Mid-Year 2025: Mile 13

Investing through 2025 has felt much the same. The Payden Unconstrained Bond Strategy left the starting line in January with a clear pacing plan: track the Fed’s shift from growth to inflation control, brace for a tightening of financial conditions, and count on a second-term Trump administration to lean against the deficit and inflation. We also noted the structural underpinnings of the US economy were on stable footing, but believed forthcoming policy decisions could overshadow fundamentals. Indeed, policy squalls soon rolled in. The first half of the race delivered headwinds so fiercely that many runners now crest Mile 13 running on fumes, with clearer policy direction, yet still unclear ripple effects. And while the strategy took its first strides with a thoughtful pace, we knew the 2025 course would present bends we could not envision and embraced the notion that unexpected obstacles would divert the course. Now crossing Mile 13 and the halfway point of the year, investors must reflect on a course reshaped by policy crosscurrents while maintaining their stride in the uncertain miles ahead.

Ref lection at Mile 13

The first half of 2025 delivered a tougher course than the one charted in January. Policy uncertainty and surprises rather than macro drift set the tone, forcing investors to consider a wider range of outcomes. As we revisit the January Unconstrained Bond Strategy outlook, we consider how our pre-race expectations fared against the events that followed.

Trump 2.0 Policy Mix

According to pre- and post-election polls, inflation and immigration were the policy issues that propelled President Donald Trump back to the White House in 2024. Our January outlook assumed the administration would tackle these important voter issues with a handful of growth- oriented measures such as lower taxes and deregulation coupled with a hawkish mix of tighter fiscal discipline. We also pondered the range of outcomes associated with tariffs and stricter border enforcement. Although the backbone of Trump 2.0 policy unfolded as expected, the breadth and intensity of the measures proved to be among the toughest hurdles in the opening half of the 2025 marathon.

On April 2nd, a date President Trump deemed as “Liberation Day”, the White House signed sweeping tariffs across nearly all countries with a 10% baseline tariff with higher rates applied to countries with which the U.S. carried the largest trade deficits. The tariff announcement was a significant surprise, resulting in some of the largest single- day and monthly drawdowns for risk assets like equities, in history. A week later the White House paused the step-up to allow negotiations, and equity markets clawed back the losses, setting fresh highs by mid-June. Even so, the weighted-average effective tariff on U.S. imports now stands near 17 percent, up from 2.5 percent at the start of the year, and could shave roughly 1-1.5% percentage points from U.S. GDP growth over the next four quarters, while also putting upward pressure on prices.

Another landmark policy decision in the first half of the year was the passage of the One Big Beautiful Bill Act (OBBBA) in July, a sweeping legislative reform package spearheaded by the Trump administration that will likely maintain the federal budget near its current value of 6.5% of GDP over the next few years according to the Congressional Budget Office (CBO). The bill’s fiscal footprint is hard to pin down beyond the 2026-2027 timeframe. Front-loaded tax cuts and new outlays are scheduled to fade just as spending caps tighten, but Congress could extend the expiring tax relief or delay the cuts. If that happens, baseline deficits would climb still higher. At the beginning of the year, President Trump also launched the Department of Government Efficiency (DOGE) to root out waste and trim spending, but the numbers have barely dented the deficit. DOGE claims roughly $160-$190 billion in savings, yet independent reviews put net savings closer to $30 billion (well under 2% of the annual budget gap) and some analyses suggest the cuts may even raise long-run costs.

Immigration enforcement has been a policy response we had anticipated at the beginning of the year, as Trump has followed through on his increased border security campaign promise. The net effects of immigration have started to show in macro data, with tighter immigration policies set to trim ~0.4% from 2025 real GDP growth while also serving to shrink the labor force size by 1-1.5%. With little chance of immigration policy easing, this contraction in labor supply presents an undercurrent of negative growth and adds an upward pressure to wage inflation.

Treasury Supply Under Secretary Scott Bessent

In January, the team believed the appointment of Treasury Secretary Scott Bessent suggested a return to fiscal pragmatism, with policy shifts aimed at steering the U.S. economy onto a more sustainable path. The team believed this policy would likely include tighter financial conditions or delay the cuts. If that happens, baseline deficits would climb still higher. At the beginning of the year, President Trump also launched the Department of Government Efficiency (DOGE) to root out waste and trim spending, but the numbers have barely dented the deficit. DOGE claims roughly $160-$190 billion in savings, yet independent reviews put net savings closer to $30 billion (well under 2% of the annual budget gap) and some analyses suggest the cuts may even raise long-run costs.

Immigration enforcement has been a policy response we had anticipated at the beginning of the year, as Trump has followed through on his increased border security campaign promise. The net effects of immigration have started to show in macro data, with tighter immigration policies set to trim ~0.4% from 2025 real GDP growth while also serving to shrink the labor force size by 1-1.5%. With little chance of immigration policy easing, this contraction in labor supply presents an undercurrent of negative growth and adds an upward pressure to wage inflation.

Treasury Supply Under Secretary Scott Bessent

In January, the team believed the appointment of Treasury Secretary Scott Bessent suggested a return to fiscal pragmatism, with policy shifts aimed at steering the U.S. economy onto a more sustainable path. The team believed this policy would likely include tighter financial conditions or delay the cuts. If that happens, baseline deficits would climb still higher. At the beginning of the year, President Trump also launched the Department of Government Efficiency (DOGE) to root out waste and trim spending, but the numbers have barely dented the deficit. DOGE claims roughly $160-$190 billion in savings, yet independent reviews put net savings closer to $30 billion (well under 2% of the annual budget gap) and some analyses suggest the cuts may even raise long-run costs.

Immigration enforcement has been a policy response we had anticipated at the beginning of the year, as Trump has followed through on his increased border security campaign promise. The net effects of immigration have started to show in macro data, with tighter immigration policies set to trim ~0.4% from 2025 real GDP growth while also serving to shrink the labor force size by 1-1.5%. With little chance of immigration policy easing, this contraction in labor supply presents an undercurrent of negative growth and adds an upward pressure to wage inflation.

Treasury Supply Under Secretary Scott Bessent

In January, the team believed the appointment of Treasury Secretary Scott Bessent suggested a return to fiscal pragmatism, with policy shifts aimed at steering the U.S. economy onto a more sustainable path. The team believed this policy would likely include tighter financial conditions via more long-end Treasury issuance, a belief supported by Bessent’s criticism of former Secretary Yellen for relying too heavily on shorter-dated debt. This policy shift would serve to contain inflation and allow the Fed to reduce rates over time, slowly easing the federal interest-expense burden. That thesis did not materialize in 1H 2025. Instead, the February, May, and July refunding announcements left long-bond auction sizes unchanged, keeping the Treasury bill share of outstanding marketable debt near 22%.

Ultimately, at the midpoint of the 2025 marathon, supply-driven tightening of financial conditions is a lower probability outcome relative to early 2025, with long- maturity yields being most influenced by policy decisions away from the Treasury office.

Chairman Jerome Powell & the Federal Reserve

In January 2025, the Unconstrained Bond Strategy team believed the Fed had flipped the script. Chairman Powell abandoned the late-2024 easing bias and adopted a more hawkish stance, accepting tighter financial conditions and slower growth as necessary to contain inflation. Markets validated this shift; entering 2025, rate cut expectations had fallen to near zero, a sharp reversal from the multiple cuts priced during Q3 2024. The team saw this pivot and its economic implications as a compelling case for more front- end interest rate exposure and less credit spread exposure.

That call proved correct as U.S. growth has since slowed, and front-end yields have declined year-to-date. Notably, short-duration bonds have also acted as more stable credit hedges, with far less volatility than longer maturities.

Yet Mile 13 brings fresh complexity. The Trump 2.0 policy mix and a slowing economy, layered on top of structural shifts and inflationary geopolitical risks, leaves the Fed weighing a wide range of potential trade-offs when setting projections and policy in the months ahead.

Fueling the Final Stretch

In the Boston Marathon the final 13 miles are often the most punishing. The course climbs steadily through the Newton hills beginning near mile 16 and then narrows into wind tunnels formed by Boston’s downtown streets. Taking stock of the first half of 2025, we expect the back half of the year to bring a similar mix of elevation and headwinds. Policy crosscurrents with mixed effects on growth and the labor market, uncertainties around long- term inflation expectations, and geopolitical flare-ups will test investors’ stamina and reward deliberate pacing by keeping energy gels in the form of liquidity and patience for potential late-race surges.

Alongside a growth negative policy mix, the broader terrain for the US economy appears to be slowing. Wage growth has declined from mid to low single digits. The labor market has cooled, evidenced by a decline in job openings and less wage pressure. Inflation has also declined. The net result is nominal GDP likely in the 3-4% range, which should slow nominal spending, corporate revenue, and corporate profits absent margin expansion or a productivity boom.

Meanwhile, market pricing reflects a tailwind that may not hold. U.S. Equities are near record highs with forward P/E multiples for the S&P 500 near 24x. U.S. high yield corporate bond spreads are just shy of cycle tights, while

U.S. interest rate pricing suggests a soft landing. In other words, investors are running as though the finishing miles are flat and well-paved.

Taken together, we believe the road ahead offers more certainty regarding the direction of policy but lingering uncertainty regarding policy implications. With the structural underpinnings of the US economy weakening and valuations stretched, there is an increased fragility in risk assets.

Conclusion: Breaking the Tape

As we enter the second half of the year’s race, the Unconstrained Bond Strategy has lightened its pack and lengthened its stride. Within credit, we remain cautious, running a modest underweight to credit risk given the interplay of policy, sentiment, and valuations. We continue to favor emerging market debt and sectors exposed to the prime U.S. consumer, such as housing. In contrast, we are more cautious on subprime consumer credit and cyclical sectors like energy. Importantly, despite our measured view on spread risk, elevated starting yields across fixed income should help cushion volatility.

Within interest rate risk, we remain overweight, with a preference for the front end of the U.S. yield curve, which appears reasonably priced and should serve as a hedge to credit risk. The strategy has been increasing interest rate exposure outside the U.S., including emerging markets and other select developed markets like Europe. Finally, with the global pack of runners structurally overweight U.S. assets and growth differentials between the U.S. and other developed markets widening, we maintain an underweight to the U.S. Dollar.

Crossing the finish line invites reflection on both the lessons learned and the sheer achievement of tackling a marathon. Even a race marked by unexpectedly steep climbs and tumbles is worth celebrating, proving that disciplined preparation can lay the groundwork for future learning and sets the stage for the next starting line.

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