Podcast Summary: "U.S. Economy: Solid Footing For Now, Uncertainty Ahead"

Thoughts on the Market
Host: Morgan Stanley
Episode Title: U.S. Economy: Solid Footing For Now, Uncertainty Ahead
Release Date: May 6, 2025

Introduction

In this episode of Thoughts on the Market, Morgan Stanley hosts Matthew Hornbach, Global Head of MacroStrategy, and Michael Gapen, Chief U.S. Economist, to discuss the current state of the U.S. economy, the implications of the recent Federal Open Market Committee (FOMC) meeting, and the evolving dynamics of the treasury market. The conversation delves into the solid foundations of the economy, upcoming challenges, and investor reactions to recent economic indicators.

Current State of the U.S. Economy

Michael Gapen begins by assessing the broader economic landscape:

“[00:41] Michael Gapen: Yeah, I think right now, Matt, I would say the economy is still on relatively solid footing...”

Despite a slight moderation, the economy remains robust. The first-quarter GDP saw a negative print, primarily due to a significant increase in imports—over 40% on an annualized basis—used for inventory and business spending, which acted as a mechanical drag on activity. The labor market remains strong, with average job additions slowing to about 145,000 per month in 2025 from 170,000 in the latter half of the previous year. Importantly, there are no signs of a sharp slowdown or a rise in layoffs.

However, uncertainty looms, particularly due to geopolitical events like Liberation Day. Gapen highlights:

“[02:16] Michael Gapen: ...Liberation Day...puts a lot of uncertainty in front of us. It risks a sudden shock to the economy and we risk a sudden stop in trade volume.”

While the economy currently stands on solid footing, upcoming concerns include potential trade disruptions and rising inflation, necessitating cautious monitoring.

FOMC Meeting Expectations

The discussion shifts to the anticipated outcomes of the ongoing FOMC meeting:

Matthew Hornbach sets the stage by referencing New York Fed President John Williams' recent projections, which align closely with Gapen’s outlook:

“[02:38] Michael Gapen: ...John tends to be one of the kind of a median participant...”

Williams projects GDP growth slowing to below 1% in 2025, inflation rising to between 3.5% and 4% for the year, and unemployment hovering between 4.5% and 5%. These projections mirror Morgan Stanley’s expectations, suggesting the Fed shares similar economic concerns.

Gapen anticipates the Fed’s main message to be a stance of patience:

“[03:49] Michael Gapen: ...the Fed's main message this week will be that they're prepared to wait, that they think policy is in a good spot right now.”

The Fed is likely to emphasize the need for clarity on whether the current inflationary pressures are temporary or persistent, maintaining a position of inaction unless economic indicators, such as the labor market, show signs of weakening. However, Gapen warns that the Fed may adopt a more hawkish tone than markets expect, potentially catching investors off guard.

Treasury Market Dynamics

Transitioning to the treasury market, Matthew Hornbach reflects on recent unusual behaviors:

“[05:23] Matthew Hornbach: ...US Treasuries didn't act like the safe haven asset many have come to expect...”

Despite traditional expectations, treasury yields initially fell post-Liberation Day but then rose sharply over the past month. Hornbach draws parallels to the Great Financial Crisis and the early stages of the COVID-19 pandemic, suggesting that systemic uncertainty prompted investors to reduce duration risk—selling longer-term bonds in favor of shorter maturities.

Gapen observes discrepancies between market expectations and economic forecasts:

“[07:09] Michael Gapen: So, Matt, one aspect of market pricing that stands out to me is how rates markets are pricing 75 basis points of rate cuts this year...”

While the market had previously priced in approximately 100 basis points of rate cuts after April 2, current projections—endorsed by Gapen—do not support such aggressive reductions. Hornbach explains that market pricing represents an aggregation of diverse scenarios, making it challenging to isolate and adjust to a single baseline expectation.

Market Pricing and Yield Curve Expectations

Matthew Hornbach discusses his conviction in the rates market, emphasizing the likelihood of a steepening yield curve by December 2025:

“[09:13] Matthew Hornbach: ...we have the highest conviction in terms of what happens with the treasury market this year is we have a steeper yield curve by the time we get to December.”

This expectation is based on the anticipated divergence between shorter and longer-term yields. As the Fed contemplates rate reductions in 2026, increased treasury supply driven by fiscal policies will pressure longer-term yields upward relative to shorter maturities.

Conclusion

The episode wraps up with a synthesis of the key points:

• The U.S. economy remains on solid footing despite some moderating indicators.
• Upcoming geopolitical events like Liberation Day introduce significant uncertainty, potentially impacting trade volumes and economic stability.
• The Fed is likely to adopt a patient stance in its monetary policy, emphasizing the need to assess inflation trends before making further adjustments.
• Treasury market behaviors have deviated from historical norms, reflecting heightened uncertainty and shifts in investor risk appetites.
• Market expectations for rate cuts are more aggressive than Morgan Stanley’s projections, but alignment is expected to occur gradually as economic data unfolds.

Gapen and Hornbach offer a cautious yet optimistic outlook, emphasizing the importance of monitoring economic indicators and maintaining strategic flexibility in response to evolving market conditions.

Notable Quotes

• Michael Gapen on Economic Footing:
  “I think right now, Matt, I would say the economy is still on relatively solid footing.”
  [00:41]

• Gapen on Liberation Day’s Impact:
  “Liberation Day...puts a lot of uncertainty in front of us. It risks a sudden shock to the economy and we risk a sudden stop in trade volume.”
  [02:16]

• Gapen on Fed’s Message:
  “...the Fed's main message this week will be that they're prepared to wait, that they think policy is in a good spot right now.”
  [03:49]

• Hornbach on Treasury Market Behavior:
  “I think investors were paring back duration risk, which helped the US treasury market perform pretty poorly at one moment over the past month.”
  [05:23]

• Hornbach on Yield Curve:
  “...we have the highest conviction in terms of what happens with the treasury market this year is we have a steeper yield curve by the time we get to December.”
  [09:13]

This comprehensive summary encapsulates the critical discussions and insights shared by Morgan Stanley’s Matthew Hornbach and Michael Gapen, providing listeners and non-listeners alike with a clear understanding of the current economic landscape and future outlook.