Risks linger despite pause on tariffs

Markets staged a breathtaking recovery last week after the White House announced a 90-day pause on its planned reciprocal tariffs, with China as an exception. Although the rally was heartening, with the S&P 500 bouncing back to 5363 on April 11 after a low of 4983 on April 8, Morgan Stanley’s Global Investment Committee is not ready to declare that the coast is clear. Rather, investors should look beyond the tariff headlines to understand why the White House changed course, and, importantly, what it means for markets and the economy going forward.

Despite all the news and the massive market movements, not much has actually changed since the initial tariffs announcement on April 2. The revised plan lowers the effective blended tariff rate from around 22% to 17%, but that’s still a dramatic rise from the current rate of 3% – an increase that’s likely to weigh on economic growth, corporate margins, and consumer behavior.

First of all, the probability of recession, while lower than before the tariff pause, is still about one-in-three. Morgan Stanley Research’s US economists again reduced their 2025 and 2026 gross domestic product (GDP) growth estimates, to 0.6% and 0.5%, respectively.

Increased tariffs on China, in particular, are apt to dent US growth. Independent analysts at Pantheon Macroeconomics estimate that China’s roughly 7% share of US exports will likely decline to zero, potentially shaving around 35 basis points from US GDP growth.

Meanwhile, corporate earnings are likely to fall due to lower global demand and weaker profit margins. Furthermore, according to the Budget Lab at Yale, the household burden of tariffs will be $4,700 per year on average.

While equity market turmoil grabbed many investors’ attention, it was actually turbulence in the Treasury market that forced the Trump administration’s hand in delaying most reciprocal tariffs. Bond volatility soared, Treasury yields rose sharply, and the additional yield that investors demand for owning riskier bonds, known as “credit spreads,” widened. Such turmoil may be signaling potential risks beyond recession and inflation. Consider that:

• Higher long-term Treasury rates present a threat of higher borrowing costs not only for businesses but also for the US Treasury. With the Treasury scheduled to refinance more than $10 trillion in US debt this year, soaring rates make refinancing that debt more expensive. With the US budget deficit already outsized, higher rates and, thus, higher interest expenses may limit what Washington can do in the federal budget. That likely includes how ambitious US lawmakers can afford to be with proposed tax cuts.
• Shifting trade-war dynamics could affect the flow of capital into the US, which could lead to weaker foreign demand for Treasuries and more currency volatility. In particular, China holds roughly one-sixth of foreign-owned US Treasuries. A sharp drop in Treasury demand from that country, amid escalating trade tensions, would likely drive rates higher, further increasing borrowing costs.
• There is growing investor concern that the administration won’t make enough progress on US debt and deficit reduction, making it difficult to deliver economically stimulative tax cuts that go beyond a mere extension of the existing Tax Cut and Jobs Act.

Investors should expect volatility to persist as tariff policy continues to evolve. Avoid knee-jerk reactions to headlines. Instead, stay diversified and balanced in your portfolio, with a focus on your longer-term financial goals and strategic asset allocation. Consider adding excess reserves to short-term fixed income while boosting exposure to real assets, such as commodities.

Long-term investors can consider 5100-5500 a defensible range for adding exposure to the traditional “cap-weighted” S&P 500 (in which the largest stocks have the biggest impact on performance). That said, the Global Investment Committee still prefers the “equal-weighted” version of the index (which allocates the same amount to each stock), as the large technology companies that comprise a significant piece of the cap-weighted index are exposed to tariff risks.

The source of this article, “Risks Linger Despite Pause on Tariffs,” was originally published by Morgan Stanley Wealth Management on April 15, 2025.

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