Thoughts on the Market: Searching for Signals in U.S. Policy Noise

Podcast Information:

• Title: Thoughts on the Market
• Host: Morgan Stanley
• Episode: Searching for Signals in U.S. Policy Noise
• Release Date: February 28, 2025

Morgan Stanley's podcast episode, Searching for Signals in U.S. Policy Noise, delves into the recent tumultuous landscape of U.S. public policy and its implications for investors. Hosted by Michael Zesus, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy, the episode navigates through the maze of policy announcements, tariff changes, and their reverberating effects on the economy and markets.

1. Navigating Policy Noise

Michael Zesus sets the stage by addressing the current state of U.S. public policy:

“[...] the past few weeks have been disorienting. Tariff announcements have continued, but with shifting details on timing and magnitude, and Congress passed a bill to enable substantial spending cuts. But subsequent media reports made clear the votes to actually enact these cuts later this year may not be there. Our recent client conversations have revealed that investor confusion has reached new heights and there's little consensus or conviction about whether U.S. policy choices are set to help or hurt the economy and markets. Net net, it's a lot of policy noise and very little signal.”
— Michael Zesus [00:00]

Zesus highlights the prevalent uncertainty among investors due to fluctuating policy signals, particularly surrounding tariffs and fiscal measures.

2. Tariff Dynamics and Trade Policies

The discussion pivots to the specifics of tariff implementations and their broader economic impacts. Zesus outlines Morgan Stanley's stance on current tariff actions:

“Actual tariff actions have followed a graduated pace, in line with our base case of fast announcement, slow implementation where tariffs on China start and continue to climb. But tariffs on the rest of the world move slowly and are more subject to negotiation.”
— Michael Zesus [00:00]

China Tariffs: Zesus emphasizes that tariffs on China are escalating steadily due to unresolved trade disagreements:

“Tariffs on China, already raised an incremental 10% a few weeks back, seem likely to step up again as there are much bigger disagreements that the two nations don't appear close to resolving.”
— Michael Zesus [00:00]

Mexico and Canada Tariffs: In contrast, tariffs on Mexico and Canada are expected to progress more cautiously:

“Tariffs on Mexico and Canada appear, in our view, likely to be pushed out once again, given progress in negotiation on harmonizing trade policy and progress in reduced border crossings.”
— Michael Zesus [00:00]

3. Economic Implications of Tariff Policies

Zesus explores the dual-edged sword of tariff policies aimed at reshoring and strengthening supply chains:

“The U.S.'s goal is to bring more investment onshore, with an aim toward increasing goods production, thereby reducing trade deficits, securing important supply chains and growing industrial jobs. The theory is that higher tariff barriers might incentivize more direct investment into the US as companies build supply chains in the US to avoid the higher tariff costs.”
— Michael Zesus [00:00]

However, he cautions about the associated costs of such transitions:

“In a recent blue paper, my colleague Rajeev Sibal led a team through an analysis demonstrating that the next phase of supply chain realignment would be considerably costlier to companies given the complexity of production that must be shifted. So either way, companies take on new costs, tariffs, capex or both that challenges corporate margins and economic growth, at least for a time, and there's plenty of execution risk along the way.”
— Michael Zesus [00:00]

4. Strategic Recommendations for Investors

In light of the prevailing uncertainties, Morgan Stanley advises a strategic pivot towards bond investments:

“Our cross asset and interest rate strategy teams think it's time to lean more heavily into bonds. Equity markets may do just fine here, with investors looking through the near term costs, but the risk of something going wrong with, for example, tariff escalation or broader geopolitical conflict may keep a ceiling on investors' risk appetite.”
— Michael Zesus [00:00]

Zesus further elucidates the rationale behind this recommendation, noting that a potential growth slowdown could bolster the case for bond holdings:

“Conversely, a growth slowdown presents a clearer case for owning bonds, particularly since it wasn't that long ago that better economic data helped the treasury market price out most of the expected monetary policy cuts for 2025.”
— Michael Zesus [00:00]

5. Concluding Insights

Michael Zesus wraps up the episode by reinforcing the importance of discerning signal from noise in policy developments and aligning investment strategies accordingly. He underscores the delicate balance investors must maintain in navigating policy-induced volatility while positioning portfolios to mitigate risks and capitalize on opportunities.

Notable Takeaways:

• Policy Uncertainty: Recent U.S. policy announcements have created significant confusion among investors, with unclear impacts on the economy and markets.
• Tariff Strategy: While tariffs on China are expected to rise incrementally, those on Mexico and Canada are likely to see slower progression due to successful negotiations.
• Economic Impact: Efforts to reshore investments and secure supply chains through tariffs may lead to increased costs for companies, affecting margins and growth.
• Investment Strategy: Leaning towards bonds is advised amidst the current policy uncertainties and potential growth slowdowns, offering a safer harbor compared to equities.

This comprehensive analysis by Morgan Stanley provides investors with a nuanced understanding of the current U.S. policy environment and actionable insights to navigate the complex market dynamics.