Throughout much of the year, concerns about tariffs, inflation, a slowing economy, and weak corporate and consumer sentiment dominated the headlines. However, those fears have dissipated, and it is now clear that the U.S. economy is chugging along at a healthy clip. The Atlanta office of the Federal Reserve publishes running estimates for GDP growth during the current quarter, GDPNow. The Atlanta Fed raised their GDPNow estimates for real GDP growth (seasonally adjusted annual rate) from 2.2 percent in August to 3.8 percent by the end of September.
The International Monetary fund (IMF) slightly raised its full year 2025 projected growth rate for the U.S. economy to 2 percent, stating several reasons for the stronger performance. Most countries refrained from retaliating against the tariffs imposed by the United States, and the private sector front-loaded imports while rerouting supply chains. The artificial intelligence-driven investment boom in data centers and computing power has also boosted the economy.
The IMF’s report notes that many of these factors may “only reflect temporary relief, rather than underlying strength in economic fundamentals”. Still, the CITI Economic Surprise Index has been trending higher since bottoming in June of this year, and remains in positive territory, indicating the U.S. economy is performing better-than-expected.
Unfortunately, the labor market is not getting the message that the economy is strengthening. While official data releases are currently suspended by the government shutdown, a host of private sources of data show the jobs picture is weakening.
The ADP National Employment Report showed the United States lost 32,000 jobs in September. Moody’s Analytics said that their private sources of data show the jobs market getting weaker and that September saw “essentially no job growth”. Glassdoor’s job market analysis noted that wage growth is slowing. The ISM Employment Index, which measures changes in manufacturing employment, contracted for the 8th month in a row.
US ADP Private Employment Change
Source: ADP Research
Consumer sentiment about the outlook for the labor market is falling, and small businesses say they are experiencing poor sales, which both are leading indicators suggesting the labor market will continue to weaken.
Jobs are not being created because of the boost in efficiency and productivity brought on by improvements in automation. At the same time the workforce is shrinking due to lower immigration, reducing the number of people looking for work. The decreasing labor supply also means companies are reluctant to lay off workers. Those that do get laid off are having difficulty finding a job in what has been described as a “low hire, low fire” labor market.
US Hiring Announcements for Each September
(thousands)
US Job Cut Announcements
(thousands)
Source: Rosenberg Research, Haver Analytics, Challenger Gray & Christmas
The labor market is weakening even though economic growth is strengthening in the United States. During this “jobless economic boom”, consumer spending continues to be the driving force behind the economy, but the difference between the spending of the upper- income versus the lower-income consumer is becoming more profound.
There has been a lot written about the “K” economy, where the top 20 percent of earners are still spending but the rest of consumers struggle to make ends meet. These consumers are facing a tenuous job situation combined with high prices, and they may not get relief any time soon. Importers have been paying most of the higher tariff costs, not foreign companies, but eventually these costs could be passed on to their customers.
It is uncertain if the top 20 percent of earners will continue spending until the economy is strong enough to raise the incomes of the other 80 percent of consumers. If not, consumer spending could fall and bring about an end to economic expansion. The government shutdown is another risk to economic growth. Although government shutdowns have historically had minimal effect on growth, it remains to be seen if this time is different as the Trump Administration tries to enforce permanent cuts to government spending.
Strong economic growth has supported healthy corporate profits and boosted the stock market. According to FactSet, earnings per share (EPS) in the third quarter of 2025 for companies in the S&P 500 Index are expected to grow by 8.0 percent on average, which would be the ninth consecutive quarter of year-over-year growth. Analysts have been raising their corporate earnings growth expectations for many companies for next year, and now EPS growth for the full year of 2026 is expected to accelerate to 13.8 percent.
Corporate productivity, or the efficiency in producing goods or services, is being helped by investments in Artificial Intelligence and an increase in capital expenditures boosted by tax breaks in the “One Big Beautiful Tax Bill”. This improvement in productivity has been most pronounced in the Information Technology sector, so it is no surprise this sector has led the rally in stocks. However, the improvement in operating margins is happening in many companies outside of technology. As a result, corporate earnings growth is broadening beyond the mega cap technology stocks and helping to drive the stock market higher. Going forward, Artificial Intelligence provides all economic sectors with the opportunity for margin expansion.
Valuations in the stock market remain a concern, as FactSet calculates that the average next 12-month P/E of companies in the S&P 500 Index ratio remain above its 10-year average at 21.4x. However, many stocks outside the mega caps are more attractively valued. The valuation of the S&P 500 Index if the top ten stocks are removed is a much more reasonable 18.3x according to FactSet, which indicates a healthier stock market environment.
Source: Factset, Standard and Poors, JP Morgan Asset Management
In fixed income markets, although yields remain attractive, the path forward is clouded by continuing uncertainty regarding global trade dynamics and changes in immigration policy, and the downstream effects of both on labor markets. Assessments are further complicated by the recent government shutdown and the consequent delay of inflation and labor market data releases. These two datasets are front of mind for bond investors eagerly anticipating clarity on the path of Federal Reserve easing.
Inflation remains above the Fed’s long-term target, but the feared re-acceleration has so far failed to materialize, easing pressure in the U.S. bond market. With inflation fears receding and labor market data weakening, U.S. Treasury yields fell across the curve in the third quarter. Shorter maturities declined up to 11 basis points while longer maturity yields declined as much as eight basis points. High quality taxable fixed income strategies have enjoyed strong year-to-date returns, with the Bloomberg Aggregate Bond Index returning 6.13% in the first three quarters of 2025. Municipal bond strategies underperformed earlier this year due mostly to increased supply of bonds in the new issue market but outperformed taxable bonds in September.
After holding rates steady for five consecutive meetings, the Fed resumed easing its policy rate in September due to recent weakness in labor market indicators. FOMC members noted their concern for the trajectory of labor markets in their decision to ease its policy rate by 25 basis points. Investors are now pricing an additional 100 bps of Fed interest rate cuts through the end of 2026, around 40 basis points more than the FOMC’s updated Summary of Economic Projections.
Investment grade corporate credit spreads continued to move lower during the third quarter and have narrowed to only 73 basis points (as measured by the Bloomberg U.S. Corporate Index). This represents the lowest level since 1998 (see Figure 1). Corporate bonds have outperformed Treasuries year-to-date, but future outperformance is more limited at current valuations.
Figure 1: Option Adjusted Spread- Bloomberg US Corporate Index
Source: Bloomberg LP
However, we see support for a less-extreme view of valuations than the graph in Figure 1 expresses. Although corporate spreads to Treasuries are at historic tights, spreads to overnight index swaps are at far more reasonable levels. This implies that investors are requiring a higher risk premium for holding longer U.S. Treasuries than has been the case historically. This dynamic can also be seen in recent global steepening trades, investor cost to insure against a default from the U.S. government, (Figure 2) and investor sentiment regarding the sustainability of fiscal debt. If corporate credit spreads are recalibrated to a different “risk-free” reference rate than U.S. Treasuries, valuations don’t look quite as stretched and therefore some upside potential remains in corporate credit.
Figure 2: U.S. Sovereign Debt: 5 Year Credit Default Swap (CDS)
Source: Bloomberg LP
We believe that interest rates are attractive at their current levels as nominal yields remain above current and future expected inflation rates. Fixed income securities offer compelling income return with further opportunity for price appreciation if inflation recedes and/or economic activity stalls.
The U.S. economy finds itself in an unusual position—strong growth and robust corporate earnings coexist with a weakening labor market, creating a complex environment for investors. While the disconnect between economic expansion and job creation raises concerns about sustainability, particularly for lower-income consumers, the ongoing AI-driven productivity gains and broadening corporate earnings growth provide reasons for cautious optimism. In this environment, a diversified approach remains prudent. Equities outside the mega-cap technology names offer attractive valuations, while fixed income continues to provide compelling yields with potential for capital appreciation. As we navigate the uncertainties of trade policy, government spending cuts, and evolving labor dynamics, the importance of having a cohesive financial strategy becomes even more critical. Your HBKS wealth advisor can help you evaluate how these economic trends impact your specific financial situation and ensure your portfolio is positioned to weather both the opportunities and challenges ahead. The key to success in 2025 and beyond will be maintaining flexibility, staying attentive to the diverging signals across different segments of the economy, and working with experienced professionals who understand your unique goals.
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