Our analysts Michael Zezas and Ariana Salvatore discuss the
upcoming expiration of reciprocal tariffs and the potential
impacts for U.S. trade.
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.
Ariana Salvatore: And I'm Ariana Salvatore,
US Public Policy Strategist.
Michael Zezas: Today we're talking about
the outlook for US trade policy. It's Wednesday, July 2nd at
10:00 AM in New York.
We have a big week ahead as next Wednesday marks the expiration
of the 90 day pause on reciprocal tariffs. Ariana, what's the
setup?
Ariana Salvatore: So this is a really key
inflection point. That pause that you mentioned was initiated
back on April 9th, and unless it's extended, we could see a
reposition of tariffs on several of our major trading partners.
Our base case is that the administration, broadly speaking, tries
to kick the can down the road, meaning that it extends the pause
for most countries, though the reality might be closer to a few
countries seeing their rates go up while others announce
bilateral framework deals between now and next week.
But before we get into the key assumptions underlying our base
case. Let's talk about the bigger picture. Michael, what do we
think the administration is actually trying to accomplish here?
Michael Zezas: So when it comes to defining
their objectives, we think multiple things can be true at the
same time. So the administration's talked about the virtue of
tariffs as a negotiating tactic. They've also floated the idea of
a tiered framework for global trading partners. Think of it as a
ranking system based on trade deficits, non tariff barriers, VAT
levels, and any other characteristics that they think are
important for the bilateral trade relationship. A lot of this is
similar to the rhetoric we saw ahead of the April 2nd "Liberation
Day" tariffs.
Ariana Salvatore: Right, and around that
time we started hearing about the potential, at least for
bilateral trade deals, but have we seen any real progress in that
area?
Michael Zezas: Not much, at least not
publicly, aside from the UK framework agreement. And here's an
important detail, three of our four largest trading partners
aren't even scoped for higher rates next week. Mexico and Canada
were never subject to the reciprocal tariffs. And China's on a
separate track with this Geneva framework that doesn't expire
until August 12th. So we're not expecting a sweeping overhaul by
Wednesday.
Ariana Salvatore: Got it. So what are the
scenarios that we're watching?
Michael Zezas: So there's roughly three
that we're looking at and let me break them down here.
So our base case is that the administration extends the current
pause, citing progress in bilateral talks, and maybe there's a
few exceptions along the way in either direction, some higher and
some lower. This broadly resets the countdown clock, but keeps
the current tariff structure intact: 10% baseline for most
trading partners, though some potentially higher if negotiations
don't progress in the next week. That outcome would be most in
line, we think, with the current messaging coming out of the
administration.
There's also a more aggressive path if there's no visible
progress. For example, the administration could reimpose tariffs
with staggered implementation dates. The EU might face a tougher
stance due to the complexity of that relationship and Vietnam
could see delayed threats as a negotiating tactic. A strong macro
backdrop, resilient data for markets that could all give the
administration cover to go this route.
But there's also a more constructive outcome. The administration
can announce regional or bilateral frameworks, not necessarily
full trade deals, but enough to remove the near term threat of
higher tariffs, reducing uncertainty, though maybe not to
pre-2024 levels.
Ariana Salvatore: So wide bands of
uncertainty, and it sounds like the more constructive outcome is
quite similar to our base case, which is what we have in place
right now. But translating that more aggressive path into what
that means for the economy, we think it would reinforce our house
view that the risks here are skewed to the downside.
Our economists estimate that tariffs begin to impact inflation
about four months after implementation with the growth effects
lagging by about eight months. That sets us up for weak but not
quite recessionary growth. We're talking 1% GDP on an annual
basis in 2025 and 2026, and the tariff passed through to prices
and inflation data probably starting in August.
Michael Zezas: So bottom line, watch
carefully on Wednesday and be vigilant for changes to the status
quo on tariff levels. There's a lot of optionality in how this
plays out, as trade policy uncertainty in the aggregate is still
high. Ariana, thanks for taking the time to talk.
Ariana Salvatore: Great speaking with you,
Michael.
Michael Zezas: And if you enjoy Thoughts on
the Market, please leave us a review wherever you listen and
share the podcast with a friend or colleague today.
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