Rewiring Global Trade

Summary

Podcast Summary: "Rewiring Global Trade" from Thoughts on the Market

Release Date: March 7, 2025
Host: Morgan Stanley
Episode: Rewiring Global Trade

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1. Introduction and Current Policy Landscape

In the March 7th episode of Morgan Stanley’s Thoughts on the Market, Michael Zesas, the firm's Global Head of Fixed Income Research and Public Policy Strategy, delves into the intricate web of recent U.S. policy developments and their implications for investors. Opening the discussion at [00:00], Zesas sets the stage by highlighting the relentless stream of news surrounding tariffs, immigration, and geopolitics, culminating in President Trump's State of the Union address.

"In recent weeks, the news flow on tariffs, immigration, and geopolitics has been relentless, culminating in this week's State of the Union address by President Trump," Zesas notes, underscoring the heightened state of policy uncertainty. He references the Baker Bloom and Davis Index, pointing out that measures of policy uncertainty have surged to all-time highs, mirroring the confusion experienced by corporate clients and investors alike.

2. Transition Toward a Multipolar World

Zesas introduces a pivotal theme for 2025: the transition toward a multipolar world. At [00:54], he emphasizes that despite the ongoing policy noise, there are underlying signals indicating this significant global shift.

"These policy developments track with one of our four key themes of 2025: the transition toward a multipolar world," he explains. This transition reflects the evolving role of the U.S. in international affairs, as illustrated by the tense White House meeting between Presidents Trump and Zelensky.

The imposition of tariffs on Mexico, Canada, and China is presented as the U.S.'s strategic move to rewire global trade, signaling a more inward-looking economic stance driven by economic populism—a sentiment gaining traction across both major U.S. political parties.

3. Implications for the European Defense Sector

One of the standout takeaways from the discussion is the positive outlook for the European defense sector. Zesas outlines how the combination of U.S. tariffs and a shifting U.S. security posture is likely to prompt Europe to increase its defense spending significantly.

"The combination of tariffs and the evolving US posture on global security has long been part of our thesis on why Europe would eventually chart a new path and step up to spend more on defense," Zesas states at [02:15]. He cites the ongoing Russia-Ukraine conflict as a catalyst that could drive an additional $0.9 to $2.7 trillion in European defense spending through 2035.

Germany's proactive stance on defense expenditure is highlighted as a key indicator of this trend, reinforcing the expectation that European nations will take a more substantial role in their own security needs.

4. U.S. Trade Realignment and Market Dynamics

The episode also explores the ramifications of U.S. trade realignment on macroeconomic indicators and sector-specific equity preferences. Zesas discusses how the administration's approach to reducing trade deficits through reciprocal trade barriers is reshaping the investment landscape.

"Tariffs are part of the cost," he notes at [01:45], explaining that while the immediate impact of these tariffs is to dampen economic activity, the long-term strategy aims to incentivize greater domestic production. Morgan Stanley's economists predict that these tariff-induced costs will lead to slower economic growth, which, in turn, may prompt a more dovish monetary policy stance.

This anticipated shift is expected to drive bond yields lower—a boon for fixed income investors—but presents challenges for equity markets. As Zesas summarizes, "Our cross asset team is currently flagging a preference for fixed income," reflecting a strategic pivot in investment focus due to the evolving market conditions.

5. Supply Chain Realignment and Sectoral Impacts

A critical component of the discussion revolves around the realignment of global supply chains in response to the new trade dynamics. Zesas points out that while the intention is to decouple from geopolitical rivals, the complexity and concentration of existing supply chains make this transition costly and challenging.

"Supply chains that need to be moved now are complex and concentrated in geopolitical rivals," he explains at [02:45]. This presents significant hurdles for sectors such as U.S. IT hardware and consumer discretionary, which rely heavily on these established networks.

However, Zesas also identifies opportunities arising from this shift. The necessary investments to reorganize supply chains are expected to bolster demand in the capital goods and broader industrial sectors, suggesting a nuanced landscape where some industries may thrive amidst the restructuring.

6. Conclusion and Investor Takeaways

Wrapping up the episode, Zesas reiterates that the current policy noise is set to persist, continuing to influence market dynamics through various cross currents. He assures listeners that Morgan Stanley remains committed to providing insights into these ongoing developments.

"The policy noise will continue, as will the market cross currents it's driving," he concludes at [03:30], emphasizing the firm's dedication to keeping investors informed and prepared for the evolving economic and geopolitical environment.

For investors navigating these turbulent times, the episode underscores the importance of staying attuned to policy shifts and their broad-reaching impacts on different market sectors. The preference for fixed income over equities, the golden opportunity in the European defense sector, and the challenges and prospects in supply chain realignment are critical considerations highlighted throughout the discussion.

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This summary encapsulates the key points and insights shared by Michael Zesas in the episode "Rewiring Global Trade," providing a comprehensive overview for those who have not listened to the podcast.

Transcript

[Michael Zesas]

Welcome to Thoughts on the Market. I'm Michael Zesas, Morgan Stanley's global head of fixed income research and public policy strategy. Today we'll be discussing what investors need to focus on AMIDST all the U.S. policy Headlines. It's Friday, March 7th at 12:30pm in New York. In recent weeks, the news flow on tariffs, immigration and geopolitics has been relentless, culminating in this week's State of the Union address by President Trump. And if headlines hold a partial reversal in course on Mexico and Canada tariffs that were just levied earlier this week. Understandably, measures of policy uncertainty such as the Baker Bloom and Davis Index have reached all time highs, and this tracks with the confusion expressed by investing in corporate clients. In our view, this policy noise is going to continue. But there is an important signal these developments track with one of our four key themes of 2025 the transition toward a multipolar world. The tense White House meeting between Presidents Trump and Zelensky, played out live in front of the news cameras, was another reminder that the US is evolving its role in driving international affairs, and tariffs on Mexico, Canada, and China are a reminder of the US's interest in rewiring global trade. The reasons behind this are myriad and complex, but in the near term it's about the US looking more inward. Economic populism is well popular with voters in both parties. There's a few net takeaways for investors here. One is a positive for the European defense sector. The combination of tariffs and the evolving US posture on global security has long been part of our thesis on why Europe would eventually chart a new path and step up to spend more on defense. The current situation in Russia and Ukraine underscores this with potential for another 0.9 to $2.7 trillion in defense spending through 2035. Germany's new whatever it takes approach to defense spending is a key signpost in this trend, per our colleagues in European economics, equities and foreign exchange. Another critical takeaway is around the effects of US trade realignment on both macro markets and equity sector preferences. Whether these trade policy changes play out well over time or not, the attempt costs something in the near term. Tariffs are part of that cost. And while the precise path of tariff increases is unclear, what is clear is that they're headed higher in the aggregate, a tactic in service of the administration's goal of reducing trade deficits and creating reciprocal trade barriers in order to incentivize greater production in the US over the next year. Our economists expect that those tariff costs will crimp economic activity that slower growth should eventually feed through into a more dovish monetary policy. Both factors, in the view of our U.S. rate strategy team, should continue pushing yields lower. Good news for bond investors, but more challenging posture for equity investors and a key reason why our cross asset team is currently flagging a preference for fixed income. That tariff activity should also drive supply chain realignment, but going forward, changing those supply chains may now be more costly. Per work from our global economics team, the supply chains that need to be moved now are complex and concentrated in geopolitical rivals. That's a challenge for certain sectors like US it, Hardware and consumer discretionary, but the investment to make it happen creates demand and is a benefit for the capital goods and broader industrial sectors. Bottom line, the policy noise will continue, as will the market cross currents it's driving. We'll keep you informed on it all here. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

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