Tariffs Could Drag on Growth in Asia as Well as U.S.

Summary

Podcast Summary: "Tariffs Could Drag on Growth in Asia as Well as U.S."

Episode Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: Tariffs Could Drag on Growth in Asia as Well as U.S.
• Release Date: April 25, 2025

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Overview

In this insightful episode of Thoughts on the Market, Morgan Stanley’s chief U.S. economist, Michael Gapen, and chief Asia economist, Chetan Aya, delve into the significant implications of ongoing tariff tensions between the United States and China. Released on April 25, 2025, the discussion centers on revised growth forecasts for Asia, the potential impact on the U.S. economy, and the broader global trading environment. The hosts provide a detailed analysis of policy responses, investor sentiments, and key economic indicators to watch in the coming months.

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1. Introduction and Context

Michael Gapen kicks off the episode by setting the stage for the discussion. He introduces the main topic: the recent adjustments to Asia’s growth forecast in light of escalating tariffs and the subsequent effects on the U.S. economy. Gapen emphasizes the critical nature of current trade tensions and their potential to reshape economic landscapes in both regions.

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2. Asia’s Growth Forecast Amid Tariff Adjustments

Chetan Aya explains the initial stance that current U.S.-China tariffs are so prohibitive that they effectively halt trade transactions between the two giants [00:30]. He notes recent discussions on easing tariffs but highlights that even reduced rates remain significantly high, with a weighted average tariff expected to hover around 32%, a stark increase from the approximately 5% in early January [01:07]. Aya underscores the immense uncertainty this creates for regional investment growth, projecting a considerable slowdown.

Notable Quote:

“The weighted average tariff will still be around 32%, and this number was close to 5% in early January. So we're talking about a huge amount of uncertainty related to this tariff path.” — Chetan Aya [01:07]

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3. Revisions to Asia's Growth Forecast

Gapen addresses the recent downward revision in Asia’s GDP growth projections. Aya details that Asia’s overall GDP growth is now expected to decline from 4.8% in Q4 last year to 3.6% by Q4 this year. Specifically, China’s growth forecast has been reduced from 5.4% to 3.7%, indicating a significant economic slowdown [02:05].

Notable Quote:

"For China, we think it’ll be the fiscal policy that will do the heavy lifting…" — Chetan Aya [02:45]

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4. Policy Responses in Asia to Counteract Tariffs

Aya elaborates on the anticipated policy measures by Asian economies to mitigate the impact of tariffs. He expects a combination of monetary and fiscal policy easing across the region. For China, fiscal measures such as a 2.5% increase in GDP through infrastructure projects and consumer support programs are expected to be pivotal. Other Asian economies may rely more heavily on monetary tools, including rate cuts ranging from 50 to 150 basis points [02:52].

Notable Quote:

"We are expecting 50 to 150 basis points, depending upon the economy in the region in form of rate cuts…" — Chetan Aya [03:41]

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5. Impact on the U.S. Economy

Transitioning to the U.S. economy, Gapen describes it as "living on the edge," implying a precarious balance between avoiding a recession and succumbing to economic pressures [04:11]. He emphasizes that while a recession is not imminent, the economy is dangerously close, primarily due to the sustained high tariff rates and the resulting uncertainties.

Notable Quote:

“We’re living on the edge where we’re not projecting a recession, but we’re close enough to one that it’s almost a coin toss.” — Michael Gapen [04:58]

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6. Consumer and Business Confidence

Aya raises concerns about declining consumer and corporate confidence amidst ongoing policy uncertainties. Gapen responds by highlighting the dual pressures: lower consumer confidence, especially among lower and middle-income households affected by tariffs, and waning business confidence leading to reduced investments and potential layoffs. These factors could create negative feedback loops, increasing the risk of a recession [05:21].

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7. Fed’s Policy Response to Tariff-induced Inflation

The discussion shifts to the Federal Reserve’s potential response to tariff-induced inflation. Aya references Fed Chair Powell’s assertion that tariffs are causing a temporary rise in inflation. Gapen forecasts that the Fed might delay rate cuts until 2026, focusing initially on controlling inflation rather than responding immediately to economic slowdowns. However, he notes that if the economy deteriorates more rapidly than expected, the Fed may adjust its stance accordingly [07:15].

Notable Quote:

"If we were wrong on the economy and it decelerates and moves into a recession more quickly than we would anticipate, then the Fed will ease." — Michael Gapen [07:15]

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8. Key Data Points and Future Outlook

Gapen outlines several key indicators to monitor in the near term:

• Inflation Data: Particularly the pass-through of tariffs to consumer prices, starting with April’s data on autos [08:06].
• Trade Volumes: Including shipping container volumes and signs of reduced trade activity [08:15].
• Employment Figures: Watching for signs of hiring slowdowns or increased layoffs, beginning with April’s employment data [08:15].

These indicators will provide critical insights into whether the inflation impulse and economic slowdown forecasts hold true [08:15].

Notable Quote:

"We think there's a tension between how much uncertainty can be reduced on one hand and then on the other hand, how quickly volumes in the economy may slow." — Michael Gapen [04:11]

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9. Differentiation Among Asian Economies

Aya differentiates Asian economies based on their trade orientations to assess their vulnerability to the ongoing trade slowdown. He identifies India and Australia as relatively less affected due to lower dependency on trade. In contrast, Korea, Taiwan, Thailand, and Malaysia, being more trade-oriented, are expected to bear a heavier burden. Although China has a slightly lower trade orientation compared to Korea and Taiwan, the high tariffs it faces necessitate a more pronounced growth slowdown [09:56].

Notable Quote:

"India and Australia are the ones we think will be relatively less affected from this trade slowdown and global growth slowdown." — Chetan Aya [10:15]

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10. Conclusion

The episode wraps up with Gapen and Aya reiterating the critical nature of current tariff developments and their far-reaching economic implications. They encourage listeners to stay informed and consider the nuanced impacts on different economies. Gapen invites listeners to leave reviews and share the podcast to broaden its reach [10:46].

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Key Takeaways:

• Sustained High Tariffs: Despite some easing, U.S.-China tariffs remain high, significantly impacting trade and investment in Asia.
• Revised Growth Forecasts: Asia’s GDP growth projections have been markedly downgraded, with China facing the most substantial slowdown.
• Policy Responses: Asian economies are adopting a mix of monetary and fiscal policies to counteract tariff impacts, though these measures may not fully offset the negative effects.
• U.S. Economic Outlook: The U.S. economy is precariously balanced, with the potential for recession hinging on tariff developments and consumer/business confidence.
• Federal Reserve’s Stance: The Fed is likely to prioritize controlling inflation over immediate rate cuts, potentially delaying monetary easing until 2026.
• Varying Regional Impacts: Trade-oriented Asian economies like Korea and Taiwan are more vulnerable to tariff-induced slowdowns compared to less trade-dependent nations like India and Australia.

Notable Quotes:

• Chetan Aya [01:07]: “The weighted average tariff will still be around 32%, and this number was close to 5% in early January. So we're talking about a huge amount of uncertainty related to this tariff path.”
• Michael Gapen [04:58]: “We’re living on the edge where we’re not projecting a recession, but we’re close enough to one that it’s almost a coin toss.”
• Chetan Aya [10:15]: “India and Australia are the ones we think will be relatively less affected from this trade slowdown and global growth slowdown.”

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This comprehensive summary captures the essence of the episode, providing a clear and structured overview of the significant discussions and insights shared by Morgan Stanley's economists. It serves as a valuable resource for those seeking to understand the complex interplay between tariffs, Asian growth prospects, and the U.S. economic outlook without needing to listen to the full podcast.

Transcript

[Michael Gapen]

Welcome to Thoughts on the Market. I'm Michael Gapen, Morgan Stanley's chief U.S. economist.

[Chetan Aya]

And I'm Chetan Aya, chief Asia economist.

[Michael Gapen]

Today we'll discuss some significant changes to our Asia growth forecast on the heels of tariffs, as well as how the US Economy is reacting to the changes in the global trading environment. It's Friday, April 25th at 8am in.

[Chetan Aya]

New York and 8pm in Hong Kong.

[Michael Gapen]

So Cheton, since the last time we were both on the show, it appears that we are headed towards at least some de escalation of trade tensions. Just last week you wrote in your report that the tariffs on China are too prohibitive for any trade to take place and that you expected some dialing down of the escalatory action. And this week the administration started to talk about easing tariffs on China significantly. Considering all the events since April 2, and it's felt like a lot of events since April 2, where does it leave you in terms of how you are thinking about the outlook?

[Chetan Aya]

So Mike, that's right. You know what we thought was that the current level of tariffs that the US has on China and what China has on the US Means that effectively there are no transactions possible. But look, even after those tariff rates are going down, we are still expecting it to be in the range of around 60% and that would still be relatively high level of tariffs if I were just to translate this into what it means for the whole region. So for the whole region, the weighted average tariff will still be around 32%. And remember this number was close to 5% in early January. So we're talking about a huge amount of uncertainty related to this tariff path and the tariff level itself is going to remain somewhat high. And so with that concern on uncertainty, we're expecting a region's investment growth to be affected significantly, taking down regions growth lower.

[Michael Gapen]

So Chetan, I was looking over your growth forecast and noticed that you have a sharp step down in growth from the second quarter of 2025 on. Can you walk us through these revisions in particular?

[Chetan Aya]

So yes, we have changed our forecast and what we are now seeing is in terms of growth path is that Asia's overall GDP growth will slow from 4.8% that we saw in fourth quarter of last year to around 3.6% by fourth quarter of this year. And for comparable time period, China's growth will slow from 5.4 to 3.7. So that's another meaningful step down for China.

[Michael Gapen]

What do you think Asian economies can do to counteract the impact from tariffs at this point?

[Chetan Aya]

So we expect the policymakers in the region to take up both monetary and fiscal policy easing. But, you know, despite that policy easing effort, you will still see that meaningful growth drag. So for China, we think it'll be the fiscal policy that will do the heavy lifting, whereas for Asia, it's China, it's going to be more monetary policy that will do the heavy lifting. And in terms of the exact magnitude, we're expecting 50 to 80, 150 basis points, depending upon the economy in the region in form of rate cuts, and specifically on China, on the fiscal policy, we expect them to take up about 2.5% of GDP increase in fiscal deficit in form of investment in infrastructure, as well as some programs for supporting consumption spending.

[Michael Gapen]

So, Chetan, it sounds like a lot of monetary and fiscal policy easing and support is coming from the Asian economies. But I guess the bottom line is that you don't think it would be suffic to fully counteract the impact from tariffs, Is that right?

[Chetan Aya]

That's right, Mike. And let me come to you now and get your thoughts on how you see the development of these tariffs, et cetera, affecting the U.S. economy. You already recently characterized your view on the U.S. economy as still living on the edge. What's driving this view?

[Michael Gapen]

It's a way that we were trying to communicate that we don't see the economy at the moment falling into a recession, but we think it's close. If we thought that the effective tariff rate was going to stay where it was or where it Is, roughly around 18%, then we would have a much more negative view on the outlook. And we do expect the effective tariff rate to come down for all the reasons that you suggested, and there's openings for that to happen. And that's where the conversation has been going in recent days. And so I think there's a tension between how much uncertainty can be reduced on one hand and then on the other hand, how quickly volumes in the economy, activity in the economy may slow. So I think we're in a window here where we are in a race against time to bring the effective tariff rate lower in order to keep the economy in recovery. So that was really my narrative here. We're living on the edge where we're not projecting a recession, but we're close enough to one that it's almost a coin toss. And I think we need to backpedal here relatively quickly or we could have much more negative effects on the economy.

[Chetan Aya]

And Mike, I remember that in 2018 we did not see this kind of a reaction in the consumer confidence data. But we are seeing that in this cycle and on top of it, we have this expectation that corporate confidence will also be weighed down by policy uncertainty. So how does this double whammy of weak confidence feature in your forecast?

[Michael Gapen]

I think the key component, or in this case, two key components for the outlook for the economy, because it's relatively straightforward to try and project or pass through the direct effect of tariffs on consumer spending, real incomes and trade volumes. But what's really hard to understand here is what does a highly uncertain environment do to asset markets and business sentiment? So the two channels here that you mentioned, consumer confidence and business confidence, these are kind of what might get you spillover effects and a recession. So for the consumer, what we're really focused on here is, yes, stated confidence by households is weak, but they're still generally spending and tariffs affect lower and middle income houses more than they do upper income households. So we're really keyed in on do equity markets fall enough? Do we get a negative wealth shock on upper income consumers where they decide, hey, I feel less wealthy, therefore I'm going to spend less and save more. So then the business sector delays spending and may even generate some layoffs. And recessions, as you know, happen when there's a lot of negative feedback loops in the economy. And so this is what we're worried about.

[Chetan Aya]

Another interesting debate that we as a team are having with the investors is about the Fed policy response. And so Fed Chair Powell has said that tariffs would generate at least a temporary rise in inflation. How do you think the Fed will handle a tariff induced spike in inflation?

[Michael Gapen]

So there has been an evolution in the Fed's thought and thinking around how to handle tariffs. Given the dramatic increase in tariffs, I think the Fed has to wait and they have to see the actual data come in. So in our view, with inflation rising first and activity weakening later, you probably don't get any Fed cuts this year and the Fed moves to rate cuts in 2026. If we're wrong on the economy and it decelerates and moves into a recession more quickly than we would anticipate and the labor market deteriorates rapidly, then the Fed will ease. But what they're doing here is they're responding to a world where both sides of their mandate are getting worse, and they're going to respond to the one that's more offsides than the other. And in the short run, we think that'll be inflation. So it means the Fed moves much later than markets currently in terms of.

[Chetan Aya]

The next set of data points or events that you're watching which can change your view on the growth outlook. What are you really looking out for?

[Michael Gapen]

Well, I think in the very short run it's looking at all the inflation data and seeing whether or not the higher tariff rates are getting passed through to the final consumer. We think a little of that will show up in the April inflation data that's due out in the middle of May. That'll be mainly around autos. But then we think the May, June and July data will begin to show much more increase in goods prices from the tariff pass through. So we'll be kind of watching that to see whether the inflation impulse is as strong as we think it will be. Second, I think in the very short run we'll be watching trade volumes, we'll be watching even shipping container volumes. We'll be watching for blank sales where ships skip ports because there's just not any activity or demand. And then finally I'd say employment, right? Obviously expansion versus contraction and whether the economy will stay in expansion phase will be dependent on whether employment continues to grow. We'll get an early look on that for the April employment data in early May. We don't think there'll be much negative imprint on April employment, but as we move into May, June and July, we could see hiring slow down more rapidly. So that's what I would point to. Just ascertaining the near term inflation impulse, looking out for any sharp slowdown in trade volumes and whether or not the labor market holds up before we close. Based on what I just described about the US and also how you're thinking about the tariff situation, how would you differentiate the economies in your part of the world? I only have to deal with one. You have to deal with many. How would you differentiate between economies in your region right now?

[Chetan Aya]

So Mike, what we've tried to do is to think about this more from which economies are more trade oriented and which economies are less trade oriented because we are aware about the fact that there is going to be an overall trade slowdown for the region. And so in that context, India and Australia are the ones we think will be relatively less affected from this trade slowdown and global growth slowdown. Whereas more trade oriented economies, which is, you know, the likes of Korea, Taiwan, Thailand, Malaysia would be getting more affected. The reality is that China is facing the maximum amount of tariffs within the region and therefore we are building in a bit more growth slowdown in case of China, even while its trade orientation is a bit lower than Korea and Taiwan.

[Michael Gapen]

Chetan, thanks for taking time to talk today.

[Chetan Aya]

Great speaking with you Mike, and thanks for listening.

[Michael Gapen]

If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

[Unknown]

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