U.S. tariffs have had limited impact so far on inflation and corporate earnings. Our Head of Corporate Credit Research Andrew Sheets explains why – and when – that might change.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today I'm going to talk about why tariffs are showing up everywhere – but the data; and why we think this changes this quarter.

It's Wednesday, July 16th at 2pm in London.

Investors have faced tariff headlines since at least February. The fact that it's now mid-July and markets are still grinding higher is driving some understandable skepticism that they're going to have their promised impact. Indeed, we imagine that maybe more of one of you is groaning and saying, ‘What? Another tariff episode?’

But we do think this theme remains important for markets. And above all, it's a factor we think is going to hit very soon. We think it's kind of now – the third quarter – when the promised impact of tariffs on economic data and earnings really start to come through.

My colleague Jenna Giannelli and I discussed some of the reasons why, on last week's episode focused on the retail sector. But what I want to do next is give a little bit of that a broader context.

Where I want to start is that it's really about tariff impact picking up right about now. The inflation readings that we got earlier this week started to show US core inflation picking up again, driven by more tariff sensitive sectors. And while second quarter earnings that are being reported right about now, we think will generally be fine, and maybe even a bit better than expected; the third quarter earnings that are going to be generated over the next several months, we think those are more at risk from tariff related impact. And again, this could be especially pronounced in the consumer and retail sector.

So why have tariffs not mattered so much so far, and why would that change very soon? The first factor is that tariff rates are increasing rapidly. They've moved up quickly to a historically high 9 percent as of today; even with all of the pauses and delays. And recently announced actions by the US administration over just the last couple of weeks could effectively double this rate again -- from 9 percent to somewhere between 15 to 20 percent.

A second reason why this is picking up now is that tariff collections are picking up now. US Customs collected over $26 billion in tariffs in June, which annualizes out to about 1 percent of GDP, a very large number. These collections were not nearly as high just three months ago.

Third, tariffs have seen pauses and delayed starts, which would delay the impact. And tariffs also exempted goods that were in transit, which can be significant from goods coming from Europe or Asia; again, a factor that would delay the impact. But these delays are starting to come to fruition as those higher tariff collections and higher tariff rates would suggest.

And finally, companies did see tariffs coming and tried to mitigate them. They ordered a lot of inventory ahead of tariff rates coming into effect. But by the third quarter, we think they've sold a lot of that inventory, meaning they no longer get the benefit. Companies ordered a lot of socks before tariffs went into effect. But by the third quarter and those third quarter earnings, we think they will have sold them all. And the new socks they're ordering, well, they come with a higher cost of goods sold.

In short, we think it's reasonable to expect that the bulk of the impact of tariffs and economic and earnings data still lies ahead, especially in this quarter – the third quarter of 2025. We continue to think that it's probably in August and September rather than June-July, where the market will care more about these challenges as core inflation data continues to pick up.

For credit, this leaves us with an up in quality bias, especially as we move through that August to September period. And as Jenna and I discussed last week, we are especially cautious on the retail credit sector, which we think is more exposed to these various factors converging in the third quarter.

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen; and also tell a friend or colleague about us today.

Stocks hold steady as tariff uncertainty continues. Our CIO and Chief U.S. Equity Strategist Mike Wilson explains how policy deferrals, earnings resilience and forward guidance are driving the market.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing why stocks remain so resilient.

It's Monday, July 14th at 11:30am in New York.

So, let’s get after it.

Why has the equity market been resilient in the face of new tariff announcements? Well first, the import cost exposure for S&P 500 industries is more limited given the deferrals and exemptions still in place like the USMCA compliant imports from Mexico. Second, the higher tariff rates recently announced on several trading partners are generally not perceived to be the final rates as negotiations progress. I continue to believe these tariffs will ultimately end up looking like a 10 percent consumption tax on imports that generate significant revenue for the Treasury. And finally, many companies pre-stocked inventory before the tariffs were levied and so the higher priced goods have not yet flowed through the cost of goods sold.

Furthermore, with the market’s tariffs concerns having peaked in early April, the market is looking forward and focused on the data it can measure. On that score, the dramatic v-shaped rebound in earnings revisions breadth for the S&P 500 has been a fundamental tailwind that justifies the equity rally since April in the face of continued trade and macro uncertainty. This gauge is one of our favorites for predicting equity prices and it troughed at -25 percent in mid-April. It’s now at +3 percent. The sectors with the most positive earnings revisions breadth relative to the S&P 500 are Financials, Industrials and Software — three sectors we continue to recommend due to this dynamic.

The other more recent development helping to support equities is the passage of the One Big Beautiful Bill. While this Bill does not provide incremental fiscal spending to support the economy or lower the statutory tax rate, it does lower the cash earnings tax rates for companies that spend heavily on both R&D and Capital Goods.

Our Global Tax Team believes we could see cash tax rates fall from 20 percent today back toward the 13 percent level that existed before some of these benefits from the Tax Cuts and Jobs Act that expired in 2022. This benefit is also likely to jump start what has been an anemic capital spending cycle for corporate America, which could drive both higher GDP and revenue growth for the companies that provide the type of equipment that falls under this category of spending.

Meanwhile, the Foreign-Derived Intangible Income is a tax incentive that benefits U.S. companies earning income from foreign markets. It was designed to encourage companies to keep their intellectual property in the U.S. rather than moving it to countries with lower tax rates. This deduction was scheduled to decrease in 2026, which would have raised the effective tax rate by approximately 3 percent. That risk has been eliminated in the Big Beautiful Bill.

Finally, the Digital Service Tax imposed on online companies that operate overseas may be reduced. Late last month, Canada announced that it would rescind its Digital Service Tax on the U.S. in anticipation of a mutually beneficial comprehensive trade arrangement with the U.S. This would be a major windfall for online companies and some see the potential for more countries, particularly in Europe, to follow Canada’s lead as trade negotiations with the U.S. continue.

Bottom line, while uncertainty around tariffs remains high, there are many other positive drivers for earnings growth over the next year that could more than offset any headwinds from these policies. This suggests the recent rally in stocks is justified and that investors may not be as complacent as some are fearing.

Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!