention. You look at risk premiums and interest rates. It's called the term premium. That has driven much of the increase in long-term rates, particularly like in a 30 year Treasury. So what does that mean? It means higher financing costs for, for companies, higher, you know, mortgage rates staying high, business loans, car loans and that can dampen growth. But more importantly, increases, you know, funding costs for the government. And interest expense is already over $1 trillion a year, which is equal to about half of discretionary spending. And my concern is you get stuck in this. I would call it like a doom loop, where higher interest rate costs, caused the deficit to increase because more and more goes to pay just interest costs. And as the deficit increases, that can increase interest rates, which then again start hitting, you know, the amount of debt that you have.

Now Moody's recently downgraded, you know, the last Triple-A rating for the U.S. down to double A. It’s the last of the three agencies to do it. Markets didn't really react, you know, as widely expected. But you can look at what I called credit default swaps and those kind of give you a probability of, you know, default risk. And the U.S. is at the same level as Greece right now. And remember, Greece is rated much lower but is also the poster child of the European debt crisis. Microsoft is triple A and is rated better than the U.S. government, which is kind of an interesting way to think about it. The corporation is a better credit than the government, you know, and if you look historically, debt levels don't matter a lot until you hit this tipping point and then suddenly, they matter a lot and funding costs go up to unsustainable, level. And, you know, that could ultimately happen if we don't start lowering deficits.

We wanted to know how the budget deficits impact the Treasury yield curve. Here’s what White had to say:

White: The primary impact on the Treasury curve is an increase in the term premium, which is basically the extra amount you need to be paid to lend money to the government for longer periods of time. This term premium has been rising since the beginning of the year. You can see it in the difference between 30-year and five-year Treasury yields. At the beginning of the year, that difference was about 35 basis points or 0.35%. It's currently 95 basis points. So, the term premium has increased by over half a percent.

There's a lot of factors that affect the term premium, but the one that's probably had the greatest impact is the size of the fiscal deficits that we're likely to see in the next few years. It's these ongoing fiscal deficits increase the amount of potential debt that the Treasury is going to need to issue, and particularly supply at the long end, where there aren't as many natural buyers. That's where we're seeing the most upward pressure on rates. So, that term premium, the Treasury curve has steepened where long-end rates have increased more than front-end rates.

Moving on to credit markets such as investment grade and high-yield corporates. We asked White if they have been as volatile as the equity markets this year. We also wanted to get his expectations for these credit markets…

White: We've definitely seen volatility in the credit markets, especially in the second quarter. We started the year near historical tight levels in investment-grade credit. We've seen a significant amount of volatility related to trade policy during the month of April and have recently returned to levels we saw back in February. It's been a back and forth, one-way trip, two-way trip, I guess. We've seen the same volatility no matter the credit asset class. We've seen it in high yield, other credit markets like emerging market debt, and even in municipal debt markets. We expect to see volatility persist through the year, not to the degree that we just saw, but going forward, I think what we're likely to see is an investment-grade credit and other credit markets stay in a rather narrow and rich trading range until we begin to actually see some weakness show up in the hard data, which might take a few more months. Right now, expecting things to be narrow range unless there's some other geopolitical events, which I think hopefully are behind us, but still just in a narrow range, still rich, and waiting for things to turn, potentially.

With credit markets remaining rich, we asked White if they are still attractive investments at these levels.

White: Yes. Well, off the recent highs, investment grade and high yield spreads still appear fully valued to us, though. We don't feel like we're getting compensated for all the risks and uncertainty that are currently in the market, particularly economic risk, and valuations are very tight. However, very strong demand for yield continues to keep spread levels at these rich levels, and we don't anticipate that that's going to change. That's the foundation of what's keeping things as rich as they are. It's just this huge demand for yield, which is understandable. We haven't seen yield levels like this in 15 years or so. We believe from our yield perspective that fixed income, no matter what asset class, is still at attractive levels, given our forward outlook. I would say really, one market that does look cheap is the municipal bond market. They've really underperformed, and they have lagged coming back other credit markets. And tax adjusted yields there, especially in the longer dated municipal debt, look really attractive at this point.

You heard White mention tax-adjusted yields. To be clear, that means the yield an investor would need to earn on a taxable bond in order for its yield to be equivalent to a tax reinvestment

Next, we turn our attention to equities. Back in April, U.S. equities briefly hit bear market levels, but then they rebounded very sharply. We asked Spangler his opinion on what was driving that rally and whether it is sustainable:

Spangler: It's actually relatively simple, which is that uncertainty caused the market draw down and a removal of some level of uncertainty allowed them to rebound. What was important was that we all knew that we were going to have a tariff announcement. We knew that, but what we didn't know was what it was going to be and how big it was going to be. And this was not the size in the scope of it was not priced into the markets. However, when we then relatively quickly, likely due to some bond market reaction, had a rollback of some of the tariffs that were announced early in April, then that provided an opportunity for the markets to rebound off of that.

I think that overall, generally, we are in a longer term secular bull market. We stay over weighted to equity, but we keep our eye on the overall volatility within the market. I think that if we don't see ourselves in a more protracted and expansive war in the Middle East as an example, then that uncertainty will also begin to abate as well. The challenge is that the starting point is difficult from this point on forward. Right now, we're at all-time highs or near all-time highs. Valuations are on a longer term basis relatively rich in the equity markets. So, to be able to move from here in a meaningful way is challenged. I think that we could find ourselves overall a little bit capped and sort of move up and down a little bit sideways, but I don't necessarily see a sell off from this point.

With the Magnificent Seven, or Mag 7, still making up about 30 percent of the market capitalization, we wanted to know if Spangler is concerned about the breadth of the market:

Spangler: Yes and no, which is to say that they are at unprecedented levels, and that does present some level of risk within the market. If you’re indexed within the S&P 500, you have to be very conscious of what's happening within the area of Mag 7, which is to say that if you see some of the narratives change, if you were to see questions arise again on the ability to monetize on AI, that could be an issue. If you see something come out of, let's say, China, similar to, let's say, DeepSeek earlier in the year, that then calls into question some of the significant capex spending on data centers and otherwise, then that could also be a challenge, too. You have to watch to see if there's any type of a material shift in the narrative. Then assess whether you think that this is a blip or a longer term type of a sea change that would require some action to be taken in terms of the overweight and concentration in the market.

But on the other hand, that's where the innovation comes from. One of the things that I think that people don't really think about is it could be a $2 or $3 trillion large-cap tech company. But the company in and of itself is one of the most innovative companies in the world. It also has a lot of investments in smaller private companies, and they act more or less like a venture capital company themselves.

Next, we want to hear what is concerning our experts. We will start with White:

White: My main concern, really still is the whole tariff issue. It's kind of been out of the news a little bit because we've been in this quiet negotiating period where we're trying to wrap up these trade deals with individual countries. I think that tariff risk hasn't gone away, and it's definitely something that we need to keep an eye on here for the rest of the year, especially in the near term, mostly because of the impact it could have or will have on businesses and consumers. It's also likely to have the greatest impact on earnings the rest of the year as well. It's really the source of all the uncertainty that we've had or most of the uncertainty that we've had so far in the markets, equity and fixed income, so far in 2025.

Spangler also has some concerns about the effects of tariffs:

Spangler: I would think also, too, with regard to the tariffs is if they do then begin to affect corporate margins, then that can begin to flow into employment. It's not just a slowing of hiring, but then it's not hiring, and then it comes into layoffs. That's really what we have to be very conscious of, because that will then result in economic slowing within the U.S. Consumer then would pull back as well. It becomes a cycle of tariffs raises prices, the prices cause margins to depress. That can then cause cost cutting, which is jobs, which then can lead to a pullback in consumer spending. Then we do have an issue. But it all comes back to tariffs, as you mentioned.

Lowe has a different concern:

Lowe: I think longer term, the deficit is a big issue. The level of debt and that may not be an issue for five years, 10 years, but it will be someday unless we change it. Then we hit this tipping point where markets force the U.S. to get its fiscal house in order. You saw that in other countries and the United Kingdom already. That happened and long-term rates went up and they had to cut their budget pretty significantly.

Finally, we wanted to learn how our experts are positioned for the coming months. We will start with Lowe:

Lowe: More broadly, we are moderately overweight equities, so we still have a little bit of a pro long term risk stance. We're underweight fixed income versus peers, but we're not straying too far from neutral because there is a lot of uncertainty, but we have maintained that overweight to equities. I think the threshold to get underweight is pretty high as timing to get back in is difficult.

Here’s how Spangler is positioned:

Spangler: We have a modest overweight to equities. Within equities, we remain overweight, large-caps and mid-caps. Within large-caps, it's more in the large-cap tech in growth areas  — generally speaking, within our asset allocation products. We are, modestly, but underweight small-caps. But overall, we've also been adding into private equity. So, the private equity is generally more small-cap. So, as we've taken away from small-cap public equity, we've added to small-cap private equity.

We did take an opportunity to bring in a little bit our underweight to international. So, we had about, just call it on average about a 4% underweight, and now it's about a 2% underweight in general. We've talked a little bit about some of the reasons for that, which is we don't necessarily think that on a local basis that the U.S. is going to underperform the rest of the world economically or in the markets, but the dollar could depreciate still further, and that could be a headwind overall to the dollar assets that we own. We brought in the underweight a little bit on international but still are underweight in that area.

And last up is White with his positioning for fixed income:

White: On the fixed income side, we remain defensively positioned, given risk, which we believe, skewed to the downside and where valuations are currently. We still have a little bit of an up in quality bias in our portfolios. We have a little bit more U.S. Treasuries in our portfolios, a little bit more weighting to mortgage-backed securities, which seem attractively valued right now. Just within corporates, just more of a higher rated, up in quality, more defensive sectors. By defensive sectors, I mean looking out at what we see as the main risk is tariffs. We're favoring sectors that are less exposed to tariffs and to an uncertain macroeconomic environment. Those sectors are sectors like cable, telecom, U.S. utilities. We're underweight to industries that are a little bit more exposed to the tariff situation in a weak economy like consumer, retail sectors and autos.

We covered a lot of ground today, so what are the big takeaways you can share with your clients? Here are a few:

First, everyone should get comfortable with volatility. It’s not a stretch to think we will be on a bit of a rollercoaster ride through the end of the year.

Second, it’s important to keep up with what is going on with tariffs. Depending on the countries and goods involved, there could be meaningful shifts in portfolio construction.

And third is U.S. debt and deficit spending. Although not an immediate risk, this will become more of an issue in the years to come.

As to whether “volatility” or “tariff” will be the word of the year, we will just have to wait.

That wraps up our mid-year outlook. Once again, we would like to thank Steve Lowe, David Spangler and Kent White for their insights. What did you think of this episode? Email us at podcast@thriventfunds.com with your feedback or questions for our experts. Want more episodes of Advisors Market360^™ and other market and investing insights? Visit us at thriventfunds.com, where you can learn how we can partner with you, the driven financial advisor. Bye for now.

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