Markets have staged an incredible rally from the tariff-induced April lows, but as the final quarter of the year unfolds, Morgan Stanley warns that the lagged effects of tariffs remain "ahead of us, not behind," poised to weigh materially on growth, inflation, corporate margins, and labor demand.
Recent data revisions show that consumer spending and GDP are holding up better than feared, but Morgan Stanley cautions that such resilience may prove temporary as tariffs ramp up to near nominal levels in the mid-teens by year-end. So far, companies have largely absorbed tariff costs by trimming profits and labor expenses rather than passing them on to consumers. However, this is unlikely to last. "A continuation of nonfinancial corporate behavior in 2Q25 would weaken labor demand further and increase downside risks to inflation," the analysts wrote.
Retail sales, producer prices, and import data all point to accelerating tariff-related pressures. Core PCE inflation is expected to modestly top 3 percent, with goods most exposed to tariffs already showing price increases while services prices remain firm. Morgan Stanley highlights that new vehicle prices could face the steepest inflationary pressures, set to surge multiple percentage points by year-end. Meanwhile, sectors such as auto parts and home improvement may prove more resilient.
Household spending remains supported by wealth gains at the higher end, but growth in real labor income is approaching "stall speed," with weaker hiring and firmer inflation expected to dampen consumer momentum heading into year-end. While recession is not Morgan Stanley’s baseline, "the risk of recession is alive," given tariff-driven drags and a substantially slower labor market.
Among imported goods, new vehicle prices could face the steepest inflationary pressures by late 2025, rising multiple percentage points, though sectors like auto parts and home improvement might show more resilience. Investment and exports in other regions such as Europe and Asia also reflect tariff-related softness, with slowing manufacturing PMI data and export contractions hinting at global headwinds.
Morgan Stanley expects the Federal Reserve to continue its easing cycle with two more rate cuts this year and three in 2026, bringing the policy rate to 2.75-3%. However, the bank warns that stronger spending or persistent inflation could limit the extent of cuts.
Source :
https://www.investing.com/news/economy-news/as-markets-enter-q4-morgan-stanley-warns-tariffs-risks-are-ahead-of-behind-4269320
