Markets may seem calm following recent policy headlines, but for
Michael Zezas, our Global Head of Fixed Income Research and
Public Policy Strategy, investors may need to wait on more data
to assess whether the macroenvironment will remain stable.
Read more insights from Morgan Stanley.
----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I'm Michael Zezas, Global Head of Fixed Income Research
and Public Policy Strategy.
Today: Why there's no summer slowdown yet for U.S. policy
catalysts for the financial markets.
It's Friday, July 18th at 8am in New York.
The past week and a half has seen many major policy, events and
headlines relevant to the outlook for financial markets. This
includes more speculation by the U.S. administration over
leadership at the Fed, more information about the deficit impact
of the new fiscal bill, and – perhaps most tangibly –
announcements of new tariffs that, if they take effect, will be a
meaningful step up from already elevated levels.
It would all suggest a weaker growth outlook and less overseas
demand for U.S. assets. Yet major financial markets seem to have
shrugged it all off. The S & P and the U.S. dollar are up
about 1 percent over that time, and Treasury yields are modestly
higher.
So, what's going on? Two possibilities to consider, and it
implies investors should pay more attention than they may be
inclined to this summer.
First, when it comes to the impact of tariffs on the economy,
it's possible we're dealing with a delayed impact. The effective
average U.S. tariff rate shot up from 3 to 4 percent earlier this
year to 13 percent, and if recent announcements go through, that
could exceed 20 percent. That's a major escalation in costs for
U.S. companies and consumers and something our economists argue
takes growth down to 1 percent and elevates the possibility of a
recession.
But our economists also point out that we may not be experiencing
these cost increases quite yet. History suggests several months
of lag between implementation and economic impact as companies
leverage existing lower cost inventory before making tough
decisions on pricing and managing their own costs.
That means hard economic data likely does not yet tell us about
the impact or lack thereof of tariffs, but that may change in the
coming months.
Second. It's also possible that the recent announcements of
tariff increases don't tell us the whole story. As my colleagues
in our equity strategy team point out, corporate America's cost
base is most sensitive to the U.S.' largest trading partners –
China, Mexico, Canada, and Europe. As we've discussed in prior
episodes, we see tariff rate increases as likely on all these
trading partners as tough negotiations continue.
However, the details will matter greatly if rates are increased,
but with a healthy dose of exceptions or quotas. Even if they
diminish over time, then the real impact could be significantly
blunted. In that case, markets would resume taking cues from
other factors such as earnings revisions and forward-looking
expectations around AI driven productivity.
So bottom line, market movements suggest investors are assuming
benign U.S. policy outcomes. But there's plenty of developments
to track in the coming weeks and months to test if those
assumptions will hold. Trade policy details and hard economic
data are key among them.
Thanks for listening. If you enjoy Thoughts on the Market, please
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want everyone to listen.
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