Summary of "Tariffs’ Impact on Economy and Bond Markets"

Podcast: Thoughts on the Market
Host/Author: Morgan Stanley
Episode Title: Tariffs’ Impact on Economy and Bond Markets
Release Date: August 13, 2025

Introduction

In the August 13, 2025 episode of Thoughts on the Market, Morgan Stanley's Michael Zezas and Chief U.S. Economist Michael Gapen delve into the intricate effects of tariffs on the U.S. economy and bond markets. The discussion sheds light on recent developments in tariff agreements, their immediate and long-term economic implications, and the nuanced reactions within financial markets.

Current State of Tariffs and Economic Agreements

Michael Zezas opens the conversation by addressing the current landscape of U.S. tariffs. As of August 13, the U.S. has maintained an effective tariff rate of 16%, a significant increase from the approximately 3% at the beginning of the year. While this remains higher than initial projections following the April tariffs announcement, recent agreements with major trading partners like Europe indicate a stabilization in tariff policies for the near term.

[00:50] Michael Zezas: "Now the time when investors should stay away from chasing tariff headlines and guessing what the President might do next and instead focus on assessing the impact of what's been done."

He emphasizes the importance for investors to pivot their focus from the uncertainty of future tariff changes to evaluating the tangible effects of existing tariffs on the economy and markets.

Impact of Tariffs on Inflation

Michael Gapen provides an analytical perspective on how tariffs influence inflation, referencing the Consumer Price Index (CPI) data for July. Drawing parallels to the 2018-2019 tariff period, Gapen explains that tariffs are expected to gradually permeate the economy, initially affecting goods prices before potentially influencing service sectors indirectly.

[01:24] Michael Gapen: "Well, we did analysis on the 2018, 2019 tariff episode... it said yes, we should start seeing the effects of tariffs on those categories where the direct effect is high."

However, the July CPI data presents a mixed picture. While core goods prices did see an uptick—rising by 2.10% month-over-month—the increase was not as pronounced as anticipated in certain sectors.

[02:21] Michael Gapen: "Core goods prices rose by 2.10% on the month in June... But we didn't get as much as we thought."

He points out that sectors like new car prices remained flat, suggesting that some tariff-induced price pressures might be delayed until future product cycles (e.g., 2026 car models).

Economic Implications Beyond Inflation

The conversation transitions to the broader economic impact of tariffs, beyond just price inflation. Gapen underscores that while tariffs are a significant factor, other elements like consumer spending and business investment also play crucial roles in economic growth.

[05:02] Michael Gapen: "It's clear the economy has moderated... a lot of that slowdown was related to spending by the consumer and a slowdown in business spending."

He attributes the economic slowdown partly to policy uncertainty stemming from fluctuating tariff policies, which affect business planning and consumer confidence.

Tariffs and the Labor Market

Gapen elaborates on the connection between tariffs and the labor market, suggesting that increased tariffs may lead to weaker growth, which in turn could constrain hiring practices.

[04:53] Michael Gapen: "If firms can’t pass these prices along, we’ll probably get a weaker labor market."

This scenario presents a dual pathway: either inflation remains elevated due to successful price pass-throughs, or the labor market weakens as businesses grapple with increased costs.

Tariffs' Influence on Bond Markets

Zezas and Gapen discuss the ramifications of tariffs on bond markets, particularly focusing on U.S. Treasury bonds and corporate credit.

Favorable Outcomes for Bonds

Zezas posits that if tariffs lead to weaker economic growth, the Federal Reserve might initiate rate cuts, which would be beneficial for bond yields.

[06:25] Michael Zezas: "If that's the case, then obviously this would be a favorable backdrop for owners of U.S. treasury bonds."

Additionally, in a scenario where corporate fundamentals remain strong despite lower growth, corporate credit could also perform well due to declining yields and stable credit spreads.

Potential Risks

However, Zezas warns of scenarios where economic conditions could deteriorate further, such as entering a recession, which would negatively impact corporate credit and favor government bonds.

[07:45] Michael Zezas: "If we tipped into recession... you’d expect there to be some expression of fundamental weakness and credit spreads would widen."

Moreover, in a situation where economic growth unexpectedly accelerates—potentially due to factors like an AI-driven productivity boom—bond yields might increase, adversely affecting bond returns.

[08:50] Michael Zezas: "That would appear to be most likely in the scenario where US growth actually ticks higher, resetting expectations for monetary policy in a more hawkish direction."

Future Outlook and Investor Considerations

Gapen discusses various future scenarios influenced by tariffs, including the potential for Federal Reserve policy adjustments in response to labor market conditions and inflation trends.

[08:12] Michael Gapen: "We can say, yes, tariffs should slow down growth... The Fed maybe eases rates as a preemptive measure..."

He outlines a possible trajectory where the Fed may adopt an accommodative stance to mitigate labor market softness, even as inflation remains a concern, influencing bond market dynamics adversely.

Zezas adds that investors should remain vigilant about the evolving economic indicators and policy responses that could sway bond yields in either direction.

Conclusion

The episode concludes with an emphasis on the complexity and interconnectivity of tariffs with various economic indicators and financial markets. Zezas and Gapen highlight the importance for investors to adopt a nuanced approach, considering both direct and indirect effects of tariffs, as well as potential policy responses from the Federal Reserve.

[10:01] Michael Zezas: "That makes perfect sense to us. Well, Michael, thanks for taking the time to talk with me."

The hosts encourage listeners to closely monitor economic data releases and policy changes to navigate the uncertain terrain shaped by tariff policies.

Key Takeaways

• Tariff Stabilization: Recent agreements indicate a temporary stabilization of tariff rates, reducing near-term uncertainty.

• Inflation Dynamics: Tariffs are contributing to rising goods prices, though the impact varies across sectors and may become more pronounced over time.

• Economic Growth: Tariffs are exerting a moderating effect on economic growth, influenced by reduced consumer spending and business investment.

• Labor Market: There is a potential for tariffs to weaken the labor market if businesses cannot pass increased costs onto consumers.

• Bond Markets: The impact of tariffs on bond markets is contingent on Federal Reserve responses and overall economic performance, presenting both opportunities and risks for different bond categories.

Notable Quotes

• Michael Zezas [00:50]: "Now the time when investors should stay away from chasing tariff headlines and guessing what the President might do next and instead focus on assessing the impact of what's been done."

• Michael Gapen [01:24]: "We did analysis on the 2018, 2019 tariff episode... it said yes, we should start seeing the effects of tariffs on those categories where the direct effect is high."

• Michael Gapen [04:53]: "If firms can’t pass these prices along, we’ll probably get a weaker labor market."

• Michael Zezas [06:25]: "If that's the case, then obviously this would be a favorable backdrop for owners of U.S. treasury bonds."

• Michael Zezas [08:50]: "That would appear to be most likely in the scenario where US growth actually ticks higher, resetting expectations for monetary policy in a more hawkish direction."

This episode of Thoughts on the Market provides a comprehensive analysis of the current and potential future impacts of tariffs on the U.S. economy and bond markets, offering valuable insights for investors navigating these complex dynamics.