Midyear Global Outlook, Pt 1: Skewing to the Downside Hosted by Morgan Stanley | Released May 21, 2025

In this episode of "Thoughts on the Market," Serena Tang, Morgan Stanley's Chief Global Cross Asset Strategist, and Seth Carpenter, Morgan Stanley's Global Chief Economist, delve into the firm's midyear outlook for the global economy and markets. Titled "Skewing to the Downside," the discussion provides an in-depth analysis of current economic trends, policy impacts, regional performances, and investment implications amid ongoing uncertainties.

1. Overall Economic Outlook

Seth Carpenter sets the tone by explaining the rationale behind the "Skewing to the Downside" outlook, emphasizing expectations of a meaningful slowdown in both the U.S. and global economies compared to earlier projections.

“We really do think the US Economy, the global economy is set to slow meaningfully from where we were coming into this year.”
— Seth Carpenter [00:40]

While Carpenter stops short of predicting a recession, he highlights a significant deceleration in economic growth, influenced by various policy changes and external shocks.

2. U.S. Economy and Policy Changes

The discussion highlights two major policy areas shaping the U.S. economic landscape: trade and immigration.

• Trade Policy: Since the new administration took office, there has been considerable fluctuation in tariffs. Carpenter notes a likely scenario of persistent tariffs on China, reduced tariffs on other nations, and ongoing uncertainty about future policies.

  “What does that mean? Well, it means for the US Higher inflation and lower growth.”
  — Seth Carpenter [00:40]

• Immigration Policy: Reform in immigration is anticipated to slow the growth rate of the U.S. labor force, contributing to overall economic deceleration.

These policy shifts are expected to result in higher inflation coupled with reduced economic growth in the U.S.

3. Global Economic Implications

Carpenter extends the analysis to the global stage, explaining how U.S. tariffs negatively impact other economies by reducing demand for their exports.

“When the US Puts in tariffs on its imports from other countries, that's negative demand for those other countries.”
— Seth Carpenter [01:20]

He forecasts weak growth in the euro area, attributing it to subdued demand despite potential expansionary fiscal policies in countries like Germany. Additionally, China's economy is projected to continue its slow growth cycle, exacerbated by reduced U.S. demand.

4. Regional Bright Spots

Despite the overall downward trend, Carpenter identifies two regions as potential bright spots:

• India: Anticipated to exhibit the highest growth rate among covered economies, bolstered by both cyclical factors and long-term structural policies.

  “India has lots going for it. There are cyclical factors boosting growth in the near term, but there are also longer term structural policy driven reasons to think that Indian growth will stay solid for the foreseeable future.”
  — Seth Carpenter [02:38]

• Japan: While not growing as rapidly as India, Japan's reflationary cycle remains robust, suggesting continued economic momentum despite broader global challenges.

  “We're pretty optimistic still that Japanese reflation will continue.”
  — Seth Carpenter [02:38]

5. Impact of U.S. Tariffs on Inflation and Central Banks' Responses

The imposition of tariffs by the U.S. is a double-edged sword, fueling domestic inflation while acting as a demand dampener internationally.

“Tariffs are going to drive up inflation domestically and drive down growth, whereas for the rest of the world, it's mostly just a negative demand shock.”
— Seth Carpenter [03:45]

Central Bank Responses:

• U.S. Federal Reserve (Fed): Faces a dilemma as it contends with rising inflation and slowing growth. Carpenter suggests the Fed may "wait until the hard data show a bigger slowdown in the economy" before adjusting policies.

  “The Fed's probably going to wait until the hard data show a bigger slowdown in the economy...”
  — Seth Carpenter [04:45]

• European Central Bank (ECB): Likely to lower policy rates further to counteract slowing demand.

  “We think the ECB is going to lower its policy rate to probably one and a half percent and maybe even lower...”
  — Seth Carpenter [04:45]

Emerging market central banks face constraints in managing domestic economic needs while avoiding adverse currency movements in light of the Fed's potential tightening.

6. Business Investment Impact

Trade policy uncertainty significantly hampers business investment, particularly in export-oriented industries and economies closely tied to U.S. demand.

“Uncertainty tends to be very negative for business investment spending decisions.”
— Seth Carpenter [05:30]

Businesses are hesitant to commit to long-term investments like building new factories amid unpredictable tariff landscapes, leading to broader economic caution.

7. Spillover Effects on Emerging Markets

Emerging markets (EM) are affected both directly and indirectly by U.S. tariff policies:

• Direct Impact: Countries like Mexico, despite trade agreements mitigating some tariff effects, still face economic slowdowns due to reduced U.S. demand.

  “Mexico is very attached to the US economy and so as the US Economy slows because of these tariffs, the Mexican economy will slow as well.”
  — Seth Carpenter [06:32]

• Indirect Impact: EM central banks are constrained in lowering interest rates to support domestic economies without risking currency instability, especially if the Fed maintains higher rates longer than expected.

  “EM central banks who might want to lower their policy rate... have to pay attention to external matters.”
  — Seth Carpenter [06:32]

8. Forecasting and Navigating Uncertainty

Acknowledging the heightened difficulty in economic forecasting amidst exceptional volatility, Carpenter emphasizes the importance of scenario planning.

“You have to start thinking more and more... in terms of scenarios.”
— Seth Carpenter [08:01]

Morgan Stanley employs a range of scenarios to anticipate potential policy shifts and their implications, recognizing that flexibility is crucial in adapting forecasts as new data emerges.

9. Investment Implications

Carpenter advises investors to maintain a strong focus on the macroeconomic environment, underscoring its significant influence on asset prices. However, he cautions against overconfidence in specific economic projections due to inherent uncertainties.

“For investors, the macro economy still matters, but having a lot of conviction about where it's going... is the trickier part.”
— Seth Carpenter [08:49]

Staying adaptable and ready to revise investment strategies in response to changing economic indicators is essential for navigating the current market landscape.

Conclusion

The episode concludes with Serena Tang and Seth Carpenter acknowledging the complexities of the current economic environment. While there are identifiable growth areas like India and Japan, overarching challenges such as U.S. trade policies, global demand shocks, and central bank constraints paint a cautious picture for the remainder of the year and into 2026.

“We've got our forecast, but we are ready to make a revision if the facts change.”
— Seth Carpenter [08:49]

Listeners are encouraged to stay informed and adaptable, recognizing that the interplay of various economic factors will continue to shape market dynamics in the near future.

For more insights and detailed analyses on market trends, tune into future episodes of "Thoughts on the Market" by Morgan Stanley.