Intro

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.

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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 wherever you listen and share the podcast with a friend or colleague today.