Our Global Head of Fixed Income Research & Public Policy
Strategy, Michael Zezas, shares the answers to clients’ top U.S.
policy questions from Morgan Stanley’s Japan Investor Summit.
Read more insights from Morgan Stanley.
----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed
Income Research & Public Policy Strategy. Today, takeaways
from our Japan Investor Summit.
It’s Wednesday, May 28th at 10:30am in New York.
Last week, I attended our Japan Investor Summit in Tokyo: Two
full days of panels on key investment themes and one-on-one
meetings with clients from all parts of the Morgan Stanley
franchise. During the meeting, Morgan Stanley Research launched
its mid year economics and market strategy outlooks. So needless
to say there was a healthy dialogue on investment strategy over
those 48 hours. And I want to share what were the most frequent
questions I received and, of course, our answers to those
questions.
As you could guess, U.S. tariff policy was a key focus. Could
tariffs re-escalate? Or was the worst behind us; and if so, could
investors set aside their concerns about the U.S. economy? It’s a
complicated issue so accordingly our answer is nuanced. On the
one hand, the current state of play is mostly aligned where we
thought tariff policy would be by end of year. It’s just arrived
much earlier. Higher overall U.S. tariffs with a skew toward
higher tariffs on China relative to the rest of world, as the
U.S. has less common ground with them and thus greater challenges
in reaching a trade agreement with China in a timely manner. So
that might imply we’ve arrived at the end point. But we think
that’s too simple of a way for investors to think about it.
First there’s plenty of potential for escalation from current
levels as part of ongoing negotiations. And even if it’s only
temporary it could affect markets. Second, and perhaps more
importantly, even though the U.S. cutting tariffs on China from
very high levels recently brought down the effective tariff rate,
it’s still considerably higher than where we started the year. So
one’s market outlook will still have to account for the pressures
of tariffs, which our economists translate into slower growth and
higher recession risk this year.
Another key concern – U.S. fiscal policy, and whether the U.S.
would be embarking on a path to smaller deficits, in line with
campaign promises. Or if the tax and spending bill making its way
through Congress would keep that from happening. For investors we
think it’s most important to focus on the next year, because what
happens beyond that is highly speculative. And we do not expect
deficits to come down in the next year. Extending expiring tax
cuts, and extending some new ones, albeit with some spending
offsets, should modestly expand the deficit next year in our
estimates; and some further deficit expansion should come from
other factors baked into the budget, like higher interest
payments.
It's understandable these two questions came up, because we do
think the answers are key to the outlook for markets. In
particular, they inform some of the stronger views in our
markets’ outlook. For example, slower relative U.S. growth and
the related potential for foreign investors to increasingly
prefer their portfolios reflect their local currency should keep
the U.S. dollar weakening – a key call our team started this year
with and now continues. Another example, the shape of the U.S.
Treasury yield curve. Higher deficits and the uncertainty about
inflation caused by tariffs should make for a steeper yield
curve. So while we expect U.S. Treasury yields to fall, making
for good returns for high grade bonds including corporate credit,
the better returns might be in shorter maturities.
Thanks for listening. If you enjoy Thoughts on the Market, please
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