Asset Allocation Chart of the Month
Looking Beyond the Noise
- The U.S. economy cooled in the first half of 2025 compared to last year. We expect growth to remain slow, but not stall, in the second half, weighed down by a weakening job market, a soft housing sector, and slowing consumption. Inflation is likely to remain closer to 3%, as we anticipate a greater portion of tariffs being passed through to consumers in the second half.
- While unsettled, it increasingly appears that U.S. import tariffs will stabilize around 15%. With the government now reliant on tariff revenue, this level may persist. Although it could cause a onetime bump in prices, we expect it will ultimately weigh on growth as businesses and consumers adjust.
- Against this backdrop, the Fed has been cautious, keeping rates steady amid uncertainty over trade policy. Officials remain wary of tariff-related inflation, choosing to hold off on rate cuts despite signs of labor market weakness.
- The Fed also faces sustained political pressure to lower rates. Treasury Secretary Bessent recently argued that “if you look at any model,” the fed funds rate should be 150-175 basis points lower. However, models we track, such as the Taylor Rule, which links interest rates to inflation and growth, suggest the opposite: that the current rate could be too low, not too high.
- This political noise is problematic, as it could distort long-term interest rates. As Dan Carter, Senior Fixed Income Portfolio Manager at Fort Washington Investment Advisors, recently noted, “the current fed funds rate has only a limited impact on where investors value the 10-year yield.”
- Long-term yields are also influenced by factors such as inflation expectations, fiscal policy, Treasury issuance, and investor demand. Politically driven policy shifts risk un-anchoring inflation expectations, pushing yields higher. At the same time, rising Treasury supply, needed to fund persistent deficits, could elevate the term premium if demand lags.
- For now, market-based inflation expectations remain stable. The 10-year breakeven inflation rate is holding between 2-3%. Given evolving conditions, we expect the Fed to modestly ease rates before year-end, but likely not to the extent urged by Secretary Bessent.
- Consequently, we anticipate a steeper yield curve, as short-term rates decline more than long-term yields. This outlook reflects our assumption that economic growth will slow to roughly 4% nominal and 2% real GDP.
Source: Carter, Dan, Monthly Market Pulse, Monthly Spotlight “The Fed Doesn’t Control Long Rates” August 5, 2025, Fort Washington Investment Advisors.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, and Tim Paulin, CFA – Senior Vice President, Investment Research and Product Management, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800.638.8194 for more information.
A Word About Risk
Fixed-income securities can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/ or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities may be downgraded by a Nationally Recognized Statistical Rating Organization to below investment grade status. Non-investment grade debt securities are considered speculative with respect to the issuers' ability to make timely payments of interest and principal, may lack liquidity and has had more frequent and larger price changes than other debt securities. Equities are subject to market volatility and loss. Growth stocks may be more volatile than investing in other stocks and may underperform when value investing is in favor. Value stocks may not appreciate in value as anticipated or may experience a decline in value. Stocks of large-cap companies may be unable to respond quickly to new competitive challenges. Stocks of small- and mid-cap companies may be subject to more erratic market movements than stocks of larger, more established companies. Investments in foreign, and emerging market securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. The risks associated with investing in foreign markets are magnified in emerging markets, due to their smaller and less developed economies.
The information provided reflects the research and opinion of Touchstone Investments as of the date indicated, and is subject to change without prior notice. Past performance is not indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing in certain sectors may involve additional risks and may not be appropriate for all investors. The indexes mentioned are unmanaged statistical composites of stock or bond market performance. Investing in an index is not possible. For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions
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