Our U.S. and Asia economists Michael Gapen and Chetan Ahya
discuss how tariff uncertainty is shaping their expectations for
these economies over the second half of 2025.
Read more insights from Morgan Stanley.
----- Transcript -----
Michael Gapen: Welcome to Thoughts on the
Market. I'm Michael Gapen, Morgan Stanley's Chief U.S.
Economist.
Chetan Ahya: And I'm Chetan Ahya, Chief
Asia Economist.
Michael Gapen: Today we'll discuss some
significant changes to our Asia growth forecast on the heels of
tariffs. As well as how the U.S. economy is reacting to the
changes in the global trading environment.
It's Friday, April 25th at 8am in New York.
Chetan Ahya: And 8pm in Hong Kong.
Michael Gapen: So, Chetan, since the last
time we were both on the show, it appears that we are headed
towards at least some de-escalation of trade tensions. Just last
week, you wrote in your report that the tariffs on China are too
prohibitive for any trade to take place – and that you expected
some dialing down of the escalatory action. And this week the
administration started to talk about easing tariffs on China
significantly.
Considering all the events since April 2nd – and it's felt
like a lot of events since April 2nd –where does it leave
you in terms of how you are thinking about the outlook?
Chetan Ahya: So, Mike, that's right. You
know what we thought was that the current level of tariffs that
the U.S. has on China and what China has on the U.S. means that
effectively there are no transactions possible
But look, even after those tariff rates are going down, we are
still expecting it to be in the range of around 60 per cent. And
that would still be relatively high level of tariffs. If I were
just to translate this into what it means for the whole region?
So, for the whole region, the weighted average tariff will still
be around 32 per cent. And remember this number was close to 5
per cent in early January.
So, we are talking about a huge amount of uncertainty related to
this tariff path and the tariff level itself is going to remain
somewhat high.
And so, with that concern on uncertainty, we are expecting a
region's investment growth to be affected significantly,
taking down region's growth lower.
Michael Gapen: So, Chetan, I was looking
over your growth forecast and noticed that you have a
sharp step down in growth from the second quarter of 2025 on. Can
you walk us through these revisions in particular?
Chetan Ahya: So yes, we have changed our
forecast and what we are now seeing is in terms of growth path is
that Asia's overall GDP growth will slow from 4.8 per cent that
we saw in fourth quarter of last year, to around 3.6 per cent by
fourth quarter of this year.
And for comparable time period, China's growth will slow from 5.4
to 3.7 [per cent]. So that's another meaningful step down
for China
Michael Gapen: What do you think Asian
economies can do to counteract the impact from tariffs at this
point?
Chetan Ahya: So, we expect the policy
makers in the region to take up both monetary and fiscal policy
easing. But, you know, despite that policy easing effort, you
will still see that meaningful growth drag. So, for China, we
think it'll be the fiscal policy that will do the heavy lifting.
Whereas for Asia ex-China is going to be more monetary policy
that will do the heavy lifting.
And in terms of the exact magnitude, we're expecting 50 to 150
basis points depending upon the economy in the region in
form of rate cuts. And specifically on China; on the fiscal
policy, we expect them to take up about 2.5 per cent of GDP
increase in fiscal deficit in form of investment in
infrastructure, as well as some programs for supporting
consumption spending.
Michael Gapen: So Chetan, it sounds like a
lot of monetary and fiscal policy easing and support
is coming from the Asian economies. But I guess the
bottom line is that you don't think it would be sufficient to
fully counteract the impact from tariffs. Is that right?
Chetan Ahya: That's right Mike. And let me
come to you now and get your thoughts on how you see the
development of the tariffs, et cetera, affecting the U.S.
economy. You've already recently characterized your view on the
U.S. economy as still living on the edge. What's driving this
view?
Michael Gapen: It's a way that we were
trying to communicate that, you know, we don't see the economy at
the moment, falling into a recession, but we think it's
close. If we thought that the effective tariff rate was
going to stay where it was -- or where it is -- roughly around 18
per cent, then we would have a much more negative view on the
outlook. And we do expect the effective tariff rate to come down
for all the reasons that you suggested there. And there's
openings for that, to happen. And that's where the
conversation has been going in recent days.
And so, I think there's a tension between how much uncertainty
can be reduced on one hand. And then on the other hand, how
quickly volumes in the economy, activity in the economy may slow.
So, I think we're in a window here where – where we are in a race
against time to bring the effective tariff rate lower, in order
to keep the economy in recovery. So that was really my narrative
here where living on the edge, where we're not projecting a
recession, but we're close enough to one. That, it’s almost a
coin toss. And I think we need to backpedal here relatively
quickly, or we could have much more negative effects on the
economy.
Chetan Ahya: And Mike, I remember that, in
2018, we did not see this kind of a reaction in the consumer
confidence data, but we are seeing that in this cycle. And on top
of it, we have this expectation that corporate confidence will
also be weighed down by policy uncertainty. So how does this
double whammy of weak confidence feature in your forecast?
Michael Gapen: I think the key component or
in, in this case two key components for the outlook for the
economy – because it's relatively straightforward to try and
project or pass through the direct effect of tariffs on consumer
spending, real incomes and trade volumes. But what's really
hard to understand here is what does a highly uncertain
environment do to asset markets and business sentiment?
So, the, the two channels here that you mentioned,
consumer confidence and business confidence. These are kind of
what might get you spill over effects, and a recession.
So, for the consumer, what we're really focused on here is,
yes. Stated confidence by households is weak, but
they're still generally spending. And tariffs affect lower- and
middle-income houses more than they do upper income households.
So, we're really keyed in on: Do equity markets fall enough? Do
we get a negative wealth shock on upper income consumers, where
they decide, ‘Hey, I feel less wealthy, therefore I'm going to
spend less than save more.’
So, then the business sector delays spending and may even, you
know, generate some layoffs; and recessions, as you know, happen
when there's a lot of negative feedback loops in the economy. And
so, this is what we're worried about.
Chetan Ahya: Another interesting debate,
that we as a team are having with the investors is about the Fed
policy response. And so, Fed Chair Powell has said that tariffs
would generate at least a temporary rise in inflation. How do you
think the Fed will handle a tariff induced spike in inflation?
Michael Gapen: So, there has been an
evolution in the Fed's thought and thinking around how to handle
tariffs. Given the dramatic increase in tariffs,, I
think the Fed has to wait and they have to see the actual data
come in.
So, in our view, with inflation rising first and activity
weakening later, you probably don't get any Fed cuts this year.
And the Fed moves to rate cuts in 2026. If we're wrong
in the economy, and, and it decelerates, and moves into a
recession more quickly than we would anticipate, and the labor
market deteriorates rapidly, then the Fed will ease.
But what they're doing here is they're responding to a world
where both sides of their mandate are getting worse. And they're
going to respond to the one that's more offsides than the other.
And in the short run, we think that'll be inflation. So, it means
the Fed moves much later than markets currently expect.
Chetan Ahya: In terms of the next set
of data points or events that you're
watching, uh, which can change your view on the growth
outlook – what are you really, looking out for?
Michael Gapen: Well, I think in the very
short run, it's looking at all the inflation data and seeing
whether or not the higher tariff rates are
getting passed through to the final consumer. We think a little
of that will show up in the April inflation data that's due out
in the middle of May. That'll be mainly around autos. But then we
think the May, June, and July data will begin to show much more
increase in goods prices from the tariff pass through. So, we'll
be kind of watching that to see whether the inflation impulse is
as strong as we think it will be.
Second, I think in the very short run, we'll be watching trade
volumes. We'll be watching even, shipping container volumes.
We'll be watching for blank sales where ships skip ports because
there's just not any activity or demand. And then finally, I'd
say employment, right? Obviously, expansion versus contraction
and whether the economy will stay in expansion phase will be
dependent on whether employment continues to grow. We'll get an
early look on that. For the April employment data in early May.
We don't think there'll be much negative imprint on April
employment, but as we move into May, June, and July, we could see
hiring slow down more rapidly.
So, Chetan, that's what I would point to – just ascertaining the
near-term inflation impulse, looking out for any sharp slowdown
in trade volumes and whether or not the labor market holds up.
Michael Gapen: Before we close, based on
what I just described about the U.S. and also how you're thinking
about the tariff situation, how would you differentiate the
economies in your part of the world? I only have to deal with
one. You have to deal with many. How would you differentiate
between economies in your region right now?
Chetan Ahya: So Mike, what we've tried to
do is to think about this more from which economies are more
trade oriented and which economies are less trade oriented.
Because we are aware about the fact that there is going to be an
overall trade slowdown for the region. And so, in that context,
India and Australia are the ones we think will be, relatively
less affected from this trade slowdown and global growth
slowdown. Whereas more trade-oriented economies, which is, you
know, the likes of Korea, Taiwan, Thailand, Malaysia would be
getting more affected.; The reality is that China is facing the
maximum amount of tariffs within the region. And therefore we are
building in a bit more growth slowdown in case of China, even
while its trade orientation is a bit lower than Korea and Taiwan.
Michael Gapen: Chetan, thanks for taking
time to talk today.
Chetan Ahya: Great speaking with you, Mike,
Michael Gapen: And thanks for listening. If
you enjoy Thoughts on the Market, please leave us a review
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colleague today.
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