Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's, U.S. Thematic and Equity Strategist.
Ariana Salvatore: And I'm Ariana Salvatore, U.S. Public Policy Strategist.
Michelle Weaver: Yesterday all eyes were on President Trump's announcement about sweeping global tariffs. Today we want to dig deeper into the details of the new executive order and how companies can counteract negative impacts from tariffs at the micro level.
It's Thursday, April 3rd at 10am in New York.
Ariana, you've been on the show quite a bit recently to discuss tariffs and their various repercussions. It's the main thing the market cares about right now. Did the April 2nd announcement change your views on the key objectives of President Trump's tariff policy?
Ariana Salvatore: Earlier this year, we identified the Trump administration as having really two key objectives when it comes to tariff implementation. So on the one hand, we think the administration recognizes that they can use tariffs for quicker policy concessions. We saw that with Mexico and Canada, for example. But on the other hand, the administration also has signaled an intent to use tariffs as a means to more significantly de-risk in key strategic industries and engage in a broader base supply chain realignment globally. So what we saw yesterday was effectively, in our view, a mix of both.
It didn't change our expectations for how the administration would approach this date for the overall trade review. President Trump in advance of yesterday signaled that he wanted to retool the global trading order based on this premise of reciprocity, and I think yesterday was really just an indication that they're in fact stepping in that direction.
Michelle Weaver: How do you think trade relationships will unfold for the rest of the year and beyond?
Ariana Salvatore: One of our key questions heading into April 2nd was whether or not this would be, in fact, a clearing event for trade policy one way or another. So converting trade policy uncertainty from more of a variable into a constant.
As you know, of course, Michelle, it's really that uncertainty that's been weighing on markets. I think what we learned yesterday is that these rates are by no means final, and the uncertainty component isn't going away anytime soon – as we start to engage in these bilateral discussions.
So to put a finer point on it, we really are watching for two things from here. First country's reaction function. If our trading partners retaliate, that will indicate how high these tariff rates can go. Treasury Secretary Bessent said yesterday that the tariff rates imposed are meant to be caps, so going lower in scope; and that's in line with our view that the April 2nd rates would represent a maximalist starting point. But of course, these rates could potentially have room to go higher if our trading partners announced retaliatory measures.
The second thing we're looking for is any potential clues on how quickly these talks can come together. Commerce Secretary Lutnick said the U.S. is already talking with trading partners and even ahead of this April 2nd announcement, some countries in certain blocks, like the EU, Brazil, and India, according to background reporting, have been offering concessions to really kick off that negotiation process.
But we also know that managing multiple bilateral negotiations at the same time will be challenging. So I think you can expect to see at least a good portion of these tariffs actually come into effect on the scheduled dates – April 5th and later April 9th.
Michelle Weaver: And how about non-tariff barriers in addition to the announced tariffs?
Ariana Salvatore: So this was frankly, a large part of the administration's rationale for levying these tariffs. If you recall, Trump said that they were looking at three things: The country's VAT; its reciprocal tariff rate on a product level; and this category that you mentioned of unfair trade practices. And those were all inputs to the overall country rate.
So, I think what we've seen so far indicates that that third component is actually the most fungible one. It's really important to the administration. So I think it's going to be a critical part of the negotiations from here. But we also know that certain non-tariff barriers can be easier to remove than others, and in many cases, they're actually slower moving than just lowering the tariff rates.
For example, Trump has cited burdensome re-regulation in certain sectors like EU food and agriculture. And then in other geographies he's talked about cumbersome and environmental regulations. I think negotiations on those topics are going to be slow moving because in many cases you're going to need to involve multiple regulatory agencies.
And getting them to sync up, as well as syncing up with the U.S. as regulatory agencies will be a challenging and probably long process. So I think where that leaves us is with uneven tariff implementation on a country and product level over the next three to six months; or even further out than that, as these negotiations progress on different tracks.
Michelle Weaver: And then based on your conversations with Morgan Stanley's economists and your own analysis, how much will these comprehensive tariffs impact the economic growth outlook, both in the U.S. and globally?
Ariana Salvatore: Yeah. I'll just hit on the different regions here. So starting with the U.S., our economists did take down their GDP estimates earlier this year on the back of that uncertainty to 1.5 per cent.
That's really what's been weighing on markets in the economy, to my point earlier about this lack of clarity. And we see that through multiple channels – like corporates holding back on CapEx, the sentiment data we see showing us less confidence about the near term outlook. I think what we saw last night was enough for our economists to rethink that baseline. They removed a Fed cut in June, and from here, we think the risks are skewed to the downside. But of course the extent of that downside will be primarily a function of how long these tariffs are in place and how broad they are.
So when it comes to the other regions in Europe, our economists’ rule of thumb is that a permanent 20 per cent universal increase of tariffs on EU goods would reduce Euro area GDP by 60 to 120 basis points. That lower range, the 60 basis points reflects direct trade impacts and the upper range adds that impact of uncertainty and financial tension.
Lastly, in Asia, our economists think that the region is actually most exposed globally – given that at most it runs a trade surplus with the U.S., which as we talked about is one of the key metrics for the Trump administration. But the outlook really depends on each country's ability to negotiate trade deals. Inside that framework, we see India, Japan, Korea, and Indonesia as most likely to get a trade deal done. But the worst positioned on both the extent of the tariff increase as well as the ability to get a deal would probably be China and Vietnam.
But Michelle, it's clear that tariff increases across the board will likely have significant macro repercussions. What about the micro implications? What sort of strategies can companies deploy to mitigate the impact of these tariffs?
Michelle Weaver: So managing risks from tariffs is going to be an ongoing process for the rest of the second Trump administration. And I don't think tariff threats are going away anytime soon. And we identified five different strategies companies can take to mitigate the risk of tariffs and think through some of the different ways industries might approach this. So I'll go through these different strategies in order of easiest, fastest to implement, and then longest and most expensive to implement.
So the first is pricing power. Companies can choose to either pass off all of the costs of their tariffs to customers or share some of the burden of higher prices and accept lower margins. This does assume companies have a strong degree of pricing power, though, and is not going to work for every industry.
The next strategy is some companies are employing a more robust FX hedging program. The announcements from tariffs are causing a lot of movement in the currency markets, so some companies have chosen to take on a more robust hedging program.
The third strategy is redirecting products to markets without tariffs. So if you're a big multinational company and you produce products in multiple regions, as well as sell products in multiple regions, you can take some of the goods that were bound for the U.S. that were going to be under tariffs. So for example, you produce in China, and instead of routing those goods to the U.S. you can route them to a different end market. So you can send them to Europe or another market that doesn't have the same tariff structure.
The fourth strategy companies are thinking about is stockpiling inventory. And we've already seen companies building some level of inventory ahead of tariffs. But given the costs associated with holding excess inventory though, we think companies are taking a more modest approach here. They're filling existing warehouse space, but we know they're not trying to hold inventory for the long term because we haven't seen a pickup in industrial warehouse leasing. This is also, once again, going to vary industry to industry. For a company that's in a space like apparel, there's fashion risk. So you don't want to try and hold inventory for a really extended period because the fashion trends and the cycle may change.
And then the last and fifth strategy that companies are using is diversifying supply chains. And we saw under the first Trump administration, those tariffs did catalyze a reorganization of supply chains. And you can think about reorganizing your supply chains under a few different strategies. So there's China Plus One, nearshoring and reshoring.
Under China Plus One, you can move factories from China to other nearby locations with low cost labor. We saw this during the last tariff regime, and you saw some movement from China to other locations in Southeast Asia like Vietnam. Then there's also a nearshoring strategy, and we saw some companies move production to Mexico. This strategy does bring production closer to sources of end demand, so it offers some more insulation from supply chain malfunctions. During the tariffs that were announced yesterday, we did still see some carve outs for USMCA products, so I wouldn't be surprised if companies continue to do this.
And then the last option for reorganizing your supply chains is a full-shoring strategy and bringing production back to the United States. This is expensive but it does locate production close to your end consumers.
Ariana Salvatore: How are U.S. and foreign companies talking about these strategies and how confident are management teams in being able to actually implement them?
Michelle Weaver: So we're seeing different industries talk about different strategies. But if I zoom out and think about this overall, the number one way companies are thinking about mitigating tariff risk is through diversifying supply chains.
But you do need some more degree of tariff certainty before companies are going to execute on this. There is policy risk where if policy changes, you don't want to say, ‘Okay, I'm gonna bring a bunch of production to Mexico,’ and then be concerned that the tariff regime is going to change there. And then you'll have spent a lot of money to reorganize your supply chain, but still be under tariffs. And then the other strategy companies are talking about most is pricing power. This is the easiest to implement. It costs virtually nothing to implement. We're seeing a lot of discussion around that, and I think that's the lever companies are going to pull first.
Ariana Salvatore: Which strategies you mentioned are particularly relevant and applicable to specific sectors and industries?
Michelle Weaver: So I think for capital goods, they have a strong degree of pricing power. I think they're going be able to take price. They are impacted by these tariffs, but fairly constructive, around their ability to mitigate the impact.
Another pocket of the market that's especially exposed here is consumer goods. They don't have as big of a pricing power lever to pull. I think they're going to try to do that to the extent they can, but their ability to mitigate is a little tougher. And then, we saw energy companies talking about redirecting products. They're dealing in global commodities, so that should be a fairly achievable thing for them to implement.
And then finally, Ariana, what key catalysts and announcements are you watching for next, both from the U.S. and from other countries?
Ariana Salvatore: Well, it's important to remember that the tariffs we got yesterday are actually country level. For the moment, Trump has exempted certain sectors, including pharmaceuticals and semiconductors. But the administration has also said that they're conducting Section 232 reports to prepare tariffs on those products later on. We don't know exactly when that will conclude, but typically Section 232 studies take about six to eight months and 270 days on the long end.
Similarly, we have an upcoming deadline of May 3rd for the administration to also scope in non-USMCA compliant auto parts. And June 24th is the deadline to establish the process to tariff non-US content inside of that USMCA compliant auto parts bucket.
Trump also mentioned a 25 per cent tariff on countries purchasing Venezuelan oil. That wasn't part of the announcements yesterday, so we might hear something on that too. We just don't know exactly when.
Michelle Weaver: Ariana, thank you for taking the time to talk, and thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
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