Sam, Chris, and Brad

Welcome to the Market Observatory, where we scan the economic horizon and spotlight the key trends that will shape the month ahead. I'm Sam Millette, director of fixed income research. And I'm Chris Fasciano, chief market strategist. This month, we're excited to bring you a special Midyear Outlook edition of the Market Observatory, joined by very special guest Chief Investment Officer Brad McMillan. Welcome, Brad. Great to be here. Thank you for having me. We're looking forward to hearing your perspective, Brad. So, let's jump right in with what we're expecting for the economy and markets in the second half of the year.

Chris

The first half of the year was quite a roller coaster, driven almost daily by headlines about tariffs and trade policy, and those headlines had a big impact on the equity markets and the fixed income markets. But the other area we saw was in some of the soft economic data, like consumer confidence, which dropped to lows that we haven't seen in a long time. But the interesting thing is that the hard economic data remained pretty robust. Jobs growth has slowed, but we still have pretty good jobs growth. And that means people still have money and they're spending it. So from my perspective, I think what we need to see going forward for that to continue is we need to get some resolution around trade policy that eliminates or reduces tariffs further. And then we need to see the budget bill get negotiated, agreed to, and pass in Congress because that will actually start to put some stimulus into the economy in the back half of the year. And I think if we can continue to build that momentum in the back half of the year, then that will have meant the momentum we saw at the end of 2024 allowed us to get through the headwinds. And then you get stimulus to take us into 2026. But I'm curious what you're seeing, Brad.

Brad

Well, I certainly agree with everything you said. And you know, and going forward, we have the existing momentum, and that's likely to continue. But at the same time, that depends on if we get the tariffs sorted out, if we get the budget passed: if, if, if! I mean, you know, there's a lot of things that have to go right for that to happen. And the fact of the matter is, we are seeing some slowdown, and we are seeing some potential signs of recession. So, I don't think that's by any means nailed down. I acknowledge the possibility, and I think the real issue here is that momentum will cushion any downside. But I'm a little bit more cautious going forward.

Chris

So, Sam, that's kind of a wide range of potential economic outcomes that we might see in the back half of the year. What does it mean for fixed income investors?

Sam

Yeah, that's a great question, Chris, and I think it's the exact question that the Federal Reserve has kind of been dealing with throughout the course of this year. It's that idea of where is the economy and what's the right level for monetary policy. I would argue that, as you mentioned, the soft data has been relatively concerning to start the year. You see confidence fall pretty consistently, and a big driver of that fall in confidence has been increased short-term inflation expectations, which the Fed is keeping a close eye on because rising inflation expectations can create a vicious inflationary cycle. With that being said, the hard data, so actually reported inflation data, has been improving throughout the course of the year, right? On a consumer basis, year-over-year, prices last month had their best result in multiple years. So, I think that that's really going to be the question. That being said, uncertainty historically has helped high-quality fixed income, right? So, I think that that could be a potential tailwind for fixed income investors as we enter into the second half of the year.

Chris

Yeah, so it's interesting how we tie this all together, Brad, because there were points in the first half of the year where people were very worried about the way the equity market was functioning and the way the fixed income market was functioning. And I'm curious what you think of that as we move forward.

Brad

Chris, the real takeaway here was, everything was working. You know, the market was responding to very real economic issues, and it was responding in a way that indicated that it was really working through the consequences. In other words, it was rational, and that's exactly what you want and need to see in a market. You know, things change pretty quickly. You want the market to respond reasonably, and that's what we saw. Going forward, there's a lot of things that can happen, as we talked about, but nonetheless, given everything that's already happened and the rationality of the response, I think that reduces the odds of some kind of dislocation, which is what I'm really worried about. So I'm actually reasonably cheerful about we're going to see the market continue to do something responsible rather than something irresponsible.

Chris

And I think that's something we can all agree on, despite the roller-coaster ride we've all been on for the first half of the year, decisions were being made with a rational basis, and that ought to tee the market up to act pretty well functionally going forward. And from my seat, that's a really good thing, because after a couple years where we saw returns driven by a very narrow part of the market, diversification is back in vogue. You've seen other sectors perform well. You've seen international markets perform well. And, Sam, even when the U.S. equity market was coming under pressure, bonds acted pretty well.

Sam

Absolutely. You know, that was one of the silver linings for investors over the first six months of the year was that bonds were acting like bonds in times of uncertainty. And I have full faith that they'll continue to do so in the second half of the year.

Sam

Well, thank you both for an engaging conversation, and thank you all for joining us. Please join us again next month for another update from the Market Observatory. And for further content from our 2025 Midyear Outlook, please check our Insights blog.

For more market and economic analysis, check out our Insights blog: commonwealth.com/insights

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