2025 Economic and Market Outlook

Making accurate market and economic forecasts is challenging to say the least, but there is one safe assumption we can make about 2025 - it’s going to be interesting. With its arrival, we get a new administration and what promises to be drastic policy shifts in the U.S., political turmoil around the world, ongoing conflict in Europe and the Middle East, and escalating trade tensions. But the new year also kicks off with a surging U.S. economy and near-record high domestic stock markets. The question is what comes next. 

While it’s true that markets are unpredictable and economic shocks always seem to loom just out of view, our 2025 Market Outlook will attempt to provide some useful insights into the key factors that we expect to drive economic growth and market performance over the coming year.

Before we delve into 2025, however, we always start with a review of the year just passed to gauge how accurate our predictions turned out to be.

Reviewing our 2024 Forecast

Heading into 2024, we expected the U.S. economy to expand, but at a considerably slower pace than what was actually observed. Consensus expectations for a recession were essentially a coin-flip, and given the Federal Reserve’s history of over-tightening policy (i.e., being behind the curve as the economy slowed) we had similarly tempered most of our forecasts out of prudence:

Clearly, the growth estimate was our biggest miss, with Q4 2024 GDP growth on track to finish above 3%, and recessionary fears fading with every new job market or consumer spending report released during the year. However, given that we still expected positive growth, which required the Federal Reserve to carefully guide policy rates downward to achieve a coveted soft-landing (i.e., an economic slowdown that would tame inflation, but without tipping into recession), our unemployment and inflation forecasts were on the mark. The 10-year Treasury yield, as of this writing, is above our forecast, but that appears to be mostly an artifact of the aggressiveness of the Fed’s cutting cycle and the market potentially putting too much weight on the price pressure implications of the incoming administration’s trade policy proposals.  All in all, not too shabby – and to be fair, higher-than-expected economic and earnings performance are well worth the tradeoff of an imperfect forecast.

Looking Ahead: Our 2025 Forecast

We expect the current robustness of the U.S. economy to carry forward into the coming year, keeping GDP growth above 2%, restrained only by the sheer amount of policy uncertainty coming from the new administration. Unemployment will remain in a healthy range, and inflation will trend mostly sideways as the Fed is forced to balance its dual mandate in the face of potential disruptions in labor markets from immigration reform and ongoing fiscal deficits. That said, we expect overall interest rates to trend lower as the policy landscape clears up, aided by well-anchored inflation expectations. Collectively, these metrics should be supportive of U.S. corporate earnings and stock market performance.

Forecast Backdrop

Given the complexity of the economy and the unforeseeable nature of some events, any growth forecast is going to involve significant uncertainty. 2025 is no different, if not even murkier than usual. The second Trump administration is preparing to return to the White House with an ambitious economic plan, the specifics, timing, and impact of which are still unclear. That said, we believe any policy effects in 2025, positive or negative, are likely to be limited due to the time required for implementation and for the changes to permeate the economy. 

We are also living in a time of heightened geopolitical risks. Major conflicts, such as those in the Middle East and Ukraine, can cause inflationary pressures globally as the production of essential goods declines and supply chains are disrupted. Although Europe, and particularly Germany, has been affected by the disruption in fuel supplies from Russia, the U.S. has been largely immune from any economic fallout caused by these conflicts, and we assume that will continue to be the case. 

2025 Economic Growth

With these caveats and assumptions in mind, we expect another year of strong growth in 2025. Last year ended with robust demand across the economy's three main sectors – household consumers, businesses, and government – and we anticipate further strength from at least two of these segments again this year. 

Household Consumption

Consumer spending makes up nearly 70% of total U.S. economic output and accounted for more than 80% of GDP growth in the most recently reported quarter, making this segment the key to any outlook. And much like 2024, where higher wages and a robust labor market gave the American consumer the capacity to keep spending despite higher price levels, we expect another year in which this virtuous cycle of wage and job growth supports strong consumption, further supporting labor demand.

Additionally, we see several other pro-consumption developments:

• Lower rates: For much of the last few years, younger and less affluent households have been squeezed by high inflation and rising interest rates. This stress is evident in credit card and auto loan delinquencies among 18 to 29-year-olds, which have soared to levels not seen since the Global Financial Crisis. We expect this group to enjoy some relief as rates decline and interest costs decrease.

• Easing bank lending standards: Consumer loans among U.S. banks grew 12% in 2022, but that growth slowed to less than 2% in 2024 due to the impact of higher rates and tighter lending standards. Now, however, banks are on the verge of easing standards for the first time in over two years, which should help revitalize loan growth and broadly support spending and investment.
• Wealth effects: Academic research shows that asset price appreciation tends to support consumption. With stocks and home prices up more than 50% and 10%, respectively, since late 2022, household net worth has reached record highs, putting many in a position to spend more while still maintaining an appropriate level of savings.
  

Businesses

Like consumer spending, business investment withstood higher rates and tighter lending standards better than we anticipated, with only a modest slowdown in growth last year. As these headwinds moderate or even reverse - and other growth drivers gain momentum - we should be poised for further spending gains.

Pandemic-era fiscal policies helped sustain investment in 2024, and although this impetus may be waning, we still expect second-order effects to ripple through the economy in the coming year. For example, the CHIPS Act led to a surge in the construction of semiconductor manufacturing facilities over the past couple of years. While this investment may taper off, spending in other areas, such as equipment, should increase as these plants become operational. 

We also foresee investment in artificial intelligence sustaining a rebound in technology spending. Major tech companies are projected to spend hundreds of billions of dollars on AI in 2025. As applications improve and expand into new areas, we expect a rapid increase in the number of businesses investing in this transformative technology. 

Finally, business spending stands to get a boost from some of President Trump’s policies. Although tariffs may cause short-term uncertainty and delay some spending, we believe the administration's tax cuts and deregulation efforts, such as easing restrictions on oil drilling, will more than compensate for this. So, while any policy impact is likely to be minor during the first year of the administration, as noted previously, we do expect a net positive effect on business investment.

Government

The one area where we think growth could be challenged this year is the government sector. Since 1950, government spending has declined in only 16 years, typically following wars or crises like the pandemic as elevated spending fell back to more normal levels. Given this history, it would seem like an easy bet that spending will expand again in 2025, but we believe there is a notable challenge to this historical precedent.  

President Trump has established a new non-governmental agency called the Department of Government Efficiency (DOGE) to reduce regulations and eliminate wasteful spending. Led by Elon Musk and former presidential candidate Vivek Ramaswamy, the group aims to cut costs by eliminating jobs and auditing the government’s procurement processes with an eye toward ending or renegotiating unfavorable contracts. 

While it is unlikely that the group will achieve Mr. Musk’s goal of $2 trillion in savings — since excluding interest expenses and protected areas like Medicare, Social Security, and defense only leaves about $2.6 trillion available to cut — we still foresee material reductions over the next few years. Even with legal challenges and other pushback, it is reasonable to anticipate an impact that could begin to stifle growth in this segment of the economy in 2025. 

Bringing it all together, we expect robust consumption and business investment to drive economic growth in 2025. The linchpin of the economy, the consumer, should be supported by lower rates, easing lending standards, and record net worth that has been buoyed by strong asset price appreciation over the last couple of years. Most importantly, a favorable labor market outlook should provide the essential foundation for consumer spending, ensuring that households have the income stability and confidence needed to sustain current spending trends.  

2025 Employment

In 2024, the labor market continued to normalize from COVID-related disruptions, with job openings returning to pre-pandemic (i.e., normal) levels. Additionally, job growth was strongly positive, with the U.S. economy adding more than two million positions during the year. The unemployment rate did move higher, but largely for the “right” reason - an expanding labor force, rather than layoffs.

As we begin 2025, the labor market appears to be in a “Goldilocks” state — neither hot enough to stoke higher inflation nor cold enough to threaten consumer spending and broader economic growth. The monthly rate of new job creation is about 150,000 to 200,000 which is right in line with the trend prior to the pandemic. This puts us in the sweet spot of a virtuous cycle where consumption and investment drive job gains, which in turn fuel further spending.

The clearest risk to this positive outlook is the potential for mass deportations under the new administration. However, we believe the chances of this impacting the broad labor market in 2025 are low for several reasons:

• President Trump has recently shifted his rhetoric to focus more on illegal immigrants with criminal histories, a much smaller segment of the population that is unlikely to have a significant effect on the overall labor market.
• Identifying and detaining millions of illegal immigrants would likely require cooperation from local law enforcement agencies, which is unlikely in large, Democrat-controlled cities without a lengthy battle.
• Deporting millions of people would necessitate a much larger physical and human infrastructure than currently exists, and it would likely take more than a year to fully develop this capacity.

Inflation and Prices in 2025 

Few things have generated more consternation and confusion in recent years than the causes and measurement of inflation which was quite likely a key factor in the presidential election. And despite considerable, even if slow, progress towards the Fed’s 2% target over the past year, you can clearly sense the ghost of the post-pandemic price surge every time Chairman Powell discusses Fed policy. Despite this, the Fed seemingly declared victory in September when it cut its benchmark policy rate by a larger-than-normal 0.5% and shifted its attention to what it (perhaps incorrectly, as discussed above) perceived as a weakening labor market. However, subsequent data – along with the potentially volatile policy implications of Trump’s second administration – has again introduced some uncertainty in the inflation outlook.

That said, while monthly data will be choppy and despite some recent stickiness, we expect measured inflation to remain relatively stable and continue to trend towards the Fed’s target during the year.

In fact, when examined closely, one could argue that inflation has already stabilized near an appropriate level. As you are likely well aware given the amount of coverage this topic receives in the news, there are many ways to slice and dice inflation data. And you can get quite different, or even contradictory, stories depending on whether you prefer the commonly cited CPI or the Fed’s preferred PCE inflation measure, focus on headline or core figures (or worse, individual prices, like used cars), or highlight monthly changes over annual changes. Frustratingly, there is no true “best” measure, though we have a few approaches that we do believe can help clear up the inflation picture.

Popular aggregate figures all suffer from the same issue – an imputed, poorly measured, and considerably laggy price that nobody pays but nevertheless carries significant weight (about a third):  owner’s equivalent rent (OER), or what you will often hear referred to as “shelter costs.” While we won’t dive into the specifics of how this is measured, suffice to say, higher frequency data, such as the Zillow Rent Index, shows considerably more progress on the shelter front that is being reflected in the stale OER data.¹ And this should only continue to improve as higher mortgage rates weigh on housing demand. By extension, if you simply strip OER out to remove this misleading aspect, as is done by the Harmonized CPI in the chart above, inflation looks healthy (i.e., trending in the right direction and stable), even if still above target. This may explain why, despite recent concerns around “reacceleration,” inflation expectations have remained well-anchored.²

That being said, inflation is one thing; high price levels are another.  And while the rate of general price change can be concerning, it’s often the latter that truly weighs on the minds of consumers, with some prices, like oil and gasoline, gaining much attention and generating ire. Interestingly, energy was actually a key driver of the 2024 disinflation, and this occurred despite ongoing, and in some places, escalating, conflict all over the Middle East (which we would typically expect to spike oil prices), recent escalations in Russian sanctions (the impact of which is still uncertain despite recent oil price surges), and in the face of large OPEC+ production cuts. This indicates that the story is primarily one of low demand – or more specifically, low Chinese demand. Indeed, the world’s second largest oil consumer has struggled to gain economic traction (despite the Politburo’s best intentions), which may keep a lid on price appreciation unless Middle Eastern tensions spread to the major oil producers in the Gulf Cooperation Council.  For the time being, however, and especially with Saudi Arabia recently winning the bid for the 2034 soccer World Cup, efforts to maintain a semblance of stability in the Gulf are encouraging.

But of course, given the policy uncertainty of the incoming administration, there are risks to the inflation outlook. Concern arises simply from the fact that the Fed’s job is to respond to macro factors that impact either side of its dual mandate – low and stable inflation and a strong labor market. More specifically, the Fed must efficiently offset non-monetary policy (such as fiscal, trade, and immigration policies) with monetary tools to keep the economy stable. And while countering the inflationary impact of government spending and lower taxes is nothing new, it is the potentially detrimental impact on the real economy of an escalating trade war and drastic immigration policy shifts, both of which could cause labor market disruptions, that muddles the outlook. 

Remember, inflation can be either supply driven or demand driven. Supply shocks are, by definition, unpredictable. But the key demand trends (i.e., the ones the Fed can impact) are encouraging, with wage growth and spending at healthy levels and not showing any signs of concerning acceleration. And given the inflation debacle of recent years, if the Fed is going to lean in either direction with regard to its dual mandate, it may be more likely to quickly clamp down (i.e., signal that rates cuts may come slower) on inflation pressure than to fight a small uptick in unemployment. Given this, our expectation is still that the inflation picture should continue to improve gradually over the year.

2025 Interest Rates

Of course, the Fed’s policy rate outlook is intrinsically tied to the inflation and growth outlooks discussed above, but with a few interesting wrinkles. Despite common narratives to the contrary, policy rates tell us very little about the stance of monetary policy on their own, and any given rate can indicate tight or loose policy – it all depends on whether it’s higher or lower than the so-called neutral (or natural) rate of interest.  This isn’t the space to delve too deeply into the nuance, but in short, the neutral rate moves with household and business saving and investment decisions, so the “appropriateness” of any given Fed rate is in a constant state of flux.

Directionally, the call is quite simple – short-term interest rates are very likely to fall over the course of the year given the employment and inflation normalization we are experiencing.  Fed decisions are driven heavily by forward guidance (i.e., it signals next steps in advance and isn’t likely to abruptly change course), and that guidance implies a lower policy rate as well.

However, the pace of rate cuts will likely be slower than previously expected. After the September cut, perhaps due to its size, market expectations were for a cut at every meeting through 2025. This seemed unlikely to us simply because it didn’t align with the non-recessionary environment – the market may have simply been reading too much into the “weakening” labor data. Since that first cut, the labor market has proven quite the opposite and remained remarkably robust – the Fed has back-pedaled slightly, with Chairman Powell stating that the strong economy “is not sending any signals that we need to be in a hurry to lower rates.”³

This view is also in line with the non-monetary policy uncertainty we discussed in the above section. The Fed will likely not risk losing public confidence by reversing course (i.e., admitting an error), so the best plan for an uncertain landscape may be to prepare markets for a pause, as opposed to committing to further cuts. That’s how we arrived at our lower, but not dramatically so, year-end policy rate target.

Now, the Fed’s policy rates clearly have a major impact on short-term yields, but monetary policy is reflected just as much in the long-term – the connection just may not be as easy to parse. 

To illustrate this point, remember that the 10-year Treasury yield, which serves as a solid bond benchmark as well as the “base” for mortgages, can be thought of as a combination of two factors: the path of short-term rates (or policy rates), and a term premium, which is essentially the opportunity cost of holding a long-term bond as opposed to rolling over short-term bonds. This premium can also be thought of as the sum of inflation risk and growth expectations, as higher expected levels of both increase longer-term yields. Of course, inflation and growth expectations also impact how quickly the Fed cuts rates, hence the difficulty in parsing the impact they may have on the overall Treasury curve. 

That said, the 10-year yield has been on quite a roller coaster during the year, peaking near 4.7% in April and falling precipitously over the next few months heading into the Fed’s September meeting. However, the response to that first cut was telling – yields surged higher, sending a clear signal that the cut was perhaps too large, and that inflation was still weighing heavily on investor minds. The presidential election also drove yields higher, likely on the expectation of “inflationary” pressure from tariff policy and higher expected real growth from the expansive shift in regulatory and fiscal policy.

Interestingly, this yield move has continued despite the above-mentioned shift in Fed rhetoric (the slower pace of cuts), which is the type of guidance markets tend to react strongly to. But given that one or two rate cuts are still looming (one part of the 10-year construction) and given our views on inflation discussed above – mainly the still well-anchored expectations, which are a key component of the term premium - we think this dramatic move in yields will reverse as tariff hyperbole is digested (i.e., policy practicality takes over). However, the rate path will likely be choppy as the markets responds to each new piece of data.  

Stock Markets in 2025

We believe our macro-economic outlook bodes well for stocks. As highlighted in last year’s Outlook, the combination of positive economic growth and a lower policy rate has historically been a powerful one. Since 1970, the S&P 500 has averaged a 20% gain in years with these attributes, compared to 9% for all years.

That said, we also recognize unique factors that may limit the potential for outsized gains in the year ahead. One reason we are more cautious on stocks than economic conditions might otherwise warrant is uncertainty over the implementation and impact of some of the incoming administration’s policy proposals. While investors’ initial reactions following the election were positive, the prospect of large tariffs or mass deportations could yet weigh on the market.

Another consideration is the amount of enthusiasm already surrounding stocks. A recent report from State Street shows that professional investors’ allocations to stocks are the highest they have been in over sixteen years,⁴ while a separate survey from Bank of America indicates that cash levels are unusually low.⁵ And it is not just the professional investors - government data similarly shows that households have a record share of their financial assets invested in stocks, despite investment grade bonds now offering a competitive yield of about 5% (compared to just over 1% the last time equity holdings surged in 2021). Together, this data suggests that there is less of a potential thrust from new money entering the market to drive prices higher.

That being said, we believe the more compelling story for stocks in 2025 could be a rotation into market segments that have lagged the explosive gains of the past couple of years, which were largely centered in the mega-cap names that dominate the S&P 500 index. For example, small- and mid-cap stocks have underperformed the S&P 500 by 31% and 25%, respectively, since the end of 2022 and now look attractive for several reasons:

• They have more exposure to the U.S. than large, multinational companies, which means they stand to benefit more from many of President Trump’s policy changes such as lower taxes and deregulation efforts. They are also likely to have greater protection from potentially harmful tariffs.
• Their fundamentals may be starting to turn as well. Companies outside the S&P 500 tend to come from more cyclical industries with less pricing power than large-cap companies. As a result, when inflation slows, top-line growth for these larger companies can fall off sharply pressuring margins and thus driving earnings lower. After limited progress in 2024, we are starting to see early signs of better fundamentals, particularly among mid-caps, where sales growth has recently accelerated.

• The valuation of small- and mid-cap stocks is significantly more attractive than that of large-caps. While valuation gaps do not typically drive near-term relative performance, the historically large existing spread suggests that once fundamentals such as sales and earnings improve, smaller companies could outperform their larger counterparts by a sizeable amount.

The First Command Investment Philosophy

At First Command, we value time in the market versus attempting to time the market, accept volatility as an inherent short-term risk for stock investors and attempt to use it to our advantage to potentially improve market returns.

Additionally, given that market declines are inevitable, as Figure 13 makes quite clear, our Advisors are trained to utilize the wide range of investment options we offer to ensure that our clients’ investments are aligned with their financial plan and, just as importantly, to keep them on plan and on track through such periods.

Experience, and quite a bit of market history, has taught us that volatility can potentially improve financial outcomes, particularly when addressed via a well-designed, globally diversified portfolio that is aligned with your financial plan, investment time horizon, and risk tolerance.

If you haven’t met with your Financial Advisor recently to review your plan and assess your portfolio, we encourage you reach out to make sure you’re well-positioned for whatever the next year may bring.

Thank you for the confidence you have placed in First Command.

¹US - CPI for Rent vs. New Tenant & Zillow Rent Index. (2024). MacroMicro.
²Federal Reserve Bank of Cleveland. (n.d.). Inflation Expectations.
³Cox, J. (2024, November 14). Powell says the Fed doesn’t need to be “in a hurry” to reduce interest rates. CNBC.
⁴Insights | The home for Global Markets Research | Investor Indicators Holdings. (2025). Statestreet.com.
⁵Harring, A. (2024, December 17). Investors are so confident in stocks, they have a record low allocation to the safety of cash. CNBC.

The information in this report was prepared by John Weitzer, CFA, Chief Investment Officer, Matt Wiley, CFA, Vice President of Investment Management, Dan Murphy, CFA, Investment Strategist, and Matt Conner, Senior Investment Consultant of First Command. Opinions represent First Command’s opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual advisor. All statistics quoted are as of the date of this publication, unless otherwise noted. First Command does not undertake to advise you of any change in its opinions or the information contained in this report. This report is not intended to be a client specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.

©2025 First Command Financial Services, Inc. parent of First Command Brokerage Services, Inc. (Member SIPC, FINRA) and First Command Advisory Services, Inc. Securities products and brokerage services are provided by First Command Brokerage Services, Inc., a broker-dealer. Financial planning and investment advisory services are offered by First Command Advisory Services, Inc., an investment adviser. A financial plan, by itself, cannot assure that retirement or other financial goals will be met.

First Command does not provide legal or tax advice, and this report does not contain any legal or tax advice. Should you require legal or tax advice specific to your situation, you should consult with an attorney or qualified tax advisor. The information provided to you herein is provided for informational purposes only, is not intended to be tax or legal advice, and should not be used for the purpose of avoiding tax-related penalties under the Internal Revenue Code.

Curious about our forecast from last year? Read our 2024 Market Outlook.