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Investing.com -- Markets have been bloodied by the growing prospect of a global trade war, but Morgan Stanley (NYSE:MS) warns of further pain ahead as the knock-on effects of tariffs on the U.S. consumer and corporate America could deal another blow to the U.S. growth outlook.
"The effective U.S. tariff rate has skyrocketed from 3% at the start of the year to 22%, with tariffs on imports from China now approaching 60%," Morgan Stanley said in a report Friday. "While some first-order impacts may already be priced into markets, second-order effects—such as hits to consumer and corporate confidence—could push the S&P 500 below 5000."
Sectors most exposed to tariffs including consumer discretionary and retail, are particularly vulnerable amid likely struggles to pass on higher tariff-driven costs to consumers. This could lead to margin compression and weaker earnings growth.
Corporate hiring and capital spending could slow further, dragging down household incomes and consumption, they added.
The gloomy backdrop points to a cautious trading strategy, Morgan Stanley warns, citing preference for bonds over equities.
"The investment climate remains challenging," Morgan Stanley said, advising investors to favor defensive strategies and brace for continued volatility across asset classes.
While equities remain under pressure, Morgan Stanley also highlighted impacts across other asset classes. The analysts expect tariff-induced inflation to keep the Federal Reserve on hold, removing its previously anticipated June rate cut from forecasts.
Safe-haven assets, meanwhile, such as the Japanese yen are expected to outperform in defensive FX markets, while growth-sensitive commodities like oil face downside risks.
While the road to negotiation could help provide some relief from tariffs, the level of new levies will be higher than previously expected.
"Negotiation could result in relief from these new tariff levels, but that may not arrive quickly, and tariff levels would still be meaningfully higher than previously anticipated," the analysts said.