Markets remained resilient in Q2 2025, despite experiencing a sharp dip at the beginning of the quarter. Volatility was sparked by U.S. tariffs, Middle East tensions escalating, and the downgrading of U.S. treasuries. Equities rebounded strongly, with the S&P 500 and Nasdaq Composite climbing to record highs. International stocks continued to outpace U.S. peers YTD, with Emerging Markets rallying amid easing trade fears. Global bond markets performed well, while credit spreads stabilized. Despite the early volatility, the quarter proved to be one of resiliency and historic recovery for U.S. stocks. However, investor uncertainty continues moving forward.
Global markets experienced significant volatility following the April 2 announcement of reciprocal tariffs and China’s subsequent retaliation. However, a 90-day reprieve on most aggressive tariffs initiated a week later (excluding those impacting China) prompted a swift market recovery.
Mid-June saw a broader agreement between the United States and China, contributing to market stabilization. Nevertheless, ongoing tariff uncertainty presents a risk of escalating tensions if definitive agreements are not finalized.
In the first quarter, Gross Domestic Product (GDP), the comprehensive measure of goods and services produced throughout the economy, registered its first decline since early 2022. This downturn was significantly influenced by a sharp increase in imports, likely driven by businesses’ efforts to “front-run” anticipated future tariffs. Most analysts have characterized this as a statistical anomaly or distortion, rather than a genuine signal of a broader economic recession.
The U.S. Dollar weakened sharply, with the U.S. Dollar Index falling over 7% in Q2 and nearly 11% year-to-date. This represents its worst first-half performance since the early 1970s. The selloff reflected a mix of tariff-driven economic slowdown fears, fiscal deficit concerns, and uncertainty over future Federal Reserve independence.
The Federal Reserve maintained its federal funds rate at 4.25% to 4.50% throughout the quarter, marking the fourth consecutive hold since December 2024. This reflected the Fed’s cautious stance as it navigated persistent inflation and uncertainty surrounding tariffs.
U.S. inflation remained elevated, slightly exceeding the Fed’s 2% target, with officials generally expecting tariffs to contribute to future price increases. Federal Reserve Chair Jerome Powell emphasized a data-driven approach to future rate decisions, particularly concerning the impact of tariffs on inflation.
The Federal Open Market Committee (FOMC) exhibited internal disagreement, with some members advocating for rate cuts and others urging patience. This environment suggests ongoing potential for volatility in bond markets, influenced by economic data, tariff developments, and shifts in Fed leadership.
Emerging Markets, based on MSCI EM Index, outperformed International Developed Markets, based on MSCI World Ex US Index, in Q2, rising 11.26%, aided by a weakening U.S. dollar and easing trade tensions.[1] Equity markets initially wavered after the April tariff announcement, but rebounded as a 90-day pause calmed investor fears.
Progress in U.S.-China trade talks also supported gains across Emerging Markets. Latin American and Chinese tech stocks stood out, with the MSCI Emerging Markets Information Technology Index, which measures the financial performance of companies in fast-growing economies worldwide, surging 21.23%.[2] Korea and Taiwan posted strong gains, with Korea buoyed by political stabilization and Taiwan by ongoing AI optimism. Brazil rallied as rate hikes supported its currency. Conversely, India lagged on growth concerns and Saudi Arabia declined amid Middle East geopolitical tensions.
International Developed Markets experienced a strong quarter, with a 11.20% gain in Q2.[3] Germany announced a large fiscal package, which will prioritize domestic investment in infrastructure and defense.[4] This has galvanized market sentiment across Europe, fueling broad European growth expectations. With global investors rebalancing away from U.S. markets, International Developed and Emerging Markets outperformed the U.S. in Q2.
U.S. Markets, represented by MSCI USA Index, slightly lagged global markets, gaining 10.90% in Q2 2025.[5] U.S. equities experienced a turbulent quarter, fueled by changing tariff policy and overall economic uncertainty. After April’s downturn, U.S. equities rebounded, recording the swiftest recovery (89 days) after a decline of at least 15%.[6],[7]
During the second quarter, global factors demonstrated positive performance. The Momentum factor significantly outperformed, returning 15.30%[8]. Strong returns were also observed in Small Cap securities and Quality, which posted gains of 11.96% and 9.51%, respectively. Meanwhile, the Value and Minimum Volatility factors recorded positive returns of 5.86% and 2.94%, respectively.
U.S. factors demonstrated positive performance in Q2 2025. Momentum led the gains, returning 14.24%[9]. Quality and U.S. Small Caps also exhibited strong performance, with returns of 8.24% and 7.96%, respectively. Value returned 3.57%, while Minimum Volatility rose by 0.68%.
International Developed factors demonstrated strong positive performance. Small Cap securities led the gains with a 16.29%[10] return, followed by Momentum at 15.12%. Value, Minimum Volatility, and Quality performed similarly, rising 10.0%, 9.64%, and 9.09%, respectively.
Emerging Market factors largely mirrored the strong performance observed in International Developed Markets during the quarter. Small Cap and Momentum factors were the top performers, achieving gains of 16.30%[11] and 15.28%, respectively. Quality, Value, and Minimum Volatility factors also demonstrated robust performance, increasing by 9.98%, 9.47%, and 9.23%.
The U.S. Treasury curve steepened in Q2, with shorter-term treasury yields declining and longer-term increasing. The 1-year treasury yield fell 5bps, while the 10-year treasury yield increased 7bps. The steepening caused long-duration treasury bond funds to fall, and shorter-term bond funds to outperform. Contributing to the move in yields, Moody’s credit rating agency downgraded the U.S. sovereign rating to Aa1, citing the increased burden of financing the government’s growing budget deficit.
As The Fed held rates steady, citing sticky inflation and resilient labor markets, central banks across the globe diverged. The European Central Bank and the Bank of England cut rates, while the Bank of Japan and the Bank of Canada held rates steady. Japan’s government bond market was particularly volatile, with the 30-year yield hitting a record high amid fiscal concerns and structural imbalances. The Bank of Canada struck a cautious tone due to U.S. tariff uncertainty, leading to underperformance in Canadian and Japanese bond markets. In contrast, Australia’s bond market outperformed, buoyed by weak growth and easing inflation pressures. Overall, yield curves steepened across non-U.S. markets, with long-term yields rising more sharply than short-term yields, reflecting growing concerns about debt sustainability and the global shift from monetary to fiscal support.
Corporate yield spreads tightened as strong corporate earnings, persistently low default rates, and stable economic growth collectively supported underlying credit fundamentals. Consequently, both the high-yield and investment-grade bond market outperformed U.S. Treasuries, attributable to their higher coupon and modest spread levels.
Municipal bonds faced headwinds throughout the year due to concerns that a new tax bill might eliminate their tax-exempt status. However, the latest version of the bill preserves this exemption. Additionally, fears that the bill would restrict the issuance of tax-exempt debt prompted a surge in new bond offerings.[12] This increased supply, without a proportional rise in demand, generally leads to lower bond prices and reduced returns.
[1] Emerging Markets represented by MSCI Emerging Markets Index
[2] Emerging Markets represented by MSCI Emerging Markets Index
[3] International Developed Markets represented by MSCI World Ex USA Index
[4] Benoit, B., “Germany, Once a Beacon of Frugality, Jolts Europe With Planned Spending Splurge,” Wall Street Journal, March 5 2025, https://www.wsj.com/world/europe/germany-defense-infrastructure-spending-plan-399aee04?mod=Searchresults_pos8&page
[5] U.S. Markets represented by MSCI USA Index
[6] Hur, K., “From Tariff Pain to Record Highs, a Wild Quarter on Wall Street,” Wall Street Journal, June 30, 2025, https://www.wsj.com/finance/stocks/global-stocks-markets-dow-news-06-30-2025-52905785?mod=Searchresults_pos1&page
[7] Langley, K., “Historic Rebound Sends S&P 500 to New Highs,” Wall Street Journal, June 27, 2025, https://www.wsj.com/finance/stocks/historic-rebound-sends-s-p-500-to-new-highs-44775c62?msockid=0b76807e9f6d60f214d096689e41610e
[8] Global Factors represented by MSCI ACWI Factor Indices
[9] U.S. Factors represented by MSCI USA Factor Indices
[10] International Developed Factors represented by MSCI World Ex USA Factor Indices
[11] Emerging Factors represented by MSCI Emerging Market Factor Indices
[12] Howland, C., Municipal Bonds: Mid-Year 2025 Outlook, Charles Schwab, June 27, 2025, https://www.schwab.com/learn/story/municipal-bond-outlook
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The S&P 500 Index represents the 500 leading U.S. companies, approximately 80% of the total U.S. market capitalization. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq Composite Index (NASDAQ). The NASDAQ measures all NASDAQ domestic and international based common type stocks listed on The Nasdaq Stock Market and includes over 2,500 companies. The MSCI World Ex USA GR USD Index captures large- and mid-cap representation across 22 of 23 developed markets countries, excluding the United States. The index covers approximately 85% of the free float-adjusted market capitalization in each country. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets (as defined by the MSCI). The index consists of the 25 emerging market country indexes. The Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed-income securities in the United States—including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year. The Bloomberg Barclays Global Aggregate (USD Hedged) Index is a flagship measure of global investment grade debt from 24 local currency markets. This multi-currency benchmark includes treasury, government-related, corporate, and securitized fixed-rate bonds from both developed and emerging market issuers. The Index is USD hedged.