Q3 2025: Risk assets rally despite fiscal and political headwinds

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• Equities climb as central banks ease and growth holds up
• Credit spreads tighten across regions, led by high yield
• Long-dated sovereign bonds pressured by fiscal concerns

US equities delivered healthy gains over the quarter: the S&P 500 Index rose by 8.1% in total return terms, while the NASDAQ outperformed on the back of renewed AI enthusiasm and robust earnings from large-cap tech firms. The passage of the One Big Beautiful Bill Act (OBBBA) in July, which included tax cuts and spending incentives, helped to bolster sentiment. Meanwhile, the Federal Reserve (the Fed) resumed its rate-cutting cycle in September, lowering the federal funds rate to a range between 4% and 4.25%. This dovish pivot, prompted by signs of labour market weakness, provided further support for risk assets.

Emerging markets and Asia Pacific rise on policy support and tech strength

Equities across emerging markets and developed Asia advanced, with the MSCI EM Index up 10.6% in US dollar terms. Chinese stocks led the way, buoyed by stimulus pledges and supply-side reforms, despite continued weakness in the property sector.

Broader emerging markets benefited from a softer US dollar and growing expectations of rate cuts. Developed Asia also performed well, with South Korea and Taiwan lifted by robust semiconductor demand, and Australia supported by strength in mining and energy stocks.

Export strength and investor reforms boost Japanese stocks

Japanese equities climbed sharply, with the TOPIX Index up 11.0% in yen, total return terms. Exporters gained from a weaker currency and improved trade conditions, while corporate governance reforms continued to attract foreign investment. Strong performance from semiconductor firms added to the upbeat tone, helping Japan outperform most developed markets.

UK stocks post solid gains

UK equities rose in the third quarter of 2025, supported by a weaker pound and strong global demand for commodities. The FTSE All-Share Index gained 6.9% in sterling, total return terms. In policy news, the Bank of England cut interest rates to 4.0% and slowed quantitative tightening, helping ease financial conditions and boost investor sentiment.

Political uncertainty and credit concerns weigh on Europe

European equities lagged, with the MSCI Europe ex-UK Index returning 2.8% in local currency, total return terms. Political uncertainty in France - including the resignation of Prime Minister Bayrou and a subsequent credit rating downgrade - contributed to investor caution, as did a disappointing performance from German stocks.

Long-end bond yields rise as fiscal concerns mount

Bond markets were mixed in the third quarter. Credit spreads tightened and short-dated yields fell (prices rose) as central banks resumed easing, but long-dated sovereign bonds came under pressure. In the US, the Fed’s rate cut supported front-end Treasuries. However, inflation concerns kept long yields firm.

UK gilts saw sharp moves at the long end, with 30-year yields hitting multi-decade highs. Sticky inflation, political uncertainty and fiscal risks weighed on sentiment, despite a rate cut from the Bank of England. In Europe, French OAT spreads widened following political upheaval and a credit downgrade, though the European Central Bank’s policy remained steady.

Credit markets outperformed, with high-yield and investment-grade spreads tightening across regions. Despite economic headwinds, resilient demand and stable earnings supported performance.

Outlook

United States: resilient growth, but policy uncertainty looms

The US economy is continuing to show its fortitude. Second-quarter gross domestic product (GDP) was revised up to 3.8% annualised, supported by strong consumer spending and business investment. The recent government shutdown – the third under President Trump – could slow momentum, however. While the estimated effect is modest (–0.15% for the quarter), delayed data and threats of permanent job cuts could influence sentiment and hiring.

Inflation remains stubborn, too. Core personal consumption expenditure (PCE) – a key measure watched by the Federal Reserve (Fed) – rose 2.9% year-on-year in August, driven by elevated service costs. The Fed has started to cut rates, but stronger economic data and persistent inflation are leading markets to expect fewer cuts ahead. Payroll growth has dwindled to just +29k per month, and unemployment has edged up to 4.3% – its highest since 2021. That said, recession fears are limited, and markets remain upbeat.

United Kingdom: inflation to peak, but growth remains fragile

UK economic growth also came in slightly stronger than expected in the third quarter, with the Bank of England (BoE) raising its forecast from 0.3% to 0.4%. Beneath the surface, however, challenges persist. Retail sales have fallen for twelve consecutive months, and purchasing managers’ indices (PMIs) point to weakness across both services and manufacturing. Unemployment has risen to 4.7%, while hiring remains sluggish.

Meanwhile, inflation is expected to peak at 4% in September before easing gradually. The BoE kept rates at 4.0% in its latest meeting, with a 7–2 vote split. More cuts are likely in December and into 2026, though the pace may be cautious. Meanwhile, political pressures – including calls for increased borrowing and leadership challenges facing Prime Minister Keir Starmer – could complicate the Autumn Budget.

Euro area: diverging signals amid tariff uncertainty

Turning to the euro area, growth is still modest. Composite PMIs rose slightly to 51.2 in September, with services improving but manufacturing still under pressure – particularly in France. It seems political uncertainty and trade tensions are continuing to weigh on sentiment. Germany stood out, though, with a strong rebound in services activity.

Inflation is expected to stay close to the European Central Bank’s (ECB) 2% target, albeit risks are tilted to the upside in the near term. The ECB has kept rates steady, and markets expect it to remain cautious. Credit spreads are tight, and investors remain confident that policy support will be available if needed.

Japan: political change brings policy shift

Japan heads into the final quarter of 2025 with a new political leader. Sanae Takaichi’s election as president of the Liberal Democratic Party (LDP) – and likely Prime Minister – marks a shift toward more expansionary fiscal and monetary policy. Her calls for reflation have led to a weaker yen, a steeper Japanese government bond (JGB) curve, and a rally in equities.

The Bank of Japan (BoJ) is expected to coordinate closely with the new government, delaying rate hikes and supporting fiscal expansion. But Japan faces a historic labour shortage and persistent inflation, raising concerns about overheating. Expectations for a near-term rate hike have fallen sharply, and rising long-dated JGB yields have already influenced global bond markets – including UK gilts.

The information in this article should not be regarded as financial advice and is based on our understanding in October 2025.

Money invested is at risk.