Markets staged a breathtaking recovery last week after the White House announced a 90-day pause on its planned reciprocal tariffs, with China as an exception. Although the rally was heartening, with the S&P 500 bouncing back to 5363 on April 11 after a low of 4983 on April 8, Morgan Stanley’s Global Investment Committee is not ready to declare that the coast is clear. Rather, investors should look beyond the tariff headlines to understand why the White House changed course, and, importantly, what it means for markets and the economy going forward.
Risks Linger Despite Pause on Tariffs
Apr 15, 2025
The Trump administration’s pause on reciprocal tariffs brought relief to markets, but economic risks still loom large. What should investors do now?
Key Takeaways
- Despite a pause on reciprocal tariffs, the White House is still leaving the effective tariff rate at about 17%, well above the current 3%.
- Higher tariffs mean the odds of recession remain elevated, with U.S. GDP growth forecasts for 2025 and 2026 significantly reduced.
- Turbulence in the Treasury market signals additional risks, including higher borrowing costs and constraints on U.S. fiscal policy that could stimulate the economy.
- Investors should maintain a diversified portfolio and consider adding to short-term fixed income and real assets to help manage ongoing volatility.
Tariff Are Still Likely to Slow the Economy
Despite all the news last week and the unprecedented market movements, not much has actually changed since the initial tariffs announcement on April 2. The revised plan lowers the effective blended tariff rate from around 22% to 17%, but that’s still a dramatic rise from the current rate of 3% – an increase that’s likely to weigh on economic growth, corporate margins and consumer behavior.
First of all, the probability of recession, while lower than before the tariff pause, is still about one-in-three. Morgan Stanley Research’s U.S. economists again reduced their 2025 and 2026 gross domestic product (GDP) growth estimates, to 0.6% and 0.5%, respectively.
Increased tariffs on China, in particular, are apt to dent U.S. growth. Independent analysts at Pantheon Macroeconomics estimate that China’s roughly 7% share of U.S. exports will likely decline to zero, potentially shaving around 35 basis points from U.S. GDP growth.
Meanwhile, corporate earnings are likely to fall due to lower global demand and weaker profit margins. Furthermore, according to the Budget Lab at Yale, the household burden of tariffs will be $4,700 per year on average.
Treasury Moves Indicate Emerging Risks
While equity market turmoil grabbed many investors’ attention, it was actually turbulence in the Treasury market that forced the Trump administration’s hand in delaying most reciprocal tariffs. Bond volatility soared, Treasury yields rose sharply and the additional yield that investors demand for owning riskier bonds, known as “credit spreads,” widened. Such turmoil may be signaling potential risks beyond recession and inflation. Consider that:
- Higher long-term Treasury rates present a threat of higher borrowing costs not only for businesses but also for the U.S. Treasury. With the Treasury scheduled to refinance more than $10 trillion in U.S. debt this year, soaring rates make refinancing that debt more expensive. With the U.S. budget deficit already outsized, higher rates and, thus, higher interest expenses may limit what Washington can do in the federal budget. That likely includes how ambitious U.S. lawmakers can afford to be with proposed tax cuts.
- Shifting trade-war dynamics could affect the flow of capital into the U.S., which could lead to weaker foreign demand for Treasuries and more currency volatility. In particular, China holds roughly one-sixth of foreign-owned U.S. Treasuries. A sharp drop in Treasury demand from that country, amid escalating trade tensions, would likely drive rates higher, further increasing borrowing costs.
- There is growing investor concern that the administration won’t make enough progress on U.S. debt and deficit reduction, making it difficult to deliver economically stimulative tax cuts that go beyond a mere extension of the existing Tax Cut and Jobs Act.
What Should Investors Do Now?
Investors should expect volatility to persist as tariff policy continues to evolve. Avoid knee-jerk reactions to headlines. Instead, stay diversified and balanced in your portfolio, with a focus on your longer-term financial goals and strategic asset allocation. Consider adding excess reserves to short-term fixed income while boosting exposure to private investments and real assets.
Long-term investors can consider 5100-5500 a defensible range for adding exposure to the traditional “cap-weighted” S&P 500 (in which the largest stocks have the biggest impact on performance). That said, the Global Investment Committee still prefers the “equal-weighted” version of the index (which allocates the same amount to each stock), as the large technology companies that comprise a significant piece of the cap-weighted index are exposed to tariff risks.
This article is based on Lisa Shalett’s Global Investment Committee Weekly report from April 14, 2025, “Blink!” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.
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