Special Encore: Bracing for Sticker Shock

Summary

Below is a detailed summary of the episode "Special Encore: Bracing for Sticker Shock" from the Thoughts on the Market podcast, hosted by Morgan Stanley's Andrew Sheets with guest Jenna Giannelli. The discussion centers on the puzzling impact of tariffs on prices and margins, and how retailers are maneuvering to mitigate the cost pressures while the broader market—particularly inflation and monetary policy—remains in focus.

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1. Episode Overview
   ────────────────────────────── • Purpose:
     – The episode digs into one of the market’s major conundrums—when and how tariffs imposed by the U.S. will appear in prices and affect margins.
     – Despite historically high tariffs and a surge in tariff collections, official price data and inflation figures have not yet reflected a significant impact.
     – The conversation also connects these challenges directly to retail sector dynamics and the potential macroeconomic implications for inflation and Federal Reserve policy decisions.

• Context:
  – Episode Title: Special Encore: Bracing for Sticker Shock
  – Release Date: August 15, 2025
  – Host: Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley
  – Guest: Jenna Giannelli, Head of US Consumer and Retail Credit Research
  – Description: A thoughtful examination of recent market events and tariff-related uncertainties from multiple perspectives at Morgan Stanley.

────────────────────────────── 2. Key Discussion Points and Insights
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A. Timing and Inventory Management (Starting [00:17] – [01:30])   • Tariff Impact Timing:
   – Jenna explains that the timing of tariffs has been masked by retailers' proactive inventory buildup. Retailers had already accumulated three to four months of inventory before the tariffs were fully ramped up.
   – This initial inventory, secured at lower tariff rates (or even pre-announcement), is driving sales through Q1 and into Q2, delaying the visible impact on margins and pricing.
  • Mitigation Measures:
   – Retailers are using a variety of tactics including canceled or paused shipments, altering production mixes, and re-sourcing to offset tariff exposures.
   – They are also leveraging cost-saving measures and negotiating vendor terms to absorb some of the headwinds without resorting immediately to price hikes.

B. Sector-Specific Challenges and Pricing Strategies (Discussed from [03:37] – [05:23])
  • Limited Pricing Leverage:
   – Jenna notes that raising prices—often considered a last-resort measure—is anticipated mainly as a mechanism in the later part of the year, as other mitigation strategies get exhausted.
   – Certain retail sectors (e.g., apparel and footwear, home goods, sporting goods, furniture) are particularly challenged in passing along higher costs because of their historical pricing dynamics.
  • Sectors More Likely to Pass Through Costs:
   – Staples and less discretionary items, such as beauty and personal care products, may have more flexibility to absorb tariff costs through modest price increases.
  • Future Timing:
   – Jenna predicts that any significant price rises will likely start emerging in the third quarter and then intensify in the fourth quarter during the critical holiday season—when higher cost goods will increasingly hit the income statement.

C. Comparative Market Performance and Broader Economic Impacts ([03:37] – [06:00])
  • Market Resilience vs. Sector Vulnerability:
   – Although overall equity and credit markets have remained strong on a year-to-date basis, retail equities have underperformed compared to credit, signaling potential eventual convergence or correction.
  • Macro View and Fed Policy:
   – Andrew ties the conversation back to the big macro picture, emphasizing that a potential rebound in inflation later in the year might lead the Federal Reserve to maintain or even raise interest rates rather than cut them—a view supported by Morgan Stanley economists.

D. Tariff Guidance and Earnings Impact (Latter part of conversation starting [06:41])
  • Current Outlook vs. Revised Expectations:
   – Jenna discusses recent tariff headlines, noting that for regions like Vietnam and certain parts of Southeast Asia, the tariffs coming into effect (especially from August 1st) are more severe than what many retail management teams expected.
  • Earnings Implications:
   – To quantify the impact, Jenna cites retail consumer cohort credits: while consensus expected EBITDA to drop by about 5% year-on-year, applying the current tariff rates over a half-year headwind could push the decline to about 15% on a gross basis ([07:58]).
   – This significant delta underscores the potential for a much sharper impact on earnings in the latter half of the year even if retailers manage an initial phase of mitigation.

────────────────────────────── 3. Notable Quotes and Memorable Moments
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• [00:17] Andrew Sheets introduces the key issue:
  "Where and when are tariffs going to show up in prices and MARGINS? ... tariffs are real hard dollars that importers or somebody else are paying."
  – Sets the stage for a detailed dissection of tariff impacts.

• [05:19] Andrew highlights the timing question:
  "Retailers saw this coming... the last lever is raising prices, which is the macro thing that we care about, the thing that would actually show up in inflation."
  – This statement connects the discussion of retail strategies directly to broader economic concerns.

• [07:58] The striking earnings implication:
  Jenna explains the numbers, prompting Andrew to remark, "So three times as much."
  – This exchange underlines the potential magnitude of the tariff headwind on earnings versus earlier guidance, marking a key takeaway for investors.

────────────────────────────── 4. Concluding Thoughts
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• Synthesis of Discussion:
  – Jenna and Andrew conclude that while retailers have exercised multiple strategies to cushion the impact of tariffs, the built-in delays especially due to pre-tariff inventories and strategic sourcing mean that the true inflationary effects may only become apparent by Q3 or even Q4.
  – The discussion reinforces the view that ongoing and possibly increasing tariff pressures could contribute to a resurgence in inflation later in the year, influencing Fed policy decisions and the overall market sentiment.

• Final Note:
  – Jenna’s insights indicate that even though mitigation efforts have so far softened the blow, businesses and investors should remain vigilant as the numbers suggest a potential significant downturn in margins if tariffs fully impact the earnings later in the year.

This thorough summary captures the key themes, discussion points, and the strategic insights provided throughout the episode, offering a clear picture for anyone who has yet to listen.

Transcript

[A]

In case you missed it today, we're bringing you a special encore release of a recent episode. We'll be back on Monday with a brand new episode. Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley.

[B]

And I'm Jenna Giannelli, head of US Consumer and Retail Credit Research.

[A]

And today on the podcast, we're going to dig into one of the biggest conundrums in the market today. Where and when are tariffs going to show up in prices and MARGINS? It's Friday, July 11th at 10:00am in New York. Jenna, it's great to catch up with you today because I think you can really bring some unique perspective into one of the biggest puzzles that we're facing in the market today. Even with all of these various pauses and delays, the US has imposed historically large tariffs on imports and we're seeing a rapid acceleration in the amount of money collected from those tariffs by U.S. customs. These are real hard dollars that importers or somebody else are paying. Yet we haven't seen these tariffs show up to a significant degree in official data on prices, with recent inflation data relatively modest. And overall stock and credit markets remain pretty strong and pretty resilient, suggesting less effect. So are these tariffs just less impactful than expected, or is there something else going on here with timing and severity? And given your coverage of the consumer and retail sectors, which is really at the center of this tariff debate, what do you think is going on?

[B]

So, yes, this is a key question and one that is dominating a lot of our client conversations at a high level. I'd point to a few things. First, there's a timing issue here. So when tariffs were first announced, retailers were already sitting on three to four months worth of inventory just due to natural industry lead times, and they were able to draw down on this product. This is mostly what they sold in 1Q and likely into 2Q, which is why you haven't seen much margin or pricing impact thus far. Companies, we also saw them start to stock up, have heavily on inventory before the tariffs and at the lower pause rate tariffs, which is the product you referenced that we're seeing coming in now, this is really going to help mitigate margin pressure in the second quarter that you still have this lower cost inventory flowing through on top of this timing consideration. Retailers we've just seen utilizing a range of mitigation measures, right? So whether it's canceled or paused shipments from China, a shifting production mix or sourcing exposure in the short run, particularly before the pause rate on China, and then really Leaning into just whether it's product mix shifts, cost savings elsewhere in the P and L in vendor negotiations. Right. They're really leaning into everything in their toolbox that they can. Pricing too has been talked about as something that is an option, but the option of last resort, we have heard it will be utilized, but very tactically and very surgically. As we think about the back half of the year. When you put this all together, how much impact is it having on average from retailers that we heard from in the first quarter, they thought they would be able to mitigate about half of the expected tariff headwind, which is actually a bit better than we were expecting. Finally, I'll just comment on your comment regarding market performance. While you're right in that the overall equity and credit markets have held up well year to date, retail equities and credit have fared worse than their respective indices. What's interesting actually is that credit though has significantly outperformed retail equities, which is a relationship we think should converge or correct as we move throughout the balance of the year.

[A]

So Jenna, retailers saw this coming. They've been pulling various levers to mitigate the impact you mentioned. Kind of the last lever that they want to pull is price is raising prices, which is the macro thing that we care about, the thing that would actually show up in inflation. How close are we though to kind of running out of other options for these guys, that is the only thing left is they can start raising prices.

[B]

So closer is what I would say we're likely not going to see a huge impact in 2Q. More likely as we head into 3Q and more heavily into the all important fourth quarter holiday season. This is really when those higher cost goods are going to be flowing through the P and L and retailers need to offset this as they've utilized a lot of their other mitigation strategies. They've moved what they could move, they've negotiated where they could, they've cut where they could cut. And again, as this last stop it will be to try and raise price. So who's going to have the most in least success in our universe, we think it's going to be more difficult to pass along price in some of the more historically deflationary categories like apparel and footwear. Outside of what is a really strong brand presence within our universe historically hasn't been the case. Also in some of the higher ticket or more durable goods categories like home goods, sporting goods, furniture. We think it'll be challenging as well here to pass along higher costs where it's going to be less of an issue is in our staples universe or what we'd put as less discretionary categories like beauty, personal care, which is part of the reason why we've been cautious on retail and neutral on consumer products when we think about sector allocation.

[A]

When do you think this will show up? Is it a third quarter story, a fourth quarter story?

[B]

I think this is going to really start to show up in the third quarter and more heavily into the fourth quarter and the all important holiday season.

[A]

I think that's what's really interesting about the impact of this back up to the macro again. Returning to the big picture is I think one of the most important calls that Morgan Stanley economists have is that inflation, which has been coming down somewhat so far this year, is going to pick back up in August and September and October. And because it's going to pick back up, the Federal Reserve is not going to cut interest rates anymore this year because of that inflation dynamic. So this is a big debate in the market. Many investors disagree. But I think what you're talking about in terms of there are some very understandable reasons maybe why prices haven't change so far, but that those price hikes could be coming, have real macroeconomic implications. Maybe, though, something to just close on is to bring this to the latest headlines. We're now back, it seems in a market where every day we log onto our screens and we see a new headline of some new tariff being announced or suggested towards countries. Where do you think those announcements so far are relative to what retailers are expecting? Kind of what you think is in guidance?

[B]

Sure. So look what we've seen of late. The recent tariff headlines are certainly higher or worse, I think, than what investors and management teams were expecting for Vietnam. Less so, I'd say it was more in line. But for most elsewhere in Asia, particularly Southeast Asia, the rates that are set to go in effect on August 1st as we now understand them, are higher or worse than management teams, you know, were expecting. Recall that while guidance did show up in many flavors in in one in the first quarter. So whether withdrawn guidance or lowered guidance, for those that did factor in tariffs to their guide, most were factoring in either pause rate tariffs or tariff rates that were at least lower than what proposed on Liberation Day. Right. So what's the punchline here? I think despite some of the revisions we've already seen, there are more to come. To put some numbers around this, if we look at our group of retail consumer cohort credits, consensus expectations for calling for EBITDA in our universe to be down around 5% year over year. If we apply tariff rates as we know them today for a half year headwind starting August 1st, this number should be down around 15% year over year on a gross basis.

[A]

So three times as much.

[B]

Pretty significant. Exactly. And so while there might be mitigation efforts, there might be some pricing past the long this is still a pretty significant delta between where consensus is right now and what we know tariff rates to be today could imply for earnings in the second half.

[A]

Jenna, thanks for taking the time to talk.

[B]

My pleasure. Thank you.

[A]

And thank you as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.

[C]

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