Thoughts on the Market

• U.S. Economy: Solid Footing For Now, Uncertainty Ahead

  With the May FOMC meeting in progress, our analysts Matt Hornbach and Michael Gapen offer perspective on U.S. economic projections and whether markets are aligned.Read more insights from Morgan Stanley.----- Transcript -----Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy.Michael Gapen: And I'm Michael Gapen, Morgan Stanley's Chief U.S. Economist.Matthew Hornbach: Today we're talking about the Federal Open Market Committee Meeting underway, and the path for rates from here.It's Tuesday, May 6th at 10am in New York.Mike, before we talk about your expectations for the FOMC meeting itself, I wanted to get your take on the U.S. economy heading into the meeting. How are you seeing things today? And in particular, how do you think what happened on April 2nd, so-called Liberation Day, affects the outlook?Michael Gapen: Yeah, I think right now, Matt, I would say the economy's still on relatively solid footing, and by that I mean the economy had been moderating. Yes, the first quarter GDP print was negative. But that was mainly because firms were frontloading a lot of inventories through imports. So imports were up over 40 percent at an annualized pace in the quarter. A lot of that went into inventories and into business spending. That was just a mechanical drag on activity.And the April employment report, I think, showed the same thing. We're now averaging about 145,000 jobs per month this year. That's down from about 170,000 per month in the second half of last year. So the hiring rate is slowing down, but no signs of a sudden stop. No signs in layoffs picking up. So I'd say the economy is on fairly solid footing, and the labor market is also on fairly solid footing – as we enter the period now when we think tariffs will have a greater effect on the outlook. So you asked, you know, Liberation Day. How does that affect the outlook? Right now we'd say it puts a lot of uncertainty in front of us. on pretty solid footing now. But Matt, looking forward, we have a lot of concerns about where things may go and we expect activity to slow and inflation to rise.Matthew Hornbach: That's great background, Mike, for what I want to ask you about next, which is of course the FOMC meeting this week. We won't get a new set of economic projections from the committee. But if we did, what do you think they would do with them and how would you assess the reaction function one might be able to tease out of those economic projections?Michael Gapen: You're right, we don't get a new set of projections, but New York Fed President John Williams did provide some indication about how he adjusted his forecast, and John tends to be one of the – kind of a median participant.He tends to be centrist in his thinking and his projection. So I do think that that gives us an indication of what the Fed is thinking; and he said he expects GDP growth to slow to somewhat below 1 percent in 2025. He expects inflation to rise to 3.5 to 4 percent this year, and he said the unemployment rates likely to move between 4.5 and 5 percent over the next year. And those phrases are really key. That's the same thing, Matt, as you know, we are expecting for the U.S. economy and I do think the Fed is thinking of it the same way.Matthew Hornbach: So one final question for you, Mike. In terms of this meeting itself, what are you expecting the Fed to deliver this week? And what are the risks you see being around that expectation; you know, that might catch investors off guard?Michael Gapen:I think the Fed's main message this week will be that they're prepared to wait, that they think policy's in a good spot right now. They think inflation will be rising sharply, that the tariff shock is a lot larger than they had anticipated earlier this year. And they will need time to assess whether that inflation impulse is transitory, or whether it creates more persistent inflation. So I think what they will say is we're in a good position to wait and we need clarity on the outlook before we can act.In this case, we think acting means doing nothing. But acting could also mean cutting if the labor market weakens. So I think there'll be worried about inflation today, a weak labor market tomorrow. And so I think risks around this meeting really are tilted in the direction of a more hawkish message than markets are expecting at least vis-a-vis current pricing. I think the market wants to hear the Fed will be ready to support the economy. Of course, we think they will, but I think the Fed's also going to be worried about inflation pressures in the near term. So that, I think, might catch investors off guard.So Matt, what I think might catch investors off guard may be a little misplaced. I'm an economist after all. You're the strategist, you're the expert on the treasury market and how investors may be perceiving events at the moment. So the treasury market had quite the month since April 2nd. For a moment U.S. treasuries didn't act like the safe haven asset many have come to expect. What do you think happened?Matthew Hornbach: So, Mike, you're absolutely right. Treasury yields initially fell, but then spent a healthy portion of the last month rising and investors were caught off guard by what they saw happening in the treasury market. I've seen this type of behavior in the treasury market, which I've been watching now for 25 years. I've seen this happen twice before in my career. The first time was during the Great Financial Crisis, and the second time I saw it was in March of 2020. So, this being the third time you know, I don't know if it was the charm or if it was something else, but treasury yields went up quite a bit.I think what investors were witnessing in the treasury market is really a reflection of the degree of uncertainty and the breadth with which that uncertainty, traversed the world. Both the Great Financial Crisis and the initial stage of the pandemic in March of 2020 were events that were global in nature. They were in many ways systemic in nature, and they were events that most investors hadn't contemplated or seen in their lifetimes. And when this happens, I think investors tend to reduce risk in all of its forms until the dust settles. And one of those very important forms of risk in the fixed income markets is duration risk.So, I think investors were paring back duration risk, which helped the U.S. Treasury market perform pretty poorly at one moment over the past month.Michael Gapen: So Matt, one aspect of market pricing that stands out to me is how rates markets are pricing 75 basis points of rate cuts this year. And just after April 2nd, the market had priced in about 100 basis points of cuts.How are you thinking about the market pricing today? Matt, as you know, it differs quite a bit from what we think will happen.Matthew Hornbach: Yeah. This is where, you know, understanding that market prices in the interest rate complex reflect the average outcome of a wide variety of scenarios; really every scenario that is conceivable in the minds of investors. And, of course, as you mentioned, Mike depending on exactly how this year ends up playing out there, there could be a scenario in which the Federal Reserve has to lower rates much more aggressively than perhaps even markets are pricing today.So, the market being an average of a wide variety of outcome will find it really challenging to take out all of the rate cuts that are priced in today. Or said differently, the market will find it challenging to price in your baseline scenario. And ultimately, I think the way in which the market ends up truing up to your projections, Mike, is just with time.I think as we make our way through this year and the economic data come in, in-line with your baseline projections, the market will eventually price out those rate cuts that you see in there today. But that's going to take time. It's going to take investors growing increasingly comfortable that we can avoid a recession at least in perception this year before, you know, on your projections, we have a bit of a slower economy in 2026.Michael Gapen: Well, it definitely does feel like a bimodal world, where investor conviction is low. Matt, where do you have conviction in the rates market today?Matthew Hornbach: So, the way we've been thinking about this environment where we can avoid a recession this year, but maybe 2026 the risks rise a bit more. We think that that's the type of environment where the yield curve in the United States can steepen, and what that means practically is that yields on longer maturity bonds will go up relative to yields on shorter maturity bonds. So, you get this steepening of the yield curve. And that is where we have the highest conviction; in terms of, what happens with the Treasury market this year is we have a steeper yield curve by the time we get to December.Now part of that steepening we think comes because as we approach 2026 where Mike, you have the Fed beginning to lower rates in your baseline, the market will have to increasingly price with more conviction a lower policy rate from the Fed. But then at the same time, you know, we probably will have an environment where treasury supply will have to increase.As a result of the fiscal policies that the government is discussing at the moment. And so you have this environment where yields on longer maturity securities are pressured higher relative to yields on shorter maturity treasuries.So, with that, Mike, we'll wrap our conversation. Thanks so much for taking the time to talk.Michael Gapen: It's been great speaking with you, Matt.Matthew Hornbach: 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.

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  11:18
• Munis: Tax-Free Income in Times of Stress

  Morgan Stanley Research analyst Mark Schmidt and Investment Management’s Craig Brandon discuss the heightened uncertainty in the U.S. municipal bonds market.Read more insights from Morgan Stanley.For a full list of episode disclosures click here.----- Transcript -----Mark Schmidt: Welcome to Thoughts on the Market. I'm Mark Schmidt, Morgan Stanley's Head of Municipal Strategy.Craig Brandon: I'm Craig Brandon, Co-Director of Municipal Investments at Morgan Stanley Investment Management.Mark Schmidt: Today, let's talk about the biggest market you hardly ever hear about – municipal bonds, a $4 trillion asset class.It's Monday, May 5th at 10am in Boston.Mark Schmidt: If you've driven, flown, gone to school or turned on a tap, chances are munis made it happen. Although munis are late cycle haven, they were not immune to the latest bout of market volatility. Craig, why was April so tough?Craig Brandon: So, what we say in April, it was sort of the trifecta of things that happened that were a little different than other asset classes. The first thing that happened is we saw a significant increase in treasury rates – and munis are generally correlated to treasuries. We're a very high-quality asset class, that's viewed as a duration asset class. So, one thing we saw were rates going up. When we see rates going up, you generally see money coming out of the market, right? So, I think investors were a little bit impacted by the higher rates, the correlation to treasuries, the duration, and saw some flows out of the market.Secondly, what we saw is conversation about the tax exemption in Washington D.C. What that did is it caused muni issuers to pull their issuance forward. So, if you're an infrastructure issuer, you are issuing bonds in the next year to year and a half; you're going to pull that forward because if there's any risk of loss of the tax exemption, you want to get these bonds issued today. So that's basically what drives technicals. It's supply and demand. So, what we saw was a decrease in demand because of higher rates; an increase in supply because of issuance being pulled forward.And the third part of the trifecta we refer to is the conversations about the economy. So, I would put that, it's sort of a distant third, but there's still conversations about maybe credit weakness driven by a slowing economy.Mark Schmidt: Craig, your team has been through a lot of tough market cycles. Given your experience, how did the most recent selloff compare? And why was it not like 2008?Craig Brandon: I started my career back in 1998 during the long-term capital management crisis. I lived through 2008. I lived through the COVID crisis, and you know, really when I look at the crisis in 2008 – no banks went out of business three weeks ago, right? In 2008 we were really sitting on a trading desk wondering where this was going to end.You know, we had a number of meetings with our staff, over the last couple weeks explaining to them why it was different and how. Yes, there was some volatility here, but you could see that there was going to be an end to this, and this was not going to be a permanent restructuring of the market. So, I think we felt comfortable. It was very different than 2008 and it really felt different than COVID.Mark Schmidt: That's reassuring. But with economic growth set to slow sharply, how does your credit team think the fiscal health of America's state and local governments will hold up?Craig Brandon: Well, remember state and local governments, and when we're talking about munis, we're also talking about other infrastructure asset classes like water and sewer bonds. Like, you know, transportation, bonds, airports. We're talking about toll roads.They went into this with a very strong balance sheet, right? Remember, there was a lot of infrastructure money spent by the federal government during COVID to give issuers money to make it through COVID. There's still a lot of money on balance sheets. So, what we do is we're going into this crisis with a lot of cash on balance sheets, allowing issuers to be able to withstand some weakness in the economy and get through to the other side of this.Mark Schmidt: Not only do state and local governments have a lot of cash, but they're just not that impacted by tariffs, right? So why did muni yields perform worse than U.S. treasuries over the past couple of weeks?Craig Brandon: Right. It really… We're technically driven, right? The U.S. muni market is more retail driven than some other asset classes. Remember – investment grade corporates, treasury bonds, there's a lot of institutional buyers in those markets. In the municipal market, it's primarily retail driven.So, when you know, individual retail investors get nervous, they tend to pull money out of the market. So, what we saw was money coming out of the market. At the same time, we saw an individual increase in more bonds, which just led to very weak technicals, which when we see that it eventually reverses itself.Mark Schmidt: Now I almost buried the lede, right? Why invest in munis? Well, they're great credit quality, but they're also tax free. In fact, muni bonds have been exempt from federal taxes for over a century. You have a lot of experience putting together tax bills, and right now people are worried about tax reform. Do you think investors should be concerned?Craig Brandon: Listen. I'm not really losing a lot of sleep at night over the tax exemption. And I think there's other, you know, issues to worry about. Why do I say that?As you mentioned Mark, I spent the early years of my career working for the New York State Assembly Ways and Means Committee. I spent seven years negotiating budgets and what that did is it gave me a window – into how, you know, not only state budgets, but the federal budget gets put together.So, what it also showed me was the relationship between state and local elected officials and your representatives in Congress and your representatives in the Senate. So, I know firsthand that members of Congress and members of the Senate in Washington have very close relationships with members of the state legislatures, with governors, with mayors, with city council members, with school board members – who are all delivering the message that significantly higher financing costs that could potentially happen from the loss of the exemption, could be meaningful to them.And I think members of Congress and members of the Senate and Washington get it. They understand it because they were all there when it happened. The last time the muni exemption came under fire was back in 2012; and in 2012, a lot of members of Congress were in the state legislature back then, so they understand it.Mark Schmidt: That's reassuring because right now, tax equivalent yields in the muni market are 7 to 8 per cent. That's equal to or greater than the long run rate of return on the stock market. So, whether to invest in the muni market seems pretty straightforward. How to invest in the muni market? Well, with 50,000 issuers, that's a little complicated. How do you recommend investors get exposure to tax-free munis right now?Craig Brandon: Well, and that is a very common question. The muni market can be very confusing because there are just so many bonds out there. You know, over 50,000 issuers, there's over a million individual CUSIPs in the muni market.So as an individual investor, where do you start? There's different coupon structures, different call structures, different maturity structures, ratings. There's so many different variables that go into a decision in investing in muni bonds.I can make an argument that you could probably mimic the S&P 500 with 500 different stocks. But most muni indices are over 50,000 constituents. It's very difficult to replicate the muni market by yourself, which is why a lot of people, you know, they let professional money managers, do the investing for them. Whether you're looking at mutual funds, whether you're looking at separately managed accounts, whether you're looking at exchange traded fund ETFs, there's a lot of different ways to get exposure to the muni market. But with the huge amount of choices you have to make, I think a lot of individual investors would just let a professional with the experience do it.Mark Schmidt: And active managers let you customize portfolios to your unique tax situation and risk tolerance. So, Craig, a final question for you. How do munis fit into a diversified portfolio?Craig Brandon: Munis are generally the stable part of most people's portfolios. Remember, you don't have a choice of whether you're going to pay your taxes or not. You have to pay your taxes, you have to pay your water bill, you have to pay your power bill. You have to pay tolls on highways. You have to pay airport fees when you buy an airline ticket, right?It's not an option. So, because the revenue streams are so stable, you see most muni bonds rated AA or AAA. The default rate for rated munis is significantly below 1 per cent. It's something in the ballpark of about 0.2 per cent*. So, with such a low default rate – listen, we're technically driven, as I said. You see ups and downs in the market. But over a longer period of time, munis can give you generally stable returns, tax exempt income over the long term, and they're one of the more stable asset classes that you see in your overall portfolio.Mark Schmidt: That sounds boring, and I mean that in the best possible way. Craig, thanks so much for your time today.Craig Brandon: Thanks, Mark, happy to be hereMark Schmidt: And thank you 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.*“US Municipal Bond Defaults and Recoveries, 1970-2021” – Moody’s Investor ServicesDisclosure: Past performance is no guarantee of future results. The returns referred to in the commentary are those of representative indices and are not meant to depict the performance of a specific investment.Risk ConsiderationsDiversification does not eliminate the risk of loss.There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. 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  9:27
• Why the UK May Be Poised for a Surprising Rebound

  Despite news that the UK economy is set to slow due to uncertainty around US trade policy, our analysts Andrew Sheets and Bruna Skarica explain why they have a more optimistic outlook.Read more insights from Morgan Stanley.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.Bruna Skarica: And I'm Bruna Skarica, Chief UK Economist at Morgan Stanley.Andrew Sheets: Today we're going to talk about the United Kingdom and why, despite a downbeat outlook by many in the market, we remain more optimistic.It's Friday, May 2nd at 2pm in London.Bruna, it's great to talk to you again about the UK and not just because this is an unusual day in London where it's sunny and warm, and at the moment warmer than Los Angeles. You know, when discussing the UK, I do think you kind of need to take a step back. This is a country and an economy that's had a tough number of years where growth has been sub-trend, inflation's been higher, and a lot of assets have traded at a discount.So maybe just to give some context, talk to us a little bit about the last couple of years in the UK and the challenges the economy has faced.Bruna Skarica: Indeed, Andrew, I do think it's important to take a step back to appreciate just the amount of supply side shocks the UK has seen in recent years. First, between 2016 and 2020, of course, the country had to navigate Brexit negotiations. The elevated uncertainty kept a lid on business CapEx. In 2020, of course, as the rest of the world, we saw the lockdown and the pandemic. What followed were supply chain disruptions, and then, the European energy shock in 2022. I do want to zoom in on this final point because in its scale, the natural gas price surge in the UK was twice more of a hit to growth compared to the 1970s oil price shock.We've also seen a fair share of volatile market moves, most notably around the mini budget in the autumn of 2022. On top of all of this, the Bank of England into these supply side shocks had to hike interest rates to cap the inflation surge. And they went to above 5 per cent and have recently been relatively slower in reducing policy restrictiveness than most of its peers.So, when you tally all these factors up, it's really no surprise that the UK has seen an exceptionally weak post COVID recovery.Andrew Sheets: And that's continued right into this year. You know, I remember a lot of conversations with global investors heading into 2025, and again, the sentiment around the UK was kind of downbeat. Growth was pretty soft. Inflation was still high. Because inflation was high, interest rates here were still quite high. And so, you really had this, you know, unattractive mix of weak growth, high inflation, tight monetary policy. And then you could throw onto that, this uncertainty around the U.S. and trade. And you had a Trump administration that was adopting a more adversarial policy towards trade and towards Europe, which the UK was getting caught up in.So, you know – again, did I miss any of the challenges that the UK was facing, entering this year?Bruna Skarica: No, I think that's a great summary. First, at the end of last year, of course, the government faced some pretty tough decisions in the October budget, and they hiked a tax – a payroll tax really – in order to balance the books, which created somewhat subdued sentiment around the labor market this year.Now the labor market has been soft in the UK at the start of this year, but it did hold up a little bit better perhaps than the expectations from the end of last year. At the start of the year, we also saw the energy inflation forecast rise. So, that led to a more cautious tone by the Bank of England in February and March, as you mentioned. And now on the trade front, although we have a small manufacturing sector, we are a small open economy, we're a big beta to global growth dynamics.I would just like to mention here that one of the real bright spots of the UK economy in recent years have been services exports to the U.S., the kind of high-value-added white-collar services exports, which rose between 2019 and 2023 by 50 per cent. Now with the growth in the U.S. slowing and obviously the Euro area as well, UK growth will be affected too this year. We actually took our growth forecast down by around 30 basis points in our latest GDP revisions.Andrew Sheets: But Bruna, we're here to talk about the future and you know, I do think it's fair to say that going forward we think this picture is starting to look better. So, let's jump right into that. Across a number of specific points. Why do we think the UK story could look better as you look ahead?Bruna Skarica: Absolutely. I mean, the last point that I mentioned, I do think I want to put it in context. The trade related revisions in the UK are still less than what our colleagues in the euro area and the U.S. had undertaken in recent months on the back of the U.S. trade policy shifts. So, the UK does look a little bit like a relative winner there.Second, we now think that inflation can come down faster than both the Bank of England and the market expected at the beginning of the year. Commodities prices will do a fair bit of heavy lifting this year, but we do think that next year in particular, domestically generated inflation could slow fairly sharply as wage growth sticks around 3 to 3.5 per cent, which we think is fairly inflation target consistent.This all means the Bank of England should be able to cut more than the markets expect. We anticipate 125 basis point worth of cuts between May and November, and we think the terminal rate could fall to as low as 2 ¾. So, we think the neutral rate in the UK is between 2.5 to 3.5 per cent, and we do think the market still has a bit of adjustment to do in the sense of the pricing of the terminal rate one and two years ahead.The third point around fiscal policy I think is quite interesting. Fiscal policy has been in great focus in the UK in recent years. We had a big fiscal event in October. We had another fiscal event just now in March. The borrowing increase was less than what the market expected. Deficit projections are such that we are expecting deficit to fall from around 4.8 per cent this year to 3 per cent over the course of the next three years, and for debt to GDP ratio to remain at around 100 per cent of GDP. I would perhaps contrast that with France where our economist is expecting the deficit to remain north of 5 per cent over the course of the next two years.Finally, an important point to make is that the UK government amid trade shifts in the U.S. is looking for a closer relationship with the EU, or rather a trade reset with the EU. EU remains our closest trading partner and in the aftermath of Brexit, the current government has an ambition to improve trading in food and goods; and also to ensure that the UK is part of the European Defense Program, which would allow UK defense companies to partake in the defense and security path that the European Union presented in recent weeks. There is a summit being held on May 19th, and obviously the trade and corporation agreement is coming up for revision in 2026.So, we do think those relations between UK and the EU could become somewhat closer over the course of this year and next.But now a question from me, which is, what does all this mean on the strategy side? UK assets have obviously been quite unloved in recent years. Do you think that's about to change?Andrew Sheets: So again, I think it's pretty interesting that markets are anticipatory, and I think markets are pretty smart here. So, you've already seen the British pound, the currency do quite well. This year it's up against the dollar. You've seen the UK stock market do quite well. It's up about 5 per cent this year, despite the S&P 500 being down quite significantly.So, you're already seeing, I think, some signs that investors are warming up to the UK and you know, I do think that if our expectations play out, that could continue. You know, UK stocks do tend to be concentrated and slower growing, less exciting sectors. But their valuations are also less demanding. You know, the U.S. Stock Index trades at about 21 times next year's earnings. The UK stock market trades a little bit under 13 times next year's earnings.And I also think it's really important that if the Bank of England does cut interest rates more than the market expects, which again, as you discussed, is one of our expectations here at Morgan Stanley, that could be pretty supportive for the UK bond market, which continues to offer pretty high yields.Bruna, thanks for joining me for this conversation. It's always great to catch up with you.Bruna Skarica: My pleasure, Andrew. Thank you for the invite.Andrew Sheets: And thanks for listening. If you enjoyed the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

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  8:14
• Can South Korea Afford To Grow Old?

  Our Chief Korea and Taiwan Economist Kathleen Oh discusses Korea's recent pension reform and its implications for the country's rapidly aging population.Read more insights from Morgan Stanley.----- Transcript -----Welcome to Thoughts on the Market. I’m Kathleen Oh, Morgan Stanley’s Chief Korea and Taiwan Economist. Today I’ll revisit Korea's demographic emergency and how the recent pension reform is trying to address it.It's Thursday, May 1st, at 4pm in Hong Kong.Some of you may remember that I came on the show last fall to talk about the crisis-level demographic challenges in Korea. Korea officially became a super-aged society at the end of 2024. This means that more than 20 per cent of the population is 65 or older.In the face of its rapidly aging population and a fertility rate that has hit rock bottom, Korea is taking decisive action finally. The national assembly recently passed a landmark pension reform bill to amend the National Pension Act. This measure marks the first major change to its pension system in 18 years. And it’s supposed to improve the pension fund's financial sustainability to prepare for a rapidly aging population that will only accelerate from here.The amendments include raising pension contribution rates and adjusting the income replacement ratio to 43 per cent. These changes aim to delay the depletion of the fund to 2064 to 2071, in an upside scenario. Without this reform, the fund would have been depleted by 2055, just 30 years later.This reform avoids having to sell the fund's financial assets by delaying depletion. It also assures pension-holders of the stability of future pension assets. And, last but not least, it increases the pension fund's capacity for financial investments, which could lead to higher returns.This is the first step towards making legislative, and therefore more structural changes to respond to the reality of a super-aged society. Moreover, it kicks off a sweeping reform agenda that includes the pension program, labor market, education system, and capital markets.It’s also notable because the center-left Democratic Party of Korea and the conservative People Power Party were able to show bipartisan support and a public consensus to reach a deal, especially during the recent tumultuous political events that took place in Korea.That said, the reform also has some potentially negative economic impacts. Higher pension contributions could squeeze households' disposable income, putting mild but additional downward pressure on aggregate consumption and savings. Especially considering that as people age, they tend to consume less – and this can lead to a structural slowdown in private consumption.Despite Korea's challenges with an aging population, we're cautiously optimistic about its future – especially because [of] the recent rebound in the country's fertility rate. After marking a drop every year since 2015, it rebounded to 0.75 in 2024. While still far below the ideal replacement ratio of 2.1, this rebound is a small but certainly a positive sign.Looking ahead, Korea's working population is expected to decrease by 50 per cent in the next 40 years unless the country ensures a dramatic rebound in the fertility rate to 1.0 or higher by 2030. In the meantime, we expect further adjustments to the pension reform bill, we expect further discussions around lifting of retirement age, along with the labor market reform next in line on the economic front. The Korean government will continue to execute on its demographic policy agenda.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.

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  4:32
• A Possible Roadmap for U.S. Tariff Policy

  Our analysts Michael Zezas and Rajeev Sibal unpack the significance of a little-discussed clause in the Trump administration’s tariff policy, which suggests investors should think less about countries and more about products.Read more insights from Morgan Stanley.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy.Rajeev Sibal: And I am Rajeev Sibal, Senior Global Economist.Michael Zezas: Today we look through the potential escalation and de-escalation of tariff rates and discuss what the lasting impact of higher tariffs will be for companies and the economy.It's Wednesday, April 30th at 11am in New York.Rajeev Sibal: And 4pm in London.Michael Zezas: Last week during a White House News conference, President Trump announced that tariffs on goods from China will come down substantially, but it won't be zero. And this was after U.S. Treasury Secretary Scott Bessent made comments about high tariffs against China being unsustainable, according to some news reports.Now, some of this has been walked back, and there's further discussion of challenging negotiations with China and potential escalations if those negotiations don't go well. Meanwhile, Canadian voters elected a Liberal government, led by Mark Carney yesterday. That federal election played out against the backdrop of the U.S. proposing higher tariffs on its northern neighbors. So, Rajeev, amidst all this noise, what seems clear is that tariff levels will end up higher than where we started before President Trump took office. Though we don't exactly know how high they will be. What is it that investors need to understand about the economic impacts of higher tariffs just generically?Rajeev Sibal: So yeah, we do view that tariffs are going to structurally be higher than they were before the Trump administration. This has been a baseline of our outlook since last year. Now I think the challenge is figuring out where they're going to settle as you've highlighted. We do think that peak tariff was probably a couple weeks ago, when we were at the max pain threshold, vis-a-vis China and the rest of the world. We've since seen the reciprocal tariffs move to 10 per cent for everyone but China.China's clearly higher than 60 per cent today, but we do think that over time the implied rate to China will start to graduate and come down. If you look at the electronics exemption for example, that's a big step in getting the average tariff rate out of China lower. So, we think we're on a journey. We think we were past peak tariff pain in terms of level. But over the next few months, it's going to take some time and negotiation to figure out where we settle. And we are still looking to kind of our baseline outlook, that had been defined some time ago of a 10 per cent baseline with an elevated level on China, if you will.Michael Zezas: So, I think this is an important point, that there's a lot of back and forth about tariff levels, which countries are going to be levied on, to what degree, and to what products. But at the end of the day, we think there'll be more tariffs than where we started.Rajeev, you have a view on where investors should focus, in terms of what tariffs are durable. And maybe at the end of the day it'll be less about countries and more about products. Can you talk us through that?Rajeev Sibal: You know, on April 2nd when the Trump administration released the fact sheet about tariffs and reciprocal tariffs, there was a small clause in there that I think the market did not pay enough attention to, and which is becoming front and center now.And in that clause, they identified that a number of tariffs related to Section 232 would be exempted from reciprocal tariffs. And the notion is that country tariffs would evolve or shift into sector tariffs over time. And in the note that we recently published, we highlighted some of the legal mechanisms that may be at play here. There's still a lot of uncertainty as to how things will settle down, but what we do know is that legally speaking, country tariffs are coming through IEEPA, which is the International Emergency Economic Powers Act; whereas section and sector tariffs are coming through Section 232; and some of the other section structures that exist in U.S. trade law.And so, the experience of 2018 leaned a lot more to these sections than it did to IEEPA. And that was a guiding, I guess, mechanism for us, as we thought about what was happening in the current tariff structure. And the fact that the White House included this carve out, if you will, for Section 232 tariffs in their April 2nd fact sheet was a big lead indicator for us that, over time, there would be an increased shift towards sectors.And, so for us, we think the market should be focusing more in that direction. As we think about how this evolves over time, now that we've not completely de-escalated, but brought a materially lower tariff level and everywhere in the world except for China. The big variability is probably going to be in the sector tariffs now going forward.Michael Zezas: So, what sectors do you think are particularly in focus here?Rajeev Sibal: So, on the April 2nd fact sheet that the White House provided to countries and to the market, they specifically identified steel, aluminum, autos and auto parts as already having Section 232 tariffs. And we know that's true because those investigations had started in a prior Trump administration. And so, kind of the framework was already in place for them to execute those tariffs.The guidance then suggested that copper, pharmaceuticals, semiconductors, and lumber would also potentially fall under Section 232 tariffs in the future. And then there's been a range of indications as to what might be in play, so to speak, for Section 232.I know pharmaceuticals is at the top of the list of many investors, as are semiconductors. So, this is our kind of sample list, but we're pretty certain that this will evolve over time. But that's where we're starting.Michael Zezas: Okay, so pharmaceutical, semiconductors, automobile, steel, aluminum. It's a pretty substantial list. So, if that's the sort of end game landscape here – relatively elevated China tariffs, and then all of these products specific tariffs – what does an investor need to know about a company's options in this world? Can companies just rewire their supply chains around all of this? And you know, ultimately there's some temporary price pain. But once things are rewired around this, that should dissipate. Or are the decisions more difficult than that and that there has to be some cost passed through to the consumer or to the companies themselves – because this is just too many tariffs in too many places?Rajeev Sibal: Yeah, so I think the latter of your question – the difficulty – is really where we need to be thinking about what's happening here. If you think about the bigger picture, and you go back to the note that we collaborated on earlier in the year called Supply Chain Strain, we highlighted the complexity of moving factors of production and the extreme levels of investment that have required to shift factors of production.So, companies, if they're going to move a factory from country A to country B, have to make sure that country B has the institutional framework, that it has the capital, it has the labor input, and this is a big, big decision. So, as a company you're not going to make that decision to shift your investment or reconstruct productive facilities in a new country – until you understand the cost benefit analysis. And in order to understand the cost benefit analysis, you really need to know what the sector-based Section 232 tariff looks like in the end.If we remember back in 2018, the government tried to implement a wide range of tariffs. On average, it took about 250 days for each investigation to be completed. And that's a long timeframe. And so, I think what we're going through now, apart from automobiles and steel and aluminum where that process has kind of already been done, and we kind of have the framework of the tariffs and the new sectors, companies are going to have to wait for this investigation to take place so that they understand what the tariff level is. Because the tariff level is going determine the risk of actually shifting productive facilities. Or if you just kind of absorb the cost because the tariff isn't at a high enough level that it incentivizes the shift.And so, these are the changes that I think remain an open question and will be the focus of companies over the next few months as their sectors are exposed to tariffs.Michael Zezas: Right. So, what I think I'm hearing then, and correct me if I'm wrong, is that some of the focus on the China tariffs or the country level specific tariffs in the headlines – about they're moving up, they're moving down – might mask that at the end of the day, we're still dealing with considerably higher tariffs on a broad enough array of products; that it will mean difficult choices for companies and/or higher costs. And so therefore markets are still going to have to price some of the economic challenges around that.Rajeev Sibal: Yeah, I think that's absolutely right. And we've seen the market try to price some of this stuff at a country level context. But it's been hard. And, you know, even the headline tariff rate in the U.S. is really hard to pin down for the simple reason that we don't know if the Mexican and Canadian trade into the U.S. is compliant or non-compliant, and how that gets counted in the current structure of the tariff regime. And so, as these questions remain outstanding, markets are going to be volatile, trying to figure out where the tariff level is. I think that uncertainty at a country level then shifts to the sector level as we go through these investigations that we've been highlighting.Autos is a great example. We finished the investigation. We've implemented a Section 232 tariff, and we still don't know what the implied auto tariff rate is because we don't know how many parts in a car are compliant within existing free trade agreements of the United States; and if they're compliant or not really determines what the implied tariff level is for the U.S. And until companies can decide and give forward guidance and understand what their margins look like, I think markets are going to be in this guessing game.Michael Zezas: Yeah, and that certainly syncs up with our fixed income strategy views. The idea that yield curves will continue to steepen to deal with the uncertainty about U.S. trade policy and demand for dollars, as a consequence. That equity markets might be moving sideways as perhaps we priced in some of the first order effects of tariffs, but not necessarily the second order, potentially non-linear effects on the broader global economy. And unfortunately, the lingering uncertainties that you talk about implementation, they're going to be with us for awhile.Rajeev Sibal: Yeah, I think that's really fair. And our economics outlook mirrors that as well.Michael Zezas: Well, Rajeev, thanks for joining us today to help us sort through all of thisRajeev Sibal: Mike, thanks for having me on the podcast.Michael Zezas: And to all of you, thanks for listening. If you found this podcast helpful, let us know and share Thoughts on the Market with a friend or colleague today.

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  10:56

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