The Hidden Toll of Tariffs

Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research. And I'm joined by Mayank Fatki, a member of my global economics team. And today, we're going to talk about tariffs. I bet that was a surprise. It's Thursday, April 23rd at 10 a.m. in New York. I have to say, for the past couple of months, the focus on energy markets, energy supply, energy prices, that has dominated everything that we've been talking to clients about around the world. And so everyone would be forgiven if they had forgotten that we were talking about tariffs much the same way nonstop last year. Now, tariffs kind of seem like an afterthought, but part of the stated motivation for tariffs when they were imposed was to boost reshoring. That is to have more production of goods in the United States that had been imported. So tariffs still matter. They matter for CapEx in that regard. They matter for domestic production. And because of all of that, presumably, they matter for markets and for the Federal Reserve. But for the narrow question of reshoring, the data so far, I would argue, suggests that there's been very little net effect. There will be more tariff news arriving in coming months. So Mayank, I'm going to pull you into this conversation because you have been one of the key people on the team doing a lot of the analysis and the data work on tariffs, trade, and reshoring. So could you tell us a little bit about what's been happening to the effective tariff rate for the United States recently and where we think that likely to go Tariff levels have declined steadily in recent months falling to 8 as of February with the decline having accelerated after the Supreme Court ruling The decision on AEPA forced a shift in underlying tariff authorities with country-level AEPA tariffs temporarily reconstituted under Section 122. We have long argued, even before the 2025 tariffs, that the legal basis for durable tariffs would need to be anchored in Section 232 and Section 301-based authorities rather than in IEPA. The current Section 122 tariffs are due to expire on the 24th of July, and after that, we expect more durable authorities to kick in. The shifts that we will see as IEPA tariffs are replaced by new Section 301 and 232 tariffs means that there will be some differences, but from a macro perspective, we expect the level to be roughly similar to where it stood at the end of 2025, an aggregate effective rate of around 10%. Two sets of Section 301 investigations were announced by the administration in March, covering virtually all major trading partners. These investigations are likely to run on a faster timeline than prior efforts. Those took around nine months. The comments were requested by the 15th of April, with hearings scheduled for early May. We're inclined to expect completed Section 301 investigations over the summer, while Section 232 tariffs will likely arrive in waves as sector-based investigations proceed. Got it. Okay, so I'm going to summarize that to say tariffs are not going away. Tariffs are here. In the aggregate, for macroeconomists like us, probably about the same level it's been. But that escapes the question about the individual industries and it brings us right back to this question of reshoring Is that what going to happen And so when I think about it we do have all these negotiations, but the reshoring question forces you to wonder about manufacturing, manufacturing growth, and with it, CapEx. And like I said at the top, it's non-AI CapEx that's really on the soft side of things. So you've spent a lot of time looking at the data. I would say one industry that tends to stand out in all these conversations is steel. So if we look at what's happened with the steel industry, with tariffs, with changes in imports and that sort of things, what's happened? Do we see clear evidence that there's this big reshoring push? The case of steel is certainly very interesting. It helps frame why tariff uncertainty matters, and the supply chain for steel is relatively compact, which makes it easier to observe how the sector responds to tariffs. Domestic production has risen as imports have fallen, consistent with the idea of reshoring. But when we look at the total supply of steel to the domestic economy, it hasn't risen. More importantly, U.S. steel prices have materially diverged from global peers, and the risk of more aggressive sector tariffs across the economy, in our view, is higher prices, an outcome which is consistent with our expectations from a year ago and with economic theory. As an economist, I'm always happy when the reality matches what I was expecting in theory, so that's super helpful. Now, that is one specific industry, and I know that you have spent a bunch of time looking at the data across industries. The point that you made, though, about the higher prices, the higher domestic prices for steel means to me as an economist that we have to try to maybe separate out the effects of the nominal versus the real which is to say if we measuring how much output there is how much of that increase is coming from just prices going up versus how much is coming from total quantities. So if I asked you, when you look across industries, when you look at the data, what evidence do you see in terms of lots of reshoring, that is to say a diversion of trade, a reduction of imports, and with it an increase in domestic production? Is that there broadly in the data? When we look at production and imports across industries and goods and identify the industries both with and without reduced imports, we see that the increase in domestic production has come largely in nominal terms, which means that the price has risen, but very little of that increase is actually higher output. The evidence for meaningful reshoring here is quite limited. All right. So that's super helpful to me because when I think about the implications of tariffs, The economist in me says it reduces the overall productive capacity of the economy. It raises costs for the economy. The counterargument has been we're going to make more in the United States and that's going to boost the U.S. economy. As far as I can tell, when we look at the data themselves, there's not a lot of evidence for the upside, but there is clear evidence that we're raising costs for the U.S. economy. All right. Well, Mayank, thank you for joining me. And thank you to the listeners. 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