Unpacking Tariff Uncertainty

Resigned Optimism

The second quarter of 2025 was defined by an optimism that the global economy will find a path forward, where the initial shock of aggressive tariff announcements was replaced by a period of cautious uncertainty as the resilient and resourceful U.S. consumer provided encouragement for domestic equities. Markets avoided further steep declines and gradually moved toward a course for growth as investors came to terms with tariff uncertainty, inflationary pressures, and slowing global growth.

Markets have been forgiving of the new tariff regime, perhaps correctly anticipating that the most extreme measures are negotiating tactics that will eventually moderate. However, our view is that the current environment introduces substantial volatility and is, on balance, a headwind for the U.S. economy. This reinforces our long held theme that robust global diversification is essential. The portfolio adjustments we have made, such as increasing allocations to diversified, low volatility international equities, reflect this. The central challenge for investors is no longer simply investing broadly in the global market but interpreting the relationship between policy actions and economic impact.

The Economy

The primary challenge in assessing the economy today is that traditional models and data signals are being distorted by broadcasted, large scale policy interventions. Economic data has been noisy and has deviated from usual historical patterns. Therefore, traditional economic models and even statistics like GDP can be misleading. Anticipation of tariffs can induce short term, atypical behavior like inventory buildups or pull forwards in consumption. The market may not be fully accounting for the fact that these economic signals have a different meaning than they normally would, creating a source of risk. While this is not devastating news, it suggests that many of the unknowns do not currently favor the U.S. economy.

The Tariff Impasse and Its Economic Drag

The most impactful development remains the ongoing uncertainty surrounding U.S. trade policy. A fundamental paradox lies at the heart of the tariff strategy: the tariffs cannot simultaneously be a temporary bargaining chip for negotiations and a permanent, predictable policy designed to encourage longt erm domestic manufacturing investment. For tariffs to effectively stimulate large scale capital expenditure—building factories, developing supply chains, and training workforces—businesses require a stable, long term policy environment. As long as tariffs remain in flux and subject to negotiation, they are unlikely to trigger a meaningful resurgence in domestic manufacturing. To date, while we have not yet seen catastrophic harm from the tariffs implemented, we have also seen little evidence of their benefits.

The lack of a significant inflationary spike thus far can be attributed to several factors: companies may be absorbing higher costs in their margins to protect market share; or the tariffs may be acting as a tax on consumption, leading to a reduction in economic activity that offsets the direct price impact. Regardless of the mechanism, the primary economic effect of the current tariff regime is not a major price shock, but rather a persistent state of uncertainty that discourages investment and clouds the outlook for long term growth.

The Federal Reserve’s Constrained Pause

The Federal Reserve held rates steady throughout the quarter. This inaction can be interpreted as a pause in the face of conflicting signals. On one side, core services inflation is above the Fed’s target with concerns that tariffs will contribute to additional inflation. On the other, the cumulative effect of past tightening and new policy headwinds presents a clear risk to future growth. It is plausible the Fed may be implicitly giving up on a strict 2% inflation target in an environment where tariffs are actively working against that goal.

While the Fed has so far maintained its independence and pursued a defensible policy path, a significant risk that we believe is under appreciated by the market is the potential for a change in Fed leadership and mandate in the coming years. A Fed chair appointed with a specific agenda could pursue a dramatically different policy path. In this scenario, a sharp drop in interest rates one to two years from now represents a key risk for investors to monitor.

Market & Asset Class Implications

Fixed Income: Diversifying Across the Curve

The unusual risks in the current environment, particularly the disconnect between the Fed’s current stance and potential future policy, underscore the importance of diversifying risk across the entire yield curve rather than focusing on a single duration metric. Different parts of the curve are sensitive to different risks. Long term bonds are most affected by long run inflation expectations and concerns over sovereign debt levels. Short term bonds are tethered to the Fed’s immediate policy.

Intermediate term Treasuries (e.g., 57 years) present an interesting case. They may be uniquely sensitive to a potential interest rate shock 12 years from now, should a future, more dovish Fed lower rates dramatically. In this scenario, intermediate bonds may benefit from lower rates in the foreseeable future while long bonds could be dragged down by long term debt concerns. Spreading risk across the yield curve provides a more robust exposure. We have also observed that longerterm Treasuries are behaving more normally in their role as a hedge against equity risk in a recessionary scenario, restoring a key diversification benefit to portfolios.

Equities: A Search for Rational Premiums

The Return of the SmallCap Premium: Last quarter saw a rebound for small cap stocks and other out of favor asset classes. We do not view this as a singlequarter phenomenon. It is difficult to imagine a long term market equilibrium where smallcap stocks permanently underperform large cap stocks. From a fundamental economic perspective, it does not make sense that the cost of capital should be lower for smaller, less established companies. Investors demand a higher expected return for holding less liquid, less understood assets. While this premium may not be large—and much of it can be diversified away—a rational equilibrium requires it to exist. The recent period of underperformance can be explained in hindsight by factors like initial overallocation based on backward looking return forecasts and the advent of lowcost funds enabling broad access. In the long term, smallcap stocks must be a reasonable investment.
The Dollar and Market Returns: The U.S. dollar declined substantially last quarter, boosting international assets. A country’s currency, equity market, and bond market are generally interconnected reflections of its economic health. The U.S. is often the exception due to its dominant market status, but should the U.S. become more economically isolated, we could see a stronger, more dependent link between the dollar and the value of its domestic equity market.
Dollar Momentum: Currency trends are notoriously difficult to forecast, but a persistent continuing decline in the dollar seems unlikely, as the consequences would be severe. For example, a weaker dollar combined with higher tariffs would represent a substantial price increase on all foreign goods, a shock that would be difficult for the U.S. consumer and the political system to absorb.

Alternatives: Access and Prudence

Private Assets: The "democratization" of private equity continues, though it is perhaps more accurately described as a democratization of mass marketing. While new vehicles have granted wider access, this influx of capital and new structures will likely alter the risk and return characteristics of private assets from their historical precedents. In fixed income, the convergence of private and public debt through new fund structures may eventually lead to both behaving as a single, broader asset class. The key takeaway for investors is that alternatives are more complex and require thoughtful allocation based on specific investment goals, not a simple "just add 20%" approach.
Real Assets: The exceptional 14% return of International Real Estate last quarter highlights its value as an attractive diversifier due to its idiosyncratic nature and potential for long term appreciation. The same diversification argument can be made for assets like Bitcoin, provided one believes in its long term value.

Featured Insight: AI as the Enduring Productivity Engine

Amidst the noise of short term policy debates, the transformative power of Artificial Intelligence remains a critical long term economic theme. AI continues to drive market narratives and, more importantly, has the potential to deliver tangible productivity gains across the economy for years to come. The world’s largest technology companies continue committing vast portions of their free cash flow – some of which was freed up by employee layoffs – to acquiring AI infrastructure at any price to maintain their competitive leadership.

This AI investment and innovation remains heavily U.S.focused, providing a reason to maintain significant strategic exposure to the U.S. equity market despite current headwinds. While there are concerns about a potential plateau as top models exhaust available training data, the next phase of the AI revolution will likely shift from building foundational models to deploying applications and maximizing efficiency. Competition, particularly from Chinese firms with access to cheaper chips, will force a focus on practical, cost effective AI solutions. This long term productivity narrative serves as a powerful potential offset to the economic drag imposed by policy uncertainty.

Portfolio Strategy & Outlook

The current market environment is defined by its challenges. It punishes strong conviction in any single economic outcome and rewards discipline, diversification, and a deep understanding of how broad economic themes translate into long term investment risks and opportunities. It is a market that demands experience. Asset managers who have navigated multiple regime changes and market crises are better equipped to handle the structural shifts we are witnessing today. The era of earning easy returns by simply allocating to largecap tech is likely behind us; the time for a more thoughtfully diversified portfolio is here.

Our approach remains strategic. We are pleased with the recent rebalancing actions across our portfolios that have broadened diversification and reduced risk. We believe that in a time of heightened uncertainty, one of the best defenses is robust global diversification. With the U.S. at the center of the current volatility, a globally diversified portfolio may be more prudent than usual. New Frontier’s process, which optimizes portfolios over thousands of unknown future scenarios, is designed precisely for environments like this—to produce portfolios that are likely to perform well in an uncertain future.

Key Takeaways

Policy Uncertainty is the Primary Risk: Markets have dampened their reaction to tariff news, but the unpredictable nature of U.S. trade policy creates a drag on investment and distorts economic data.
Diversify Across the Yield Curve: In a complex interest rate environment, focusing on a simple duration measure insufficiently describes risk. Spreading risk across short, intermediate, and long term bonds provides a more robust fixed income posture.
Risk Premia Should Prevail: Economic theory suggests that riskier assets like smallcap stocks must be viable assets and offer at least a small return premium.
AI Contributes to Long Term Growth: Despite nearterm challenges, the U.S.led productivity boom from AI provides a compelling reason to maintain strategic exposure to domestic equities.
Global Diversification is Crucial: With the U.S. as the primary source of policy volatility, maintaining a geographically diversified portfolio is a critical tool for risk management.

New Frontier Advisors LLC (“New Frontier”) is a federally registered investment adviser based in Boston, MA. The commentary discussed here is for informational purposes only. Past performance does not guarantee future results. As market conditions fluctuate, the investment return and principal value of any investment will change. Diversification may not protect against market risk. There are risks involved with investing, including possible loss of principal. Before investing in any investment portfolio, the investor and Financial Advisor should carefully consider the investor’s investment objectives, time horizon, risk tolerance, and fees. The opinion reflected is as of the date of distribution and is not intended as personalized investment advise.

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