2025 Midyear Outlook: Pragmatic Optimism – Measured Expectations
The current economic landscape is difficult to gauge given all the distortions that obscure the true health of the economy. After a decline in gross domestic product (GDP) in the first quarter following a surge in imports, the subsequent rebound in growth might create a perception of a strong recovery, but we think this is likely a false dawn. The whiplash in trade policy is adversely impacting official economic data and creating difficulties for investors, as it becomes almost impossible to discern whether the economy is genuinely rebounding or merely experiencing short-term fluctuations.
Such distortions highlight the importance of looking beyond government statistics to industry reports from the likes of the Institute for Supply Management (ISM) to form a clearer picture of economic conditions. The ISM Composite Index, which gives insights into business views from across the country in both the goods and services industries, fell in recent months and points to a broader slowdown coupled with reaccelerating inflation.
The May ISM Report on Business for the services sector revealed some disturbing realities for several sectors amid trade uncertainty. For example, the amount of new orders contracted for the first time in nearly a year. Tariff impacts are also likely elevating prices paid by services sector companies, with the Prices Index hitting its highest level since November 2022 when annual inflation rose to 7.1 percent.
Business leaders’ perspectives serve as a vital complement to official government statistics, which often suffer from low response rates and delayed reporting. Listening to these insights helps provide real-time signaling on industry health and emerging risks, which is even more crucial in uncertain economic times.
Fed officials have expressed concern over the difficult tradeoffs involved in navigating the current environment, especially as new tariffs and policy measures could exacerbate inflationary pressures. This echoes the past, when aggressive monetary tightening was eventually implemented to tame inflation, often at the expense of economic growth, illustrating the delicate balancing act policymakers must undergo at the moment.
For markets, these challenges present a difficult environment because they combine the adverse effects of inflation, weaker employment, and slow growth, which impact various asset classes differently. The stock market, for instance, tends to struggle when growth-oriented equities, including tech companies, start to suffer from rising borrowing costs and waning demand. The bond market, on the other hand, is historically negatively impacted when inflation rises as fixed income returns get eroded in real terms. Meanwhile, commodities like gold can often perform well in such environments, but the associated rising raw material costs can end up harming industries reliant on industrial production.
Ultimately, investors must remain vigilant, relying on industry trends and early indicators rather than lagging official statistics to identify emerging opportunities and sidestep risks.
Expect a Slight Reacceleration of Inflation in the Back Half of 2025
Headline inflation has decelerated to 2.1 percent annually so far this year. Core inflation reached 2.5 percent from a revised 2.7 percent in March. However, this looks to be a near-term low and we think inflation could reaccelerate for the remainder of 2025 as both supply and demand pressures will start to push annual inflation rates higher.
In the latter half of 2025, we expect a modest reacceleration of inflation, driven primarily by modestly growing demand and adverse supply chain dynamics. Excluding potential tariff-related impacts, the headline Personal Consumption Expenditures (PCE) index is expected to rise from its recent low of 2.1 percent in April to around 2.5 percent. Tariffs could add to this baseline inflation forecast as ongoing consumer income growth may further underpin demand-driven inflationary pressure.
Supply constraints are also anticipated to play a significant role in maintaining inflationary pressure. As companies reassess and restructure their supply chains — prompted by geopolitical shifts, technological changes, or lingering disruptions from previous shocks — there will be increased costs associated with the production of goods and their distribution. This reevaluation of supply chains will lead to shortages or delays, which in turn push consumer prices higher. Such factors underscore the complex interplay between demand-side momentum and supply-side constraints, both of which we think will ultimately work to keep inflation rates above the Fed’s 2 percent target.
Choppy Waters Could Upend the Labor Market
The labor market looks to be stable in the near-term, but we see “choppy waters” on the horizon that could serve to significantly disrupt recent positive employment trends. To start, we think many companies will start to face hurdles in maintaining current employment levels.
In the Fed’s June Beige Book, we saw all 12 Fed districts describe lower labor demand, citing declining hours worked and overtime, hiring pauses, and staff reduction plans. Given this, it is not difficult to see lower payroll numbers in the coming months, especially if we do not get more clarity on international trade policy.
Gauging this going forward, the monthly metrics on the “quits” rate and “hires” rate should give indispensable insights. The quits rate will give us a better look into workers’ inclinations to voluntarily quit work in search of better prospects. When the job market begins to weaken, workers become less inclined to quit their current jobs. Similarly, the hires rate measures businesses’ demand for labor. Both workers and firms are experiencing a weakening labor market.
Trade Uncertainty Will Be a Top Concern
American companies are currently facing significant risks stemming from tariff uncertainty, which has become a major obstacle to strategic planning and investment. Volatile trade policy, characterized by unpredictable tariff adjustments, creates an unstable environment that discourages firms from committing significant capital to expansion and new projects. When tariff policy is so fluid and unpredictable, companies are hesitant to invest in new manufacturing facilities, infrastructure, or international markets, fearing changes will erode profit margins.
This unpredictability adds a layer of financial risk that complicates long-term planning, forcing companies to adopt more cautious and conservative approaches to growth. This hesitation not only dampens immediate growth prospects but also prolongs the period of economic sluggishness, as companies prioritize risk mitigation over innovation and expansion. In this context, tariff uncertainty remains a critical barrier to sustained economic growth and competitiveness for American businesses and will drag on the economy in the second half of the year.
The Bottom Line
In the second half of the year, the delayed effects of trade policy will begin to take a more noticeable toll on the economy, resulting in slower growth, weakening labor demand, and a modest uptick in inflation. These emerging challenges will create a more complex landscape for the Fed, requiring them to navigate carefully as they assess the appropriate course for monetary policy. Tariff and geopolitical headlines will continue to drive market sentiment, adding complexity to both growth and inflation forecasts.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. Contact Jonathan Benner, Certified Financial Planner™ with LPL Financial, at jonathan.benner@lpl.ocm or 636.200.4204. To view the complete Midyear Outlook 2025: Pragmatic Optimism – Measured Expectations, visit lplmycfo.com.