Coming Soon: The Tariff Hit on Economic Data

Summary

Thoughts on the Market: Coming Soon – The Tariff Hit on Economic Data

Released on July 16, 2025, by Morgan Stanley

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Introduction

In the episode titled "Coming Soon: The Tariff Hit on Economic Data," Andrew Sheats, Head of Corporate Credit Research at Morgan Stanley, delves into the persistent presence of tariff-related headlines and their anticipated impact on economic data and corporate earnings in the near future. Sheats provides a comprehensive analysis of why tariffs haven't significantly influenced the markets thus far and outlines the factors signaling an imminent shift in their economic repercussions.

Current Market Sentiment and Tariff Skepticism

Resilience Amid Tariffs

Sheats begins by addressing the skepticism among investors regarding the efficacy of tariffs. Since February, tariff discussions have been a constant in market headlines. However, despite these persistent mentions, markets have continued to climb, fostering doubts about the actual impact tariffs are destined to have.

"Investors have faced tariff headlines since at least February. The fact that it's now mid July and markets are still grinding higher is driving some understandable skepticism that they're going to have their promised impact."
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Anticipated Shift in the Third Quarter

Despite the current market resilience, Sheats emphasizes that the effects of tariffs are expected to materialize more prominently in the third quarter. He suggests that the delay in tariff impacts is becoming more apparent and stakeholders should brace for significant changes.

"We think it's kind of now the third quarter when the promised impact of tariffs on economic data and earnings really start to come through."
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Factors Contributing to the Delayed Impact of Tariffs

Sheats outlines several key reasons why tariffs have not yet significantly impacted economic data and corporate earnings:

1. Rapid Increase in Tariff Rates

   Tariff rates have surged to historically high levels, reaching 9% as of the episode's release date. Additionally, recent governmental actions suggest that these rates could escalate further, potentially doubling to between 15-20%.

   "The first factor is that tariff rates are increasing rapidly. They've moved up quickly to a historically high 9% as of today... could effectively double this rate again from 9% to somewhere between 15 to 20%."
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2. Surge in Tariff Collections

   U.S. customs have collected over $26 billion in tariffs in June alone, which extrapolates to approximately 1% of the GDP annually. This marked increase in tariff collections indicates a growing economic impact.

   "Tariff collections are picking up now. U.S. customs collected over $26 billion in tariffs in June, which annualizes out to about 1% of GDP, a very large number."
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3. Resolution of Tariff Pauses and Delays

   Earlier delays and exemptions, such as goods in transit from Europe or Asia, had previously mitigated the immediate impact of tariffs. However, these delays are now being resolved, allowing the full effect of the tariffs to take hold.

   "Tariffs have seen pauses and delayed starts which would delay the impact... These delays are starting to come to fruition as those higher tariff collections and higher tariff rates would suggest."
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4. Depletion of Inventory Mitigation Strategies

   Companies initially responded to impending tariffs by stocking up on inventory to avoid higher costs. However, as the third quarter approaches, these inventories are being depleted. Consequently, new inventory purchases will incur higher costs of goods sold, directly affecting earnings.

   "Companies ordered a lot of inventory ahead of tariff rates coming into effect... by the third quarter and those third quarter earnings, we think they will have sold them all. And the new socks they're ordering, well, they come with a higher cost of goods sold."
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Implications for Economic Data and Corporate Earnings

Core Inflation and Tariff-Sensitive Sectors

Sheats notes that recent inflation data indicates a rise in core inflation, particularly driven by sectors sensitive to tariffs. This uptick is a precursor to the broader economic impact that tariffs are expected to exert in the coming months.

"The inflation readings that we got earlier this week started to show us core inflation picking up again driven by more tariff sensitive sectors."
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Earnings Outlook: Second vs. Third Quarter

While second-quarter earnings are anticipated to remain stable or even surpass expectations, the third quarter presents a different scenario. The forthcoming earnings reports are expected to reflect the adverse effects of tariffs, especially in the consumer and retail sectors.

"Second quarter earnings that are being reported right about now we think will generally be fine and maybe even a bit better than expected, the third quarter earnings that are going to be generated over the next several months, we think those are more at risk from tariff related impact."
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Sector-Specific Impact: Retail and Consumer

Sheats highlights the retail and consumer sectors as particularly vulnerable to the impending tariff impacts. These sectors rely heavily on imported goods, making them susceptible to increased costs and reduced profit margins as tariffs take full effect.

"This could be especially pronounced in the consumer and retail sector."
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Forward-Looking Statements and Strategic Considerations

Migration Towards Higher Quality Assets

In anticipation of the tariff-induced economic challenges, Sheats suggests an "up in quality" bias in investment strategies, particularly throughout August and September. This approach involves favoring higher quality assets that are more likely to withstand economic volatility.

"This leaves us with an up in quality bias, especially as we move through that August to September period."
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Cautious Outlook on Retail Credit Sector

Building on the earlier discussion about sector-specific impacts, Sheats and his colleague Jenna Gianli express particular caution regarding the retail credit sector. They believe it is highly exposed to the converging factors of rising tariffs and inflation, necessitating a more guarded investment stance.

"We are especially cautious on the retail credit sector, which we think is more exposed to these various factors converging diverging in the third quarter."
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Conclusion

Andrew Sheats concludes the episode by reiterating the importance of preparing for the expected tariff impacts in the third quarter of 2025. He underscores the need for investors to remain vigilant and consider strategic adjustments to mitigate potential risks associated with rising tariffs and their effects on economic data and corporate earnings.

"We think it's reasonable to expect that the bulk of the impact of tariffs and economic and earnings data still lies ahead, especially in this quarter, the third quarter of 2025."
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Final Remarks

Sheats encourages listeners to engage with the podcast by leaving reviews and sharing it with peers, emphasizing the value of the insights provided for navigating the evolving market landscape.

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Note: The disclaimer provided at the end of the transcript has been omitted as per the summary guidelines.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Andrew Sheats, head of Corporate Credit Research at Morgan Stanley. Today I'm going to talk about why tariffs are showing up everywhere but the data and why we think this changes this quarter. It's Wednesday, July 16th at 2pm in London. Investors have faced tariff headlines since at least February. The fact that it's now mid July and markets are still grinding higher is driving some understandable skepticism that they're going to have their promised impact. Indeed, we imagine that maybe more of one of you is groaning and saying, what another tariff episode? But we do think this theme remains important for markets and above all, it's a factor we think is going to hit very soon. We think it's kind of now the third quarter when the promised impact of tariffs on economic data and earnings really start to come through. My colleague Jenna Gianli and I discussed some of the reasons why on last week's episode focused on the retail sector. But what I want to do next is give a little bit of that a broader context. Where I want to start is that it's really about tariff impact picking up right about now. The inflation readings that we got earlier this week started to show us core inflation picking up again driven by more tariff sensitive sectors. And while second quarter earnings that are being reported right about now we think will generally be fine and maybe even a bit better than expected, the third quarter earnings that are going to be generated over the next several months, we think those are more at risk from tariff related impact. And again, this could be especially pronounced in the consumer and retail sector. So why have tariffs not mattered so much so far and why would that change very soon? The first factor is that tariff rates are increasing rapidly. They've moved up quickly to a historically high 9% as of today. Even with all of the pauses and delays and recently announced actions by the US Administration over just the last couple of weeks could effectively double this rate again from 9% to somewhere between 15 to 20%. A second reason why this is picking up now is that tariff collections are picking up now. U.S. customs collected over $26 billion in tariffs in June, which annualizes out to about 1% of GDP, a very large number. The these collections were not nearly as high just three months ago. Third, tariffs have seen pauses and delayed starts which would delay the impact. And tariffs also exempted goods that were in transit, which can be significant from goods coming from Europe or Asia, again a factor that would delay the impact. But these delays are starting to come to fruition as those higher tariff collections and higher tariff rates would suggest. And finally, companies did see tariffs coming and tried to mitigate them. They ordered a lot of inventory ahead of tariff rates coming into effect, but by the third quarter we think they've sold a lot of that inventory, meaning they no longer get the benefit. Companies ordered a lot of socks before tariffs went into effect, but by the third quarter and those third quarter earnings, we think they will have sold them all. And the new socks they're ordering, well, they come with a higher cost of goods sold. In short, we think it's reasonable to expect that the bulk of the impact of tariffs and economic and earnings data still lies ahead, especially in this quarter, the third quarter of 2025. We continue to think that it's probably in August and September rather than June July, where the market will care more about these challenges as core inflation data continues to pick up for credit. This leaves us with an up in quality bias, especially as we move through that August to September period. And as Jenna and I discussed last week, we are especially cautious on the retail credit sector, which we think is more exposed to these various factors converging diverging in the third quarter. Thank you as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.

[B]

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