What Now with Tariffs?

Summary

Podcast Summary: "What Now with Tariffs?"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: What Now with Tariffs?
• Release Date: May 30, 2025
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

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Introduction

In the episode titled "What Now with Tariffs?" from Morgan Stanley's "Thoughts on the Market," hosts Michael Zesas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy, and Michael Gapen, Chief U.S. Economist, delve into the recent developments surrounding President Trump's tariff policies. Released on May 30, 2025, the episode provides an in-depth analysis of a significant court ruling that impacts the administration's tariff strategy and explores the broader implications for the U.S. economy and Federal Reserve policy.

Recent Court Ruling on Tariffs

The discussion opens with a critical update on the legal landscape surrounding U.S. tariffs. On Wednesday night, the U.S. Court of International Trade struck down President Trump's reciprocal tariffs, presenting a substantial hurdle for the administration's trade policies.

Michael Gapen remarks on the timing and impact of the ruling:

"This ruling certainly seems like a fresh roadblock for the administration." [00:07]

Michael Zesas emphasizes caution, explaining that this decision does not spell the end for the current tariff hikes:

"That doesn't mean we're supposed to conclude that the recent tariff hikes are a thing of the past." [00:31]

Legal Avenues for Maintaining Tariffs

Despite the court's decision, Zesas outlines several legal strategies the administration might employ to sustain existing tariffs. These include:

1. Appealing the Decision: The administration may appeal the ruling, allowing tariffs to remain in place during the appeals process.
2. Alternative Legal Authorities: Even if the initial ruling stands, the administration can utilize other legal frameworks to justify the tariffs. Zesas details potential alternatives:
   • Section 122: As a temporary authority to maintain the 10% tariffs under the global reciprocal trade announcement.
   • Section 301: Extending existing tariffs on China imports from 2018 and 2019 to cover a broader range of goods.

Zesas succinctly summarizes the persistence of legal pathways:

"There's lots of different legal paths to keep tariffs where they are across the set of goods that they're already applied to." [02:23]

Implications for the U.S. Economy

Transitioning to the economic outlook, Michael Gapen shares his perspective on how the court ruling interacts with broader economic forecasts. He notes that while the ruling introduces short-term uncertainties, the overall economic projections remain largely unchanged.

"I'm not entirely surprised by the ruling... we thought that they would rely mainly on section 301 and 232 authority, which would mean tariffs would ramp up much more slowly." [03:42]

Gapen explains that the research group's original outlook anticipated a more gradual implementation of tariffs, with significant economic effects projected for mid-2026. The court ruling aligns with their expectations, suggesting minimal immediate disruption.

Federal Reserve Policy and Tariff Impacts

The conversation shifts to the Federal Reserve's stance on tariffs and its subsequent policy decisions. Zesas highlights that recent Fed communications indicate a wait-and-see approach, assessing the tangible impacts of trade policies before making adjustments.

Gapen elaborates on the Fed's current position:

"The Fed is offsides or likely to be offsides on both sides of its mandate... they'll react to whichever side of the mandate we're furthest from our target." [06:30]

He further explains that the Fed anticipates tariffs to initially push inflation higher, followed by potential increases in unemployment. This dual impact leads the Fed to maintain a patient stance, keeping policy rates steady to stabilize inflation expectations and preparing for possible future adjustments as economic indicators evolve.

"We'll keep the policy rate where it is to ensure that inflation expectations are stable. And then as the economy moderates and the labor market softens, then they can turn to cuts." [07:10]

Current Outlook and Future Expectations

In wrapping up the discussion, Zesas and Gapen concur that the court ruling, while significant, does not drastically alter their economic forecasts. The administration retains multiple options to sustain tariff levels, and the overall outlook for growth, inflation, and Fed policy remains consistent with previous projections.

"The upshot, from our perspective, this court case was a big deal, however, because the administration has a lot of options to keep tariffs going in the direction that they want. Not too much has really changed with our expectations for the outlook for either the tariff path and it's not going to fix to the economy." [08:20]

Conclusion

The episode "What Now with Tariffs?" provides a comprehensive analysis of the recent legal challenges to President Trump's tariff policies and explores the resilience of the administration's trade strategy. Hosts Zesas and Gapen effectively convey that despite the court's setback, the administration possesses multiple legal avenues to maintain tariffs, ensuring minimal disruption to their broader economic objectives. The discussion underscores a stable outlook for the U.S. economy, with anticipated slow growth, persistent inflation, and a cautious Federal Reserve poised to respond thoughtfully to evolving economic conditions.

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Notable Quotes:

• "There's lots of different legal paths to keep tariffs where they are across the set of goods that they're already applied to." — Michael Zesas [02:23]
• "I'm not entirely surprised by the ruling, but I'm not sure that the decision means a lot for how we think about the US Economy." — Michael Gapen [03:42]
• "The Fed is offsides or likely to be offsides on both sides of its mandate." — Michael Gapen [06:30]
• "The upshot... the administration has a lot of options to keep tariffs going in the direction that they want." — Michael Zesas [08:20]

This structured overview encapsulates the key discussions, insights, and conclusions from the podcast episode, providing a clear and comprehensive understanding for those who have not listened to the original content.

Transcript

[Michael Zesas]

Welcome to Thoughts on the Market. I'm Michael Zesas, Morgan Stanley's global head of fixed income research and public policy strategy.

[Michael Gapen]

And I'm Michael Gapen, chief U.S. economist. Today, the latest on President Trump's tariffs. It's Thursday, May 29th, at 5:00pm in New York. So, Mike, on Wednesday night, the U.S. court of International Trade struck down President Trump's reciprocal tariffs. This ruling certainly seems like a fresh roadblock for the administration.

[Michael Zesas]

Yeah, that's right. But a quick word of caution. That doesn't mean we're supposed to conclude that the recent tariff hikes are a thing of the past. I think investors need to be aware that there's many plausible paths to keeping these tariffs exactly where they are right now. First, while the administration is appealing this decision, the tariffs can stay in place. But even if courts ultimately rule against the Trump administration, there are other types of legal authorities that they can bring to bear to make sure that the tariff levels that are currently applied endure. So what the court said the administration had done improperly was levy tariffs under the International Emergency Economic Powers Act. And there's been active debate all along amongst legal scholars about if this was the right law to justify those tariff levies. And so there's always the possibility of court challenges. But what the administration could do if the courts continue to uphold the lower court's ruling is basically leverage other legal authorities to continue these tariffs. They could use Section 122 as a temporary authority to levy the 10% tariffs that were part of this kind of global tariff following the reciprocal trade announcement. They also could use the existing Section 301 authority that was used to create tariffs on China in 2018 and 2019 and extend that across all China imports, and therefore fill in the gap that would be lost by not being able to use the International Emergency Economic Powers act to tariff some of China's imports. So, bottom line, there's lots of different legal paths to keep tariffs where they are across the set of goods that they're already applied to.

[Michael Gapen]

So I think that makes a lot of sense. And with all that said, where do you think we stand right now with tariffs?

[Michael Zesas]

So if the court ruling were to stand, then the 10% tariffs on all imports that the US is currently levying, that would have to go away. The 30% tariffs on roughly half of China imports, that would have to go away, and the 25% tariffs on Canada and Mexico around fentanyl, that would have to go away as well. What you'd be left with, effectively, is anything levied under section 232 or 301. So that's basically steel, aluminum, automobile tariffs and tariffs on the roughly half of China imports that were started in 2018 and 2019. But as we said earlier, there's lots of different ways that the authority can be brought to bear to make sure that that 10% import tariff globally is continued, as well as the incremental tariffs on China. But Michael, turning to you on the US Economy, what's your reaction to the court's ruling? It seems like we're just going to have a continuation of existing tariff policy. But is there something else that investors need to consider here?

[Michael Gapen]

I'm not a trade lawyer. I'm not entirely surprised by the ruling. It did seem to exceed what I'll call the general parameters of the law. And it wasn't what we as a research group and a research team were thinking was the most likely path for tariffs coming into the year. As you mentioned, and as we as a group wrote, we thought that they would rely mainly on section 301 and 232 authority, which would mean tariffs would ramp up much more slowly. And that's what we had put into our original outlook coming into the year. We didn't have the effective tariff rate reaching 8 to 9% until around the middle of 2026. So it reflected the fact that it would take effort and time for the administration to put its plans on tariffs into place. So I think this decision kind of shifts our views back in that direction. And by that I mean we originally thought most of 2025 would be about getting the tariff structure in place and therefore the effects of tariffs would be hitting the economy mainly in 2026. We obviously revise things where tariffs would weigh on activity in 2025 and postpone Fed cuts into 2026. So I think what it does for the moment is maybe tilts risks back in the other direct. But as you say, it's just a matter of time that there appears to be enough legal authority here for the administration to implement their desires on trade policy and tariff policy. So I'm not sure this changes a lot in terms of where we think the economy's going. So I'm not entirely surprised by the decision, but I'm not sure that the decision means a lot for how we think about the US Economy.

[Michael Zesas]

Got it. The upshot, there is really no change from your perspective on the outlook for growth, for inflation or for Fed policy. Is that fair?

[Michael Gapen]

That's right. It's still a slow growth, sticky inflation, patient Fed. It's Just we're kind of moving around. When that materializes, we pulled it into 2025, given the abrupt increase in tariffs and the use of, of the IEEPA authority. And now it probably would come later if the lower court ruling stands.

[Michael Zesas]

Right. So sticking with the Fed, several Fed speakers took to the airwaves last week, and it sounds like the Fed is still waiting for some of these public policy changes to have an effect on the real economy before they react. Is that a fair way to characterize it and what are you watching at this point in terms of what determines your expectations for the Fed's policy path from here?

[Michael Gapen]

Yeah, that's right. I think, given that the appeals court has allowed the tariffs to stay in place as they review the lower court, the trade court's ruling, I think the Fed right now would say, okay, status quo, nothing has changed. What does that mean? What the Fed speakers said last week, and it also appeared in the minutes, is that the Fed expects that tariffs will do two things with respect to the Fed's mandate. It'll push inflation higher and puts risks around unemployment higher. Right. So the Fed is offsides or likely to be offsides on both sides of its mandate. So what Fed speakers have been saying is, well, when this happens, we will react to whichever side of the mandate we're furthest from our target. And their forecasts seem to say, and are pretty consistent with ours, that the Fed expects inflation to rise first, but the labor market to soften later. So what that means for our expectations for the Fed's policy path is they're likely to be on hold as they evaluate that inflation shock. And we'll keep the policy rate where it is to ensure that inflation expectations are stable. And then as the economy moderates and the labor market softens, then they can turn to cuts. But we don't think that happens until 2026. So I don't think the ruling yesterday and the appeal process initiated today changes that for now, the tariffs are still in place. The Fed's message is it's going to take us at least until proven, probably September, if not later, to figure out which way we should move. Moving later and right is preferable for them than moving earlier and wrong.

[Michael Zesas]

Got it. So, bottom line, from our perspective, this court case was a big deal, however, because the administration has a lot of options to keep tariffs going in the direction that they want. Not too much has really changed with our expectations for the outlook for either the tariff path and it's not going to fix to the economy.

[Michael Gapen]

That's right. That's, I think, what we know today and we'll have to see how things evolve.

[Michael Zesas]

Yep, they seem to be evolving every day. Mike, thanks for speaking with me.

[Michael Gapen]

Thank you, Mike. It's been a pleasure and thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

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