Global Economic Outlook Faces Strain Amid US Tariffs and Slowdown
This past week, a comprehensive update was shared through a semi-annual collaborative review conducted within the Morgan Stanley Research department. This mid-year outlook brings together insights from both economics and strategy perspectives to map out expectations for the months ahead. The team has presented their baseline assumptions regarding the trajectory of the global and domestic economies. While the focus is on what is most likely to unfold, they have also acknowledged areas of potential miscalculation, especially in light of prevailing uncertainty tied to policy shifts. Because the policy landscape is so unsettled, making a specific prediction becomes less useful. Instead, the goal is to offer a flexible structure to understand the wide range of possible scenarios.
One of the most significant elements shaping this year's outlook is the recent imposition of tariffs by the United States, a development considered to be a major disruptor. Despite a general sense among clients that some of the earlier volatility is diminishing, the presence of these trade barriers remains. In fact, they are now expected to stay considerably elevated compared to where they were earlier in the year. This view is reinforced by recent developments, including sharp increases in tariffs on goods from Europe, which make it clear that trade tensions are far from resolved. What is more concerning is that the full consequences of existing tariffs have not yet appeared in concrete economic data, suggesting that additional slowdowns could be on the horizon.
Global economic growth is projected to decline significantly from last year into this year. The drop is expected to be more pronounced in the United States than in the broader global economy. However, the risks are not evenly distributed. Even with current signs of trade conflict reduction or a complete rollback of tariffs, the chance of a meaningful rebound in growth appears limited. On the other hand, if trade tensions were to increase again, the threat of an economic downturn both in the US and globally becomes very real.
The impact of these trade measures varies depending on the region. Since the United States is the one enacting these tariffs, its economy experiences a specific pattern where growth slows while inflation rises. Other parts of the world face different challenges. Slower growth in the US translates to weaker demand for goods and services globally, which typically results in sluggish growth and subdued inflation elsewhere. For example, growth in the euro area is not expected to rise significantly through the forecast period, with inflation falling below the levels the European Central Bank aims to maintain. In China, the economy could lose substantial momentum next year compared to the previous one, and concerns about falling prices continue to loom. Japan, although affected through weaker exports, still manages to maintain a steady nominal economic performance thanks to strong domestic consumption. Meanwhile, India emerges as the most robust among the countries studied, continuing to expand at a healthy pace and with expectations of even stronger growth in the future.
Monetary policies are expected to reflect these economic patterns. In the United States, core inflation is likely to pick up again later this year. As a result, the Federal Reserve is projected to hold its policy stance steady throughout the entire year, only beginning to reduce interest rates once inflation shows clear signs of easing, likely in the following year. The idea here is that the Fed will only shift its focus from controlling inflation to supporting employment and economic activity when the balance of risks changes. In contrast, the European Central Bank is in a position to lower rates this year because inflation is expected to remain on a downward path. This gives the bank room to support growth even if the value of the euro rises. In Japan, the central bank had started to raise rates, but it is believed that these increases are now ending as circumstances evolve.
In light of these global developments, there is a growing curiosity about whether the US continues to hold its position as a dependable market, particularly as growth slows, yields on government bonds rise occasionally, and stock prices fluctuate. At a recent summit held in Japan, this question was raised frequently.
Despite the challenges, the belief is that US financial assets still maintain their appeal for now. Even though some investors around the world are rethinking how they distribute their investments, there is no convincing evidence that they are pulling away from US markets in a significant way. The era of the US consistently outperforming other markets might be coming to an end, but for the time being, there do not appear to be compelling alternatives for large-scale global investments. Nonetheless, recent developments, such as another downgrade in the rating of US government debt, serve as a reminder that conditions can change. As these changes take place, investors will need to reassess what constitutes a fair value for assets, and they must stay prepared for further shifts in the market environment.