Podcast Summary: "How to Decode Tariff Signals"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: How to Decode Tariff Signals
• Release Date: May 28, 2025
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

Introduction to the Japan Investor Summit

In the opening segment of the episode, Michael Zesas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy, sets the stage by discussing his recent attendance at the Japan Investor Summit held in Tokyo. The summit spanned two days filled with panels addressing key investment themes and facilitated one-on-one meetings with clients across Morgan Stanley's franchise.

Michael Zesas [00:45]: "Two full days of panels on key investment themes and one-on-one meetings with clients from all parts of the Morgan Stanley franchise."

He highlights the launch of Morgan Stanley Research's mid-year economics and market strategy outlooks during the summit, emphasizing the robust dialogue on investment strategies that took place over the intensive two-day period.

Focus on US Tariff Policy

A significant portion of the discussion centers around the complexities of US tariff policy, a primary concern voiced by attendees of the summit.

Current State and Potential for Escalation

Zesas delves into whether tariffs might escalate further or if the most challenging phase has passed. He explains that while the current tariff landscape aligns with Morgan Stanley's projections for the year's end, its premature arrival poses new challenges.

Michael Zesas [01:30]: "It's just arrived much earlier. Higher overall US tariffs with a skew toward higher tariffs on China relative to the rest of the world."

He points out the intensified tariffs on China, attributing them to the strained trade relations and the difficulties in swiftly reaching a comprehensive trade agreement with the nation. However, Zesas cautions against a simplistic interpretation that the worst is over.

Michael Zesas [01:55]: "We think that's too simple of a way for investors to think about it. First, there's plenty of potential for escalation from current levels as part of ongoing negotiations."

Impact on Economic Growth and Recession Risks

Despite recent reductions in tariffs on China, Zesas notes that the effective tariff rate remains significantly higher than at the beginning of the year. This sustained elevation in tariffs is translating into economic pressures, manifesting as slower growth and an increased risk of recession.

Michael Zesas [02:20]: "Even though the US cutting tariffs on China from very high levels recently brought down the effective tariff rate, it's still considerably higher than where we started the year."

These economic strains necessitate that investors remain vigilant, factoring in the lingering impacts of tariffs when assessing market outlooks.

U.S. Fiscal Policy and Deficit Concerns

Another critical topic discussed is the trajectory of U.S. fiscal policy, particularly regarding federal deficits. Zesas addresses the uncertainty surrounding whether the U.S. will move towards smaller deficits in line with campaign promises or if continued tax and spending measures will prevent such progress.

Michael Zesas [02:50]: "Extending expiring tax cuts and extending some new ones, albeit with some spending offsets, should modestly expand the deficit next year in our estimates."

He emphasizes that the focus should remain on the forthcoming year, as projections beyond that remain speculative. The expectation is that deficits will not decrease in the near term, partly due to higher interest payments and other budgetary factors.

Market Implications and Outlook

Zesas connects the discussed fiscal and tariff policies to broader market expectations, offering insights into how these factors inform Morgan Stanley's market outlook.

U.S. Dollar and Treasury Yields

He predicts that slower U.S. growth and the potential shift of foreign investors towards local currency-denominated portfolios will contribute to a weakening U.S. Dollar—a key forecast that Morgan Stanley initiated earlier in the year.

Michael Zesas [03:10]: "Slower relative US Growth and the related potential for foreign investors to increasingly prefer their portfolios reflect their local currency should keep the US Dollar weakening, a key call our team started this year with."

Regarding the U.S. Treasury yield curve, Zesas anticipates that higher deficits and inflation uncertainties stemming from tariff policies will lead to a steeper yield curve. This steepening is expected to result in falling treasury yields, presenting opportunities for favorable returns on high-grade bonds and corporate credit.

Michael Zesas [03:20]: "We expect US treasury yields to fall, making for good returns for high-grade bonds including corporate credit, the better returns might be in shorter maturities."

Conclusion

Wrapping up the episode, Zesas reiterates the importance of understanding the nuanced nature of tariff signals and fiscal policies to navigate the current market landscape effectively. His insights provide investors with a comprehensive framework to anticipate and respond to ongoing economic challenges and opportunities.

Notable Quotes:

• Michael Zesas [01:55]: "We think that's too simple of a way for investors to think about it."
• Michael Zesas [02:20]: "Even though the US cutting tariffs on China from very high levels recently brought down the effective tariff rate, it's still considerably higher than where we started the year."
• Michael Zesas [03:10]: "Slower relative US Growth and the related potential for foreign investors to increasingly prefer their portfolios reflect their local currency should keep the US Dollar weakening, a key call our team started this year with."

Disclaimer: The episode concludes with a standard informational disclaimer clarifying that the content is not financial advice and may not be suitable for all investors.

This comprehensive overview encapsulates the key discussions and insights from the episode "How to Decode Tariff Signals," providing listeners with a clear understanding of the implications of US tariff policies and fiscal strategies on market dynamics.