Trump likely to kick reciprocal tariff can down the road: Morgan Stanley

US stocks declined following President Trump's threat of 25% tariffs on Japan and South Korea, ahead of a looming 90-day tariff freeze expiration. Despite this, Morgan Stanley strategists anticipate the White House will likely extend the pause on reciprocal tariffs for most top trading partners, citing bilateral progress, though a nuanced deal-by-deal approach with potential future hikes for some remains possible. This persistent trade uncertainty and the risk of an aggressive tariff path reinforce a downside skew to the economic outlook, favoring US Treasuries and short USD positions, while signaling continued market volatility.

Analysis

US stocks have declined in response to President Trump's threat of 25% tariffs on Japan and South Korea as a 90-day tariff freeze nears its expiration. Despite the market's negative reaction, Morgan Stanley strategists project that the administration's base case is to extend the pause for most trading partners, citing 'progress' in bilateral talks. This approach is expected to be nuanced, potentially including high-level agreements with certain partners like Vietnam while maintaining the threat of future tariff hikes for others. This creates significant uncertainty, as Morgan Stanley also notes there has been little publicly reported concrete progress, and hawkish signals from the White House suggest tactical escalation remains a possibility. An aggressive tariff path would validate Morgan Stanley's forecast for downside risks to the economy, with GDP growth projected around 1% for 2025-2026. This scenario favors holding US Treasuries and short USD positions, but any surprise tariff relief would challenge that thesis. The administration's approach indicates investors should brace for continued policy-driven noise and market volatility.

Key Decisions for Investors

• Given the high uncertainty surrounding the tariff deadline, investors should anticipate increased market volatility, particularly in sectors with heavy reliance on trade with Japan and South Korea.
• A defensive posture may be prudent; the downside risk to the economic outlook presented by potential tariffs supports maintaining positions in safe-haven assets such as US Treasuries.
• Consider the risk-reward of a short USD position, which aligns with Morgan Stanley's tariff-driven soft economic outlook but is vulnerable to a sharp reversal if a broad pause is announced.
• Investors must closely monitor official White House announcements, as a selective, deal-by-deal tariff policy could create distinct winners and losers among international markets and industries, requiring tactical portfolio adjustments.