Volatility and uncertainty escalated in the second quarter following the introduction of President Trump’s “Liberation Day” tariffs on April 2. These included a universal 10% tariff on nearly all imports, with even higher “reciprocal” tariffs targeting specific countries. Markets responded swiftly: the S&P 500 fell over 13% in just a few days.
The combined impact of these tariffs, heightened economic policy uncertainty, federal spending cutbacks, and a decline in immigration and tourism now appears to be slowing the U.S. economy. While the recently passed reconciliation bill—officially the “One Big Beautiful Bill Act”—is expected to provide a temporary boost through lower income tax withholding starting in Q3 and strong tax refunds in 2026, this stimulus is likely to fade. As the refund effect diminishes and structural drags from tariffs and lower immigration persist, economic growth is expected to slow once again. This slowing momentum may challenge the sustainability of current equity market valuations and contribute to increased volatility in the second half of the year.
A slowing economy will likely act as a headwind for job creation for the remainder of 2025. However, its impact on the unemployment rate should be muted due to a sharp drop in immigration. The Trump administration has significantly curtailed illegal immigration, with only about 8,000 individuals crossing the southern border in May—down 93% from a year earlier. Combined with rising deportations and a decline in new immigrant visas issued abroad, net immigration could fall substantially in the coming years. This would reduce labor force growth, helping to cap the rise in the unemployment rate, which currently hovers around 4.5%. At the same time, recession fears are likely to offset labor market tightness, keeping wage growth relatively subdued.
As of May, inflation appeared modest, with year-over-year CPI at 2.4%. But this likely understates the impact of tariffs, whose effects may simply have been delayed. By June, CPI rose to 2.7%, and with the potential for additional steep tariffs on August 1—targeting over two dozen countries including the EU—inflation is poised to rise further. Retailers are expected to pass higher import costs on to consumers, pushing inflation toward 3.5% by Q4. Elevated prices may persist into 2026, driven by strong consumer spending from tax refunds.
This mix of slowing growth and rising inflation complicates the Federal Reserve’s policy decisions. With the economy receiving a temporary fiscal boost while inflation accelerates, the Fed is likely to keep interest rates on hold for now as it assesses the competing effects of fiscal stimulus, trade policy, and immigration restrictions. This uncertainty has also contributed to dollar weakness, which has been further pressured by persistent trade deficits and the currency’s elevated valuation entering the year.
U.S. equities have weathered the initial impact of tariffs relatively well, but high valuations may present a headwind going forward. In contrast, international equities have dramatically outperformed in the first half of the year, a trend we believe is likely to continue.
Several factors support increased international exposure: 1) The U.S. dollar remains overvalued, and its weakness could enhance returns in foreign markets, 2) U.S. investors are generally underweight international assets and may begin rebalancing portfolios toward more global diversification and 3) U.S. stock valuations are well above their 20-year average, while foreign developed markets are closer to historical norms. Among global regions, we favor Western Europe, where countries are making significant progress on competitiveness reforms and European NATO members—especially Germany—are ramping up fiscal spending on defense infrastructure, partly in response to reduced U.S. commitments.
In fixed income, we remain cautious. We are not taking outsized bets on interest rate or credit exposure. Slowing growth will put downward pressure on yields, while stubborn inflation will likely push in the opposite direction. The result: interest rates may remain range-bound in the near term.
Q2 2025 Commentary
Christopher Abbruzzese
Volatility and uncertainty escalated in the second quarter following the introduction of President Trump’s “Liberation Day” tariffs on April 2. These included a universal 10% tariff on nearly all imports, with even higher “reciprocal” tariffs targeting specific countries. Markets responded swiftly: the S&P 500 fell over 13% in just a few days.
The combined impact of these tariffs, heightened economic policy uncertainty, federal spending cutbacks, and a decline in immigration and tourism now appears to be slowing the U.S. economy. While the recently passed reconciliation bill—officially the “One Big Beautiful Bill Act”—is expected to provide a temporary boost through lower income tax withholding starting in Q3 and strong tax refunds in 2026, this stimulus is likely to fade. As the refund effect diminishes and structural drags from tariffs and lower immigration persist, economic growth is expected to slow once again. This slowing momentum may challenge the sustainability of current equity market valuations and contribute to increased volatility in the second half of the year.
A slowing economy will likely act as a headwind for job creation for the remainder of 2025. However, its impact on the unemployment rate should be muted due to a sharp drop in immigration. The Trump administration has significantly curtailed illegal immigration, with only about 8,000 individuals crossing the southern border in May—down 93% from a year earlier. Combined with rising deportations and a decline in new immigrant visas issued abroad, net immigration could fall substantially in the coming years. This would reduce labor force growth, helping to cap the rise in the unemployment rate, which currently hovers around 4.5%. At the same time, recession fears are likely to offset labor market tightness, keeping wage growth relatively subdued.
As of May, inflation appeared modest, with year-over-year CPI at 2.4%. But this likely understates the impact of tariffs, whose effects may simply have been delayed. By June, CPI rose to 2.7%, and with the potential for additional steep tariffs on August 1—targeting over two dozen countries including the EU—inflation is poised to rise further. Retailers are expected to pass higher import costs on to consumers, pushing inflation toward 3.5% by Q4. Elevated prices may persist into 2026, driven by strong consumer spending from tax refunds.
This mix of slowing growth and rising inflation complicates the Federal Reserve’s policy decisions. With the economy receiving a temporary fiscal boost while inflation accelerates, the Fed is likely to keep interest rates on hold for now as it assesses the competing effects of fiscal stimulus, trade policy, and immigration restrictions. This uncertainty has also contributed to dollar weakness, which has been further pressured by persistent trade deficits and the currency’s elevated valuation entering the year.
U.S. equities have weathered the initial impact of tariffs relatively well, but high valuations may present a headwind going forward. In contrast, international equities have dramatically outperformed in the first half of the year, a trend we believe is likely to continue.
Several factors support increased international exposure: 1) The U.S. dollar remains overvalued, and its weakness could enhance returns in foreign markets, 2) U.S. investors are generally underweight international assets and may begin rebalancing portfolios toward more global diversification and 3) U.S. stock valuations are well above their 20-year average, while foreign developed markets are closer to historical norms. Among global regions, we favor Western Europe, where countries are making significant progress on competitiveness reforms and European NATO members—especially Germany—are ramping up fiscal spending on defense infrastructure, partly in response to reduced U.S. commitments.
In fixed income, we remain cautious. We are not taking outsized bets on interest rate or credit exposure. Slowing growth will put downward pressure on yields, while stubborn inflation will likely push in the opposite direction. The result: interest rates may remain range-bound in the near term.
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