While policy noise continues to dominate the headlines, our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas points out a key theme: a transition toward a multipolar world.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today we’ll be discussing what investors need to focus on amidst all the U.S. policy headlines.

It’s Friday, March 7th, at 12:30 pm in New York.

In recent weeks the news flow on tariffs, immigration, and geopolitics has been relentless, culminating in this week’s state of the union address by President Trump and, if headlines hold, a partial reversal in course on Mexico and Canada tariffs that were just levied earlier this week. Understandably, measures of policy uncertainty, such as the Baker, Bloom, and Davis index, have reached all time highs. And this tracks with the confusion expressed by investing and corporate clients. 

In our view, this policy noise is going to continue. But, there is an important signal. These developments track with one of our four key themes of 2025. The transition toward a multipolar world. The tense White House meeting between Presidents Trump and Zelensky, played out live in front of the news cameras, was another reminder that the U.S. is evolving its role in driving international affairs. And tariffs on Mexico, Canada, and China are a reminder of the U.S.’s interest in rewiring global trade. The reasons behind this are myriad and complex, but in the near term it's about the U.S. looking more inward. Economic populism is, well, popular with voters in both parties. 

There’s a few net takeaways for investors here. One is a positive for the European defense sector. The combination of tariffs and the evolving U.S. posture on global security has long been part of our thesis on why Europe would eventually chart a new path and step up to spend more on defense. The current situation in Russia and Ukraine underscores this, with potential for another $0.9-$2.7 trillion in defense spending through 2035. Germany’s new ‘whatever it takes’ approach to defense spending is a key signpost in this trend, per our colleagues in European economics, equities, and foreign exchange. 

Another critical takeaway is around the effects of U.S. trade realignment on both macro markets and equity sector preferences. Whether these trade policy changes play out well over time or not, the attempt costs something in the near term. Tariffs are part of that cost. And while the precise path of tariff increases is unclear, what is clear is that they’re headed higher in the aggregate, a tactic in service of the administration’s goal of reducing trade deficits and creating reciprocal trade barriers in order to incentivize greater production in the U.S. 

Over the next year, our economists expect that those tariff costs will crimp economic activity. That slower growth should eventually feed through into a more dovish monetary policy. Both factors, in the view of our U.S. rates strategy team, should continue pushing yields lower – good news for bond investors, but more challenging posture for equity investors, and a key reason our cross asset team is currently flagging a preference for fixed income. 

That tariff activity should also drive supply chain realignment. But, going forward, changing those supply chains may now be more costly. Per work from our Global economics team, the supply chains that need to be moved now are complex and concentrated in geopolitical rivals. That’s a challenge for certain sectors, like U.S. IT hardware and consumer discretionary. But the investment to make it happen creates demand and is a benefit for the capital goods and broader industrials sector. 

Bottom line, the policy noise will continue, as will the market cross currents it’s driving. We’ll keep you informed on it all here. 

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.