As market turmoil continues, our global economists give their
view on the ramifications of the Trump administration’s tariffs,
and how central banks across key regions might react.
Read more insights from Morgan Stanley.
---- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's, Global Chief
Economist, and today we're going to be talking tariffs and what
they mean for the global economy.
It's Monday, April 7th at 10am in New York.
Jens Eisenschmidt: It's 4pm in
Frankfurt.
Chetan Ahya: And it's 10pm in Hong
Kong.
Seth Carpenter: And so, I'm here with our
global economists from around the world: Mike Gapen, Chief U.S.
Economist, Chetan Ahya, our Chief Asia Economist, and Jens
Eisenschmidt, our Chief Europe Economist. So, let's jump into it.
Let me go around first and ask each of you, what is the top
question that you are getting from investors around the world?
Chetan?
Chetan Ahya: Tariffs.
Seth Carpenter: Jens?
Jens Eisenschmidt: Tariffs.
Seth Carpenter: Mike?
Michael Gapen: Tariffs.
Seth Carpenter: All right. Well, that seems
clear. Before we get into the likely effects of the tariffs,
maybe each of you could just sketch for me where you were before
tariffs were announced. Chetan, let me start with you. What was
your outlook for the Chinese economy before the latest round of
tariff announcements?
Chetan Ahya: Well Seth, working with our
U.S. public policy team, we were already assuming a 15-percentage
point increase on tariffs on imports from China. And China also
was going through some domestic challenges in terms of high
levels of debt, excess capacities, and deflation. And so,
combining both the factors, we were assuming China's growth will
slow on Q4 by Q4 basis last year – from 5.4 percent to close to 4
percent this year.
Jens, what about Europe? Before these broad-based tariffs, how
were you thinking about the European economy?
Jens Eisenschmidt: We had penciled in a
slight recovery, not really getting us much beyond 1 percent.
Backdrop here, still rising real wages. We had some tariffs in
here, on steel, aluminum; in cars, much again a bit more of a
beefed-up version if you want, of the 18 tariffs – but not much
more than that. And then, of course, we had the German fiscal
expansion that helped our outlook to sustain this positive growth
rates into 2026.
Seth Carpenter: Mike, for you. You also had
thought that there were going to be some tariffs at some point
before this last round of tariffs. Maybe you can tell us what you
had in mind before last week's announcements.
Michael Gapen: Yeah, Seth. We had a lot of
tariffs on China. The effective rate rising to say 35 to 40
percent. But as Jens just mentioned, outside of that, we had some
on steel and aluminum, and autos with Europe, but not much beyond
that. So, an effective tariff rate for the U.S. that reached
maybe 8 to 9 percent.
We thought that would gradually weigh on the economy. We had
growth at around 1.5 percent this year and 1 percent next year.
And the disinflation process stopping – meaning inflation
finishes the year at around 2.8 core PCE, roughly where it is
now. So, a gradual slowdown from tariff implementation.
Seth Carpenter: Alright, so a little bit
built in. You knew there was going to be something, but boy, I
guess I have to say, judging from market reactions, the world was
surprised at the magnitude of things. So, what's changed in your
mind? It seems like tariffs have got to push down the outlook for
growth and up the out outlook for inflation. Is that about right?
And can you sketch for us how this new news is going to affect
the outlook?
Michael Gapen: Sure. So instead of
effective tariff rates of 8 to 9 percent, we're looking at
effective tariff rates, maybe as high as 22 percent.
Seth Carpenter: Oh, that's a lot.
Michael Gapen: Yeah. So more than twice
what we were expecting. Obviously, some of that may get
negotiated down.
Seth Carpenter: And would you say that's
the highest tariff rate we've seen in a while?
Michael Gapen: At least a century. If we
were to a 1.5 percent on growth before, it's pretty easy to
revise that down, maybe even a full percentage point, right?
So you’re, it's a tax on consumption and a tariff rate that high
is going to pull down consumer spending. It's also going to lead
to even much higher inflation than we were expecting. So rather
than 2.8 for core PCE year-on-year, I wouldn't be surprised if we
get something even in the high threes or perhaps even low fours.
So, it pushes the economy, we would say, at least closer to a
recession. If not, you're getting closer to the proverbial coin
toss because there are the potential for a lot of indirect
effects on business confidence. Do they spend less and hire less?
And obviously we're seeing asset markets melt down. I think it's
fair to describe it that way. And you could have negative wealth
effects on the upper income consumers. So, the direct effects get
you very modest growth a little bit above zero. It's the indirect
effects that we're worried about.
Seth Carpenter: Wow, that's quite a
statement. So, a substantial slowdown for the U.S. Flirting with
no growth. And then given all the uncertainty, the possibility
that the U.S. actually goes into recession, a real possibility
there. That feels like a big call.
Jens, if the U.S. could be on the verge of recession with
uncertainty and all of that, what are you thinking about Europe
now? You had talked about Europe before the tariffs growing
around 1 percent. That's not that far away from zero. So, what
are you thinking about the outlook for Europe once we layer in
these additional tariffs? And I guess every bit is important. Do
you see retaliatory tariffs coming from the European Union?
Jens Eisenschmidt: No, I think there are at
least three parts here. I totally agree with that framing. So,
first of all, we have the tariffs and then we have some estimates
what they might mean, which, just suppose what we have heard last
week sticks, would get us already in some countries into
recessionary territory; and for the aggregate Euro area, not that
far from it. So, we think effects could range between 60 and 120
basis points of less growth. Now that to some extent,
incorporates retaliation. And so, the question is how much
retaliation we might expect here. This is a key question we get
from clients. I'd say we get something; that seems, sure.
At the same time, it seems that Europe weighs a response that is
taking into account all the constraints that are in the equation.
After all the U.S. is an ally also in security concerns. You
don't wanna necessarily endanger that good relationship. So that
will for sure play a role. And then the U.S. has a services
surplus with Europe, so it's also likely to be a response in the
space of services regulation, which is not necessarily
inflationary on the European side, and not necessarily growth
impacting so much.
But, you know, be it as it may. This is going to be down from
here, for sure. And then the other thing just mentioned by
Michael, I mean there is clearly a read across from a slower U.S.
growth environment that will also not help growth in the Euro
area. So, all being told it could very well mean, if we get the
U.S. close to recession, that the Euro area is flirting with
recession too.
Seth Carpenter: Got it.
Chetan Ahya: Seth, can I interrupt you on
this one? I just wanted to add the perspective on retaliatory
tariffs from China. What we had actually originally billed was
that China would take up a retaliatory response, which would be
less than be less than proportionate, just like the last time.
But considering that China has actually, mashed U.S. reciprocal
tariffs, it makes us feel that it's very unlikely that a deal
will be done anytime soon.
Seth Carpenter: Okay. So then how would you
revise your view for what's going on with China?
Chetan Ahya: Yeah, so as I mentioned
earlier, we had already built in some downside but with these
reciprocal tariffs, we see another 50 to 100 [basis points]
downside to China's growth, depending upon how strong is the
policy stimulus.
Seth Carpenter: So, at some point, I
suspect we're going to start having a discussion about what it
really means to have a global recession, and markets are going to
start to look to central banks.
So, Mike, let me turn to you. Jay Powell spoke recently. He
repeated that he is in no hurry to cut interest rates. Can you
talk to me about the challenges that the Fed is facing right now?
Michael Gapen: The Fed is faced with this
problem where tariffs mean it's missing on both sides of its
mandate, where inflation is rising and there's downside risk to
the economy.
So how do you respond to that?
Really what Powell said is it's going to be tough for us to look
through this rise in inflation and pre-emptively ease. So, for
the moment they're on hold and they're just going to evaluate how
the economy responds. If there's no recession, it likely means
the Fed's on hold for a very long time. If we get negative job
growth, if you will, or job cuts, then the Fed may be moving to
ease policy. But right now, Powell doesn't know which one of
those is going to materialize first.
Seth Carpenter: Alright Mike. So, I
understand what you're saying. Inflation going higher, growth
going lower. Really awkward position for the Fed, and I think
central banks around the world really have to weigh the two sides
of these sorts of things, which one’s going to dominate…
Jens Eisenschmidt: Exactly. Seth, may I
jump in here because I think that's a perfect segue to the ECB;
which I was thinking a lot about that – just recently coming back
from the U.S. – how different the position really is here. So,
the ECB currently is on the way to neutral, at least as we have
always thought as a good way of framing their way. Inflation is
falling to target. Now with all the risks that we have mentioned,
there's a clear risk we see. Inflation going below 2 percent,
already by mid this year – if oil prices were to stay as low as
they are and with the euro appreciation that we have seen.
The tariffs scare in terms of the inflationary impact from
tariffs, that's much less clear. Now, whether that's really
something to worry about simply because what you typically see
with these tariffs – it's actually a depreciation of the exchange
rate, which we haven't seen. So, we think there is a clear risk,
downside risk to our path; at least that we have an anticipation.
A quicker rate cutting cycle by the ECB. And potentially if the
growth outlook that we have just outlined all these risks really
materializes, or threatens is more likely to materialize, then
the cuts could also be deeper.
Seth Carpenter: That's super tricky as well
though, because they're going to have to deal with all the same
uncertainty. I will say this brings up to me the Bank of Japan
because it was the one major central bank that was going the
opposite direction before all of this. They were hiking while the
other central banks were cutting.
So, Chetan, let me turn to you. Do you think the Bank of Japan's
gonna be able to follow through on the additional rate hike that
you all had already had in your forecast?
Chetan Ahya: Yes Seth. I think Bank of
Japan will have a difficult time. Japan is exposed to direct
effect of 24 percent reciprocal tariffs. It will see downside
from global trade slowdown, which will weigh on its exports and
yen appreciation will weigh on its inflation outlook. Hence,
unless if U.S. removes tariffs very quickly in the near term, we
see the risk that BOJ will pause instead of hiking as we had
assumed in our earlier base case.
Seth Carpenter: Well, this is a good place
to stop. Let me see if I can summarize the conversations we've
had so far. Before this latest round of tariffs had been
announced, we had thought there'd be some tariffs, and we had
looked for a bit of slowdown in the U.S. and in Europe and in
China – the three major economies in the world. But these new
rounds of tariffs have added a lot to that slowdown pushing the,
the global economy right up to the edge of recession. And what
that means as well is for central banks, they're left in at least
something of a bind. The Bank of Japan though, the one major
central bank that had been hiking, boy, there's a really good
chance that that rate hike gets derailed.
Seth Carpenter: Well, thank you for
listening. And if you enjoy the show, please leave us a review
wherever you listen and share Thoughts on the Market with a
friend or a colleague today.
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