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- [00:01]
A
Welcome to Thoughts on the Market. I'm Michelle weaver, Morgan Stanley's U.S. thematic and equity strategist.
- [00:06]
B
And I'm Ariana Salvatore, U.S. public policy strategist.
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A
Yesterday, all eyes were on President Trump's announcement about sweeping global tariffs. Today we want to dig deeper into the details of the new executive order and how companies can counteract negative impacts from tariffs at the micro level. It's Thursday, April 3rd at 10:00am in New York. Arianna, you've been on the show quite a bit recently to discuss tariffs and their various repercussions. It's the main thing the market cares about right now. Did the April 2 announcement change your views on the key objectives of President Trump's tariff policy?
- [00:42]
B
Earlier this year, we identified the Trump administration as having really two key objectives when it comes to tariff implementation. So on the one hand, we think the administration recognizes that they can use tariffs for for quicker policy concessions. We saw that with Mexico and Canada, for example. But on the other hand, the administration also has signaled an intent to use tariffs as a means to more significantly de risk in key strategic industries and engage in a broader base supply chain realignment globally. So what we saw yesterday was effectively, in our view, a mix of both. It didn't change our expectations for how the administration would approach this date for the overall trade review. President Trump in advance of yesterday, signaled that he wanted to retool the global trading order based on this premise of reciprocity. And I think yesterday was really just an indication that they're in fact stepping in that direction.
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A
How do you think trade relationships will unfold for the rest of the year and beyond?
- [01:38]
B
I mean, we do see an opening for bilateral talks. One of our key questions heading into April 2 was whether or not this would be in fact a clearing event for trade policy one way or another. So converting trade policy uncertainty from more of a variable into a constant, as you know, of course, Michelle, it's really that uncertainty that's been weighing on markets. I think what we learned yesterday is that these rates are by no means final. And the uncertainty component isn't going away anytime soon as we start to engage in these bilateral discussions. So to put a finer point on it, we really are watching for two things from here. First, countries reaction function. If our trading partners retaliate, that will indicate how high these tariff rates can go. Treasury Secretary Besant said yesterday that the tariff rates imposed are meant to be caps. So going lower in scope. And that's in line with our view that the April 2 rates would represent a maximalist starting point. But of course, these rates could potentially have room to go higher if our trading partners announce retaliatory measures. The second thing we're looking for is any potential clues on how quickly these talks can come together. Commerce Secretary Lutnick said the US is already talking with trading partners. And even ahead of this April 2 announcement, some countries in certain blocs, like the EU, Brazil and India, according to background reporting, have been offering concessions to really kick off that negotiation process. But we also know that managing multiple bilateral negotiations at the same time will be challenging. So I think you can expect to see at least a good portion of these tariffs actually come into effect on the scheduled dates April 5th and later April 9th.
- [03:15]
A
And how about non tariff barriers in addition to the announced tariffs?
- [03:18]
B
So this was frankly a large part of the administration's rationale for levying these tariffs. If you recall, Trump said that they were looking at three things, the country's vat, its reciprocal tariff rate on a product level, and this category that you mentioned of unfair trade practices. And those are all inputs to the overall country rate. So I think what we've seen so far indicates that that third component is actually the most fungible one and it's really important to the administration. So I think it's going to be a critical part of the negotiations from here. But we also know that certain non tariff barriers can be easier to remove than others. And in many cases they're actually slower moving than just lowering the tariff rates. For example, Trump has cited burdens of regulation in certain sectors like eu, food and agriculture. And then in other geographies he's talked about cumbersome environmental regulations. I think negotiations on those topics are going to be slow moving because in many cases you're going to need to involve multiple regulatory agencies. And getting them to sync up as well as syncing up with the US's regulatory agencies will be a challenging and probably long process. So I think where that leaves us is with uneven tariff implementation on a country and product level over the next three to six months or even further out than that as these negotiations progress on different tracks.
- [04:37]
A
And then based on your conversations with Morgan Stanley's economists and your own analysis, how much will these comprehensive tariffs impact the economic growth outlook both in the US and globally?
- [04:48]
B
Yeah, I'll just hit on the different regions here. So starting with the us, our economists did take down their GDP estimates earlier this year on the back of that uncertainty to 1.5%. That's really what's been weighing on markets and the economy. To my point earlier about this lack of clarity. And we see that through multiple channels, like corporates holding back on CapEx, the sentiment data we see showing us less confidence about the near term outlook. I think what we saw last night was enough for our economists to rethink that baseline. They removed a Fed cut in June. And from here we think the risks are skewed to the downside. But of course the extent of that downside will be primarily a function of how long these tariffs are in place and how broad they are. So when it comes to the other regions in Europe, our economist rule of thumb is that a permanent 20% universal increase of tariffs on EU goods would reduce euro area GDP by 60 to 120 basis points. That lower range, the 60 basis points, reflects direct trade impacts and the upper range adds that impact of uncertainty and financial tension. Lastly, in Asia, our economists think that the region is actually most exposed globally, given that Mosit runs a trade surplus with the US which as we talked about is one of the key metrics for the Trump administration. But the outlook really depends on each country's ability to negotiate trade deals inside that framework. We see India, Japan, Korea and Indonesia as most likely to get a trade deal done. But the worst positioned on both the extent of the tariff increase as well as the ability to get a deal would probably be China and Vietnam. But Michelle, it's clear that tariff increases across the board will likely have significant macro repercussions. What about the micro implications? What sort of strategies can companies deploy to mitigate the impact of these tariffs?
- [06:32]
A
So managing risk from tariffs is going to be an ongoing process for the rest of the second Trump administration. And I don't think tariff threats are going away anytime soon. And we identified five different strategies companies can take to mitigate the risk of tariffs and think through some of the different ways industries might approach this. So I'll go through these different strategies in order of easiest, fastest to implement and then longest and most expensive to implement. So the first is pricing power. Companies can choose to either pass off all of the costs of their tariffs to customers or share some of the burden of higher prices and accept lower margins. This does assume companies have a strong degree of pricing power though, and is not going to work for every industry. The next strategy is some companies are employing a more robust FX hedging program. The announcements from tariffs are causing a lot of movement in the currency markets. So some companies have chosen to take on a more robust hedging program. The third strategy is redirecting products to markets without tariffs. So if you're a big multinational company and you produce products in multiple regions as well as sell products in multiple regions. You can take some of the goods that were bound for the US that were going to be under tariffs. So for example, you produce in China and instead of routing those goods to the US you can route them to a different end market so you can send them to Europe or another market that doesn't have the same tariff structure. The fourth strategy companies are thinking about is stockpiling inventory. And we've already seen companies building some level of inventory ahead of tariffs. But given the costs associated with holding excess inventory, though, we think companies are taking a more modest approach here. They're filling existing warehouse space, but we know they're not trying to hold inventory for the long term because we haven't seen a pickup in industrial warehouse leasing. This is also once again going to vary industry to industry. For a company that's in a space like apparel, there's fashion risk. So you don't want to try and hold inventory for a really extended period because the fashion trends and the cycle may change. And then the last and fifth strategy that companies are using is diversifying supply chains. And we saw under the first Trump administration, those tariffs did catalyze a reorganization of supply chains. And you can think about reorganizing your supply chains under a few different strategies. So there's China +1, near shoring and reshoring. Under China +1, you can move factories from China to other nearby locations with low cost labor. We saw this during the last tariff regime and you saw some movement from China to other locations in Southeast Asia, like Vietnam. Then there's also a near shoring strategy. And we saw some companies move production to Mexico. This strategy does bring production closer to sources of end demand. That offers some more insulation from supply chain malfunctions. During the tariffs that were announced yesterday, we did still see some carve outs for USMCA products. So I wouldn't be surprised if companies continue to do this. And then the last option for reorganizing your supply chains is a full reshoring strategy and bringing production back to the United States. This is expensive, but it does locate production close to your end consumers.
- [09:40]
B
How are US and foreign companies talking about these strategies and how confident are management teams in being able to actually implement them?
- [09:47]
A
So we're seeing different industries talk about different strategies. But if I zoom out and think about this, overall, the number one way companies are thinking about mitigating tariff risk is through diversifying supply chains. But you do need some more degree of tariff certainty before companies are going to execute on this. There is policy risk where if policy changes, you don't want to say, okay, I'm going to bring a branch of production to Mexico and then be concerned that the tariff regime is going to change there. And then you'll have spent a lot of money to reorganize your supply chain but still be under tariffs. And then the other strategy companies are talking about most is pricing power. This is the easiest to implement. It costs virtually nothing to implement. We're seeing a lot of discussion around that and I think that's the lever companies are going to pull first.
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B
Which strategies you mentioned are particularly relevant and applicable to specific sectors and industries.
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A
So I think for capital goods they have a strong degree of pricing power. I think they're going to be able to take price. They are impacted by these tariffs but fairly constructive around their ability to mitigate the impact. Another pocket of the market that's especially exposed here is consumer goods. They don't have as big of a pricing power lever to pull. I think they're going to try to do that to the extent they can, but their ability to mitigate is a little tougher. And then we saw energy companies talking about redirecting products. They're dealing in global commodities, so that should be a fairly achievable thing for them to implement. And then finally, Arianna, what key catalysts and announcements are you watching for next, both from the US and from other countries?
- [11:21]
B
Well, it's important to remember that the tariffs we got yesterday are actually country level for the moment. Trump has exempted certain sectors including pharmaceuticals and semiconductors, but the administration has also said that they're conducting Section 232 reports to prepare tariffs on those products later on. We don't know exactly when that will conclude, but typically section 232 studies take about six to eight months and 270 days on the long end. Similarly, we have an upcoming deadline of May 3rd for the administration to also scope in non USMCA compliant auto parts. And June 24th is the deadline to establish the process to tariff non US Content inside of that USMCA compliant auto parts bucket. Trump also mentioned a 25% tariff on countries purchasing Venezuelan oil. That wasn't part of the announcements yesterday, so we might hear something on that too. We just don't know exactly when.
- [12:12]
A
Arianna, thank you for taking the time to talk and thanks for listening. If you enjoy thoughts on the market, please leave us a review Wherever you listen to the show and share the podcast with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for.