Podcast Summary: "The Future Reckoning of Tariff Escalation"

Podcast Information

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: The Future Reckoning of Tariff Escalation
• Release Date: July 10, 2025

Introduction

In the July 10, 2025 episode of Thoughts on the Market, hosted by Morgan Stanley, Michael Zezas, the Global Head of Fixed Income Research and Public Policy Strategy, delves into the latest developments in U.S. tariff policies and their cascading effects on global markets. With an emphasis on recent tariff increases announced by the U.S. across various nations, Zezas provides investors with a comprehensive analysis of the current trade landscape, potential market impacts, and future outlooks.

Current State of U.S. Tariffs

Michael Zezas opens the discussion by highlighting the dynamic nature of U.S. trade policy. He states, “The US is in a period of tactical escalation for tariff policy, where tariffs rise as the US explores its negotiating space, but levels remain in a range below what many investors feared earlier this year” [00:45]. This tactical approach indicates that while the U.S. is increasing tariffs, it is doing so strategically to enhance its bargaining position without committing to the highest possible rates.

Initially, analysts, including Zezas himself, anticipated a modest rise in tariffs from around 13% to 15%, primarily affecting countries like Vietnam and Japan. However, the actual announcements were more significant. “The US announced several tariff hikes set to take effect later, allowing time for negotiations” [02:10]. These increases could elevate tariffs to between 15% and 20%, a notable jump from earlier projections but still below the potential 25% to 30% that some had speculated in April.

Zezas underscores the fluid nature of U.S. trade policy, noting, “US Trade policy remains a moving target because the US Administration is still focused on reducing goods trade deficits and may not yet perceive there to be substantial political and economic risk of tariff escalation” [03:00]. This perspective suggests that while the administration is keen on addressing trade imbalances, it remains cautious about pushing tariffs to levels that could trigger significant economic backlash.

Tactical Escalation and Policy Implications

The concept of "tactical escalation" is central to understanding the current U.S. tariff strategy. Zezas explains that this approach involves incrementally increasing tariffs to pressure trade partners into negotiations without causing abrupt disruptions. “Per our economist's recent work on the lagged effect of tariffs, this reckoning could be months away” [05:15], indicating that the full impact of these tariffs on the economy and markets might not be immediately apparent.

This tactical maneuver aligns with Morgan Stanley's broader cross-asset views. The elevated tariffs on diverse geographies and products, such as copper, exert additional pressure on the U.S. growth narrative. However, according to Zezas, these pressures are unlikely to precipitate a recession. “That growth pressure is consistent with our views that both government and corporate bond yields will move lower, driving solid returns” [07:45]. Lower bond yields typically indicate higher bond prices, suggesting potential gains for bond investors despite the overarching trade tensions.

Impact on Growth and Bond Markets

Zezas delves deeper into the macroeconomic implications of the tariff increases. Higher tariffs can dampen economic growth by increasing costs for businesses and consumers, leading to reduced spending and investment. “The higher tariffs announced on a variety of geographies and products like copper put further pressure on the US Growth story, even if they don't tip the US into recession” [08:30]. This nuanced view acknowledges the negative impact on growth without forecasting an imminent economic downturn.

In response to subdued growth prospects, both government and corporate bond yields are expected to decline. Lower yields on these bonds generally translate to higher prices, thereby offering solid returns for bond investors. Zezas notes, “The growth pressure is consistent with our views that both government and corporate bond yields will move lower, driving solid returns” [09:10]. This expectation aligns with typical market behavior where economic slowdowns increase the attractiveness of bonds as safer investments compared to equities.

Equity Market Implications

Despite the upward pressure on tariffs and the associated growth concerns, Zezas remains optimistic about the equity markets. “It's also insufficient pressure to get in the way of an equity market rally” [10:05]. This confidence is bolstered by recent fiscal measures. The passage of a fiscal package by Congress, although not a “major boon to the economy overall,” provides specific benefits that support equity performance. “The fiscal package that just passed Congress might not be a major boon to the economy overall, but it does help margins for large cap companies” [11:20]. Large-cap firms, which often have more robust financial structures and global presence, are better positioned to absorb and navigate the increased tariffs.

Furthermore, Zezas points out that these large-cap companies have greater exposure to tariffs from significant trading partners like China, Canada, Mexico, and the EU, rather than from the newer targets such as Vietnam and Japan. This selective exposure helps mitigate some of the broader economic impacts, allowing equity markets to maintain their upward trajectory despite the heightened trade tensions.

Potential Risks and Areas to Monitor

While the current trajectory appears manageable, Zezas cautions investors to remain vigilant regarding future negotiations with major trading partners. “How could we be wrong? Well, pay attention to negotiations with those geographies we just mentioned, Mexico, Canada, Europe and China” [13:50]. These countries represent substantial trading relationships for the U.S. economy, and any significant escalation in tariffs with these partners could have profound effects on both top-line (revenue) and bottom-line (profitability) metrics, thereby challenging both equity and credit markets.

Zezas highlights that tariffs with these major partners are expected to stabilize near current levels, but the journey to this equilibrium could be volatile. “Tariffs with these partners are likely to land near current levels, but the path to get there could be volatile for the US, Mexico and Canada” [15:30]. The underlying reasons include mutual interests in maintaining low-tariff trade blocs and specific sticking points around harmonizing trade policies.

Specifically, with China, tariffs remain among the highest globally, despite a recent narrow agreement on semiconductors and rare earths that temporarily reduced tariffs from triple-digit levels. “The two sides remain far apart on fundamental issues, so when it comes to negotiations with the US's biggest trading partners, they're sticking points” [17:00]. These unresolved issues hint at the potential for future tariff escalations, necessitating ongoing monitoring and strategic adjustments by investors.

Outlook on Trade Negotiations with Key Partners

The future of U.S. tariff policy is intricately linked to its negotiations with key trading partners. Zezas emphasizes that maintaining stability in these relationships is crucial for preventing further economic disruptions. “Background reporting suggests there's mutual interest in maintaining a low tariff bloc, including exceptions for the product-specific tariffs the US is imposing, but there are sticking points around harmonizing trade policy” [18:30]. This mutual interest indicates a preference for stability, but the existing disagreements over trade harmonization present ongoing challenges.

In the case of China, despite temporary reductions in tariffs on select sectors, fundamental disagreements persist. “The dynamic is similar with China. Tariffs are already steep amongst the highest anywhere, while a recent narrow deal around semiconductors and rare earths led to a temporary reduction from triple-digit levels” [19:15]. Such agreements provide short-term relief but do not resolve the deeper issues that could lead to future tariff hikes or trade conflicts.

Zezas concludes that effective monitoring of these negotiations is essential for anticipating and mitigating potential risks. “And where they're sticking points, there's potential for escalation that we'll need to be vigilant in monitoring” [20:00]. Investors are encouraged to stay informed and adaptable to navigate the evolving trade landscape successfully.

Conclusion

In this episode of Thoughts on the Market, Michael Zezas provides a thorough analysis of the recent escalation in U.S. tariffs and its implications for global markets. While recognizing the potential headwinds posed by increased tariffs and their impact on economic growth, Zezas maintains a cautiously optimistic outlook for both bond and equity markets. The key takeaway is the importance of strategic monitoring of ongoing trade negotiations with major partners, as these will significantly influence future market conditions and investment strategies.

Zezas advises investors to remain informed and adaptable, highlighting that the current tariff strategy is a tactical maneuver aimed at enhancing negotiating leverage without triggering severe economic repercussions. However, the path remains fraught with uncertainties, particularly in relations with significant trading partners like China, Canada, Mexico, and the EU. As such, staying abreast of these developments is crucial for making informed investment decisions in an increasingly complex global trade environment.

Notable Quotes

• “The US is in a period of tactical escalation for tariff policy, where tariffs rise as the US explores its negotiating space, but levels remain in a range below what many investors feared earlier this year” – Michael Zezas [00:45]

• “Per our economist's recent work on the lagged effect of tariffs, this reckoning could be months away” – Michael Zezas [05:15]

• “It's also insufficient pressure to get in the way of an equity market rally” – Michael Zezas [10:05]

• “Tariffs with these partners are likely to land near current levels, but the path to get there could be volatile for the US, Mexico and Canada” – Michael Zezas [15:30]

• “And where they're sticking points, there's potential for escalation that we'll need to be vigilant in monitoring” – Michael Zezas [20:00]

This comprehensive summary encapsulates the pivotal discussions and insights shared by Michael Zezas regarding the ongoing tariff escalations and their multifaceted impacts on the market, providing valuable context and foresight for investors navigating these turbulent times.