4th QUARTER 2025 MARKET OUTLOOK
09/16/2025
Investors may want to consider rotating from cash to Treasuries and/or corporate bonds.
Thrivent Asset Management contributors to this report: John Groton, Jr., CFA, director of administration and materials & energy research; Matthew Finn, CFA, head of equity mutual funds; and Kent White, CFA, head of fixed income mutual funds
While the slowdown could accelerate, we think lower interest rates will provide some stability.
We expect three 0.25% cuts in the U.S. Federal Reserve’s policy rate by year-end, but this forecast is highly sensitive to reported economic data.
Favor large-cap U.S. equities, short-duration Treasuries and high-quality credit.
The U.S. economy has been stronger than most forecasts, despite high levels of policy uncertainty, particularly around international trade. Consumer spending has stayed robust, unemployment has stayed near historical lows, and there has been substantial investment related to artificial intelligence (AI). As a result, earnings have held up better than most analysts expected and have been repeatedly revised higher.
Recent employment data, however, suggests the labor market may be weakening faster than expected. As a result, the U.S. Federal Reserve (Fed) is likely to lower interest rates steadily in the coming quarters. If the economy deteriorates more quickly than we expect, the Fed likely would more aggressively cut its target rate. We expect the full impact of existing tariffs to reach consumers in the coming quarters; it takes time for companies to work down their existing inventories, and many companies have absorbed at least part of the tariffs, for now. Higher inflation remains a risk to both consumption and the more optimistic assumptions about the Fed’s expected interest rate cuts.
As we enter the fourth quarter, the S&P 500 Index® is trading near record highs, the VIX (a measure of stock market volatility) is close to multi-year lows, and 10-year Treasuries are currently yielding about 4.0%—near their average yield over the past few years. In short, markets are optimistic, even complacent, as they look toward year-end. While we share this optimism, we are mindful of the many risks to the economy. We continue to favor balanced portfolios with a modest overweight to stocks, and we favor higher-quality short-duration exposure in bonds, as they are most sensitive to rate cuts by the Fed.
Economic growth has moderated, likely driven in part by the uncertainty around tariff and trade policy. But consumer spending, which drives about two-thirds of the U.S. economy, has held strong. In aggregate, consumers have shown little sign of reduced spending, bolstered by income gains greater than inflation. But the aggregate data is skewed by consistently stronger spending from the higher-income tiers, which account for about half of all consumer spending. Lower income tiers have shown more apprehension about their future finances and higher prices.
The labor market is an even greater concern. The U.S. economy generated only 22,000 new jobs in August, well below expectations and the second consecutive weak report. Private payroll growth, excluding the distorting effects of the COVID-19 pandemic, is now near 15-year lows. Continuing claims (unemployment claims that extend beyond one week) are still low, but rising, and longer-term unemployment is reaching levels often associated with a recession.
While the job market could stabilize, weak employment can trigger a vicious cycle: Fewer jobs result in less spending, resulting in expectations of lower corporate profits and thus increasing layoffs. This outcome is not our base case, however. We remain optimistic that lower interest rates and a more business-friendly tax and regulatory environment should provide the needed support.
The core personal consumption index (Core PCE), the Fed’s preferred measure of inflation, has been trending up since April after plateauing just below 3% in preceding quarters. Price increases for goods have driven this uptick—thanks in part to tariffs—and services inflation has begun to increase recently, as well.
Nevertheless, after the Fed’s annual Jackson Hole meeting in August, Chairman Jerome Powell signaled that the Fed is increasingly more focused on weaker employment than higher inflation. Powell indicated that the Fed may be slightly more tolerant of inflation above its target rate, likely because it views the price increases driven by tariffs as temporary.
We expect the Fed to begin another interest-rate cutting cycle in September because of weakness in the jobs market and other less robust economic data. We also believe the Fed sees the current policy rate as somewhat restrictive, suggesting that a few 0.25% cuts would not significantly raise the risk of accelerating inflation.
Our base case is that the Fed will make three 0.25% cuts to the policy rate before the end of 2025, with additional cuts likely in 2026. But the exact number and timing of cuts will depend on employment trends.
We expect equity investors to react favorably to rate cuts, providing support to stock prices. Lower rates will help consumers by lowering borrowing costs, provide some support to an abnormally slow housing market and likely boost the economy. Additionally, lower interest rates will reduce the cost of financing the U.S. government’s debt—which is currently quite high—lowering concern about the deficit’s sustainability.
Despite the S&P500 Index being near record highs and signs of economic weakness, we think lower interest rates and a more supportive fiscal and regulatory environment will bolster equity markets in the fourth quarter of 2025. Relatively high valuations may limit further upside, but stocks’ sensitivity to shorter-term policy uncertainty has subsided, helping to refocus the market on expectations for sustained earnings growth.
Small-cap stocks outperformed their large-cap peers, thanks to improving earnings, the prospect of lower interest rates and an increase in investors’ risk appetites. However, we believe the bounce in small-cap stock prices in August was largely technically driven, following Chairman Powell’s more dovish comments after the Jackson Hole meetings. Since the August bump, small-cap stocks have underperformed large-caps.
International markets performed well in the early months of 2025 because of supportive domestic economic factors and a weaker dollar. But in recent months, international stocks have underperformed U.S. markets on a local-currency basis. Long term, we think international stocks will underperform because of long-standing structural factors outside the U.S., including weaker demographics, lower productivity and relatively higher-tax regimes.
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Shorter-dated Treasuries are already pricing in lower interest rates. Until we see evidence that the economy is accelerating, expectations for policy rates are likely to remain low or fall further, putting downward pressure on short-dated Treasury yields. The outlook for longer-dated Treasuries is more difficult to forecast, but we believe yields are subject to competing forces. A slowing labor market pushes rates lower while the Fed’s increasing tolerance for inflation and the large, growing supply of Treasuries needed to finance U.S. federal debt works to drive rates higher.
Turning to credit markets, investment-grade and high-yield bonds have performed well, trading with persistently tight credit spreads (i.e., the yield premium paid over corresponding Treasuries). Investment-grade yield spreads are approaching their lowest levels in 27 years, and high-yield (sub-investment grade) spreads are not far from their all-time lows. Demand for these bonds comes from their generally strong credit fundamentals but also from broad-based demand for yield that extends across fixed income sectors. Despite these strengths, we continue to favor higher-quality credits; the combination of tight valuations and a weakening economy raises the risk of spreads widening, which would be more amplified in lower-rated credits.
The labor market, in our view, remains the key risk for markets in the fourth quarter. To date, the economy is not losing jobs, but a sharp downturn in labor data could spark a vicious cycle, with equity markets falling and the Treasury curve flattening. Similarly, inflation also bears watching closely as an unexpected surge could derail the Fed’s willingness to cut interest rates, disrupting both stocks and bonds.
Any erosion of the Fed’s independence remains a concern. A more political Fed is much more likely to keep rates lower to boost the economy, which could push inflation higher and ultimately damage the economy in the long run. While this risk has been considered in current Treasury yields, if the Fed’s independence is threatened further, the bond market would likely react with higher long-dated rates and the dollar could weaken further.
Longer term, we are mindful that the strength in equity markets has been narrowly constrained in large-cap stocks. History shows that when markets are very concentrated, forward returns are often lower than trend levels. Large-cap stocks’ outperformance has been largely driven by the assumption that AI will fulfill high expectations. Any wavering of these expectations could trigger a repricing of future earnings, which could affect the broader market.
Tariffs, other policy decisions and an increasingly volatile geopolitical environment are major threats to financial markets. Despite these risks, we remain optimistic about the U.S. economy’s long-term ability to navigate uncertainty, innovate and deliver the earnings growth that drives market returns.
Media contact: Callie Briese, 612-844-7340; callie.briese@thrivent.com
All information and representations herein are as of 09/16/2025, unless otherwise noted.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
Past performance is not necessarily indicative of future results.
Diversification does not guarantee a profit or protect against loss in a declining market.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.
