Market Overview

In the third quarter of 2025, following a period of steady global economic growth buoyed by robust consumer demand and resilient labour markets in the US, new economic data suggested caution and recalibration for investors and policymakers.

The US economy grew at 3.8% (annualised rate) in the second quarter, supported by strong consumer spending and business investment. Yet beneath the surface, the labour market narrative shifted. August payroll data revealed a sharp slowdown in job creation, with only 22,000 jobs added and the official unemployment rate rose slightly to 4.3%, the highest in over a year, reflecting a weakening of the labour market. The revisions to prior payroll data were more striking, showing the US economy adding nearly a million fewer jobs over the past year than previously reported. This signals a cooling in momentum that had previously underpinned consumer confidence and spending.

US unemployment looks stable…

Source: Bureau of Labor Statistics, Federal Reserve Bank of Chicago

…yet US employment growth (job creation) is weak
(Nonfarm Payrolls: 12 months)

Source: FactSet

The US Federal Reserve (the Fed) responded with a cautious but clear pivot, lowering its benchmark interest rate by 0.25% in September to 4.25%, despite persistent inflationary pressures. Fed Chairman Jerome Powell characterised the move as an “insurance cut” aimed at mitigating downside risks from the labour market slowdown, rather than signalling the start of an extended easing cycle. However, markets then predicted there could be up to two more rate cuts before the year end.

In the UK, the economy appears to be on a different path, and the outlook remains challenging. GDP growth slowed to 0.3% in the second quarter, down from 0.7% earlier in the year, and inflation remained uncomfortably above target at 3.8%, driven largely by persistent food price inflation and energy costs. In response, the Bank of England cut interest rates to 4% in early August but held steady in September, reflecting a delicate balancing act between supporting growth and containing inflationary pressures. The outlook remains uncertain, and will depend on how inflation dynamics evolve both domestically and through global trade channels.

UK Inflation and Interest Rates

Source: ONS, Bank of England

Elsewhere, the Eurozone economy expanded at a slow pace of 0.1%, while China’s economy grew 5.2% year on year, maintaining momentum despite global trade uncertainties. Japan recorded 1.2% annual growth.

Mercifully, trade tensions subsided somewhat during the quarter as new agreements between the US, EU, and Japan unfolded, easing worries over tariffs that had clouded markets earlier in the year.

However, the impacts of Trump’s tariffs are still taking effect.

US Average Effective Tariff Rate since 1st January 2025

Source: The Budget Lab

Trump’s Tariffs continue to impact the US economy the most, followed by China
Long Run Change in Real GDP Level from 2025 Tariffs to Date
(Percentage point change)

FTROW = countries with a comprehensive free trade agreement with the US
ROW= all other countries. Source: The Budget Lab

Equity Markets: Riding the Wave of Tech and Artificial Intelligence

Global equity markets rallied in the third quarter, erasing much of the uncertainty that rattled investors earlier in the year. This upward momentum was driven by gains in Asia and Emerging Markets, which benefited from a rebound in semiconductor and tech stocks, particularly in China, Taiwan, and South Korea.

In the US, the S&P 500 surged to new all time highs, driven by the “Magnificent 7” technology giants (leaders in Artificial Intelligence, cloud computing, and automation) whose earnings beat expectations. These companies are capitalising on the productivity gains that AI is expected to deliver. Investors embraced the prospect of sustained innovation led growth despite broader economic headwinds.

The UK market followed suit, with the FTSE 100 also reaching a record high. The weaker British pound enhanced returns for multinational companies, whose overseas earnings translated into sterling gains. Commodity sectors, financials, and energy stocks led this rally, benefiting from higher commodity prices and resilient global demand. Conversely, smaller UK companies, more tied to domestic economic health, lagged behind, weighed down by inflationary pressures and economic uncertainty.

Looking ahead, there are opportunities in relatively unloved quality companies with strong cash flows and market leading positions. There is cause for optimism in specific sectors amid the less predictable macroeconomic backdrop.

Fixed Income and Bond Markets: Divergent Signals

In the third quarter, the bond markets painted a more complex picture. In the US, in general Treasury yields declined as rate cut expectations took hold, resulting in positive returns for government bonds. However, longer dated bonds did not follow suit, suggesting higher yields in future, and reflecting investor concerns that loose policy could fuel inflation later.

In contrast, UK government bonds (gilts) experienced yield increases, with the 10 year gilt climbing to 4.7%. Stubborn domestic inflation and fiscal uncertainties caused bond prices to fall, especially for longer dated bonds. Corporate bonds in the UK edged higher by around 0.8%, as investors sought better income and credit quality amid volatility.

UK 10 year government bond yields continue to reflect uncertainty

European bond markets showed a mixed performance, with core countries like Germany and France seeing yields rise, while peripheral nations like Italy and Spain benefited from improving fiscal confidence.

Commodities and Currencies: Stability and Selective Strength

In commodity markets, gold continued to perform well, rising nearly 19% in sterling terms during the quarter, reflecting its enduring role as a safe haven in an environment of policy uncertainty and persistent inflationary pressures.

Gold price

Source: FactSet

More generally, commodities were broadly stable in the third quarter. Brent crude oil traded near $67 per barrel, while natural gas prices eased slightly, reflecting moderating global demand. Base metals and agricultural commodities showed mixed performance as a result of supply chain developments and weather patterns.

Currency markets were dominated by the US dollar’s slight stabilisation after weakness earlier in the year. The pound weakened modestly but ended the quarter near its lows against the dollar, aiding UK exporters.

The AI Revolution: Productivity and Economic Implications

Beyond market movements, 2025 is shaping up as a landmark year for the integration of Artificial Intelligence (AI) across industries. Firms using generative AI and automation technologies are starting to report improved productivity and revenue growth. PWC’s 2025 Global AI Jobs Barometer highlights that AI adoption is creating a wage premium for workers equipped with AI skills and driving faster skill change across sectors traditionally seen as less tech oriented.

This technological leap is fostering sustained earnings growth in corporate America, particularly among the tech giants, which continue to report record profits and free cash flow even in choppy macro conditions. The productivity gains delivered by AI promise to underpin longer term economic expansion despite near term labour market disruptions, though a tougher environment for entry level jobs remains a social challenge.

For investors, the biggest challenge is navigating AI and technology themes while acknowledging that there is a real and growing bubble in the sector. The S&P500 performance is increasingly concentrated in the largest stocks, to a level which has reached 35 year highs.

Share of S&P 500 index in large stocks

Source: Schwab

Implications for Investment
In this evolving landscape, investors face a delicate balance between opportunity and risk, leading to the following headline conclusions:

Prioritise diversification and look for opportunities in quality stocks: Focus on high quality companies with strong balance sheets and resilient cash flows, especially in technology, consumer staples and financials. Overlay this with selective investment grade corporate bonds for diversification.

Monitor policy and inflation: Central bank decisions and inflation data remain key market drivers. The Bank of England and Federal Reserve must balance inflationary pressures while encouraging growth.

Embrace long term technology trends: AI and automation will continue to reshape economies and markets for the foreseeable future. AI is both the primary driver of the market rally this year and its biggest risk. Although there are clear signs of a bubble in the sector, the underlying progress in tech and innovation is real.

Conclusion
The third quarter of 2025 has been a quarter of transition and recalibration. Considering the final quarter of the year, weaker labour markets and persistent inflationary pressures threaten to dampen otherwise positive sentiment. However, resilient corporate earnings and technological developments are powerful drivers of equity market optimism, and equity markets often diverge from developments in the broader economy.