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Investing.com -- President Trump’s big u-turn on reciprocal tariffs may have saved the economy from recession, but Morgan Stanley (NYSE:MS) economists warn that the existing levies are still significant enough to lock in slow growth and sticky inflation, preventing the Federal Reserve from cutting rates until at least March next year.
“The good news is that the de-escalation greatly reduces the risk of a hard stop in trade flows and, in turn, the risk of a near-term recession in the economy,” Morgan Stanley economists said in a recent note.
The administration’s decision to roll back some of the steepest tariffs have helped avert a sharper downturn, but the relief may be short-lived.
Despite the effective tariff rate falling from a peak of 26% to 13%, Morgan Stanley warns that “the détente virtually locks in a slow growth, sticky inflation environment as the base case for the US economy.”
The current tariff rate remains far above the roughly 2% level seen at the start of the year, and the administration has only paused the most punitive tariffs for 90 days, keeping policy uncertainty high.
The impact of tariffs are likely to show up in inflation data beginning in May, with annual rates of inflation projected to rise to 3.0–3.5% by year-end.
The economy, which has benefited from consumers and businesses racing to purchase goods ahead of the tariffs, is likely already feeling tariff-related pain. Morgan Stanley is tracking second-quarter GDP at just 1.6%, as consumer spending slows and tariff-related price pressures erode purchasing power.
“The bad news is that the détente virtually locks in a slow growth, sticky inflation environment,” the report said, pointing to elevated recession risks and persistent policy uncertainty.
This likely backdrop of slower growth and higher inflation isn’t the fertile breeding ground for Federal Reserve rate cuts.
“We retain our outlook for no Fed rate cuts in 2025 on account of inflation being further away from the Fed’s 2.0% target than employment is from maximum employment this year,” the economists said, adding that the Fed is likely to stay on the sidelines until at least March 2026.
While the immediate threat of a hard landing has faded, Morgan Stanley cautions that “recession risks remain elevated,” and that the current policy mix leaves the economy stuck in a low-growth, high-inflation trap, with little relief expected from the Fed this year.