Our Global Head of Fixed Income Research and Public Policy Strategy explains why conflicting news on tariffs and government spending may point to a case for bonds.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today we’ll be discussing recent U.S. public policy headline noise and the signal within that for investors.

It’s Friday, February 28th, at 12:30 pm in New York.

For investors paying attention to events in Washington, D.C., the past few weeks have been disorienting. Tariff announcements have continued, but with shifting details on timing and magnitude. And Congress passed a bill to enable substantial spending cuts, but subsequent media reports made clear the votes to actually enact these cuts later this year may not be there.  

Our recent client conversations have revealed that investors’ confusion has reached new heights, and there’s little consensus, or conviction, about whether U.S. policy choices are set to help or hurt the economy and markets. 

Net-net, it's a lot of policy noise, and very little signal. That said, here’s what we think investors can anchor to. 

For all the headlines on potential new tariffs for China, Mexico, Canada and on products like copper, actual tariff actions have followed a graduated pace, in line with our base case of ‘fast announcement, slow implementation’ – where tariffs on China start and continue to climb, but tariffs on the rest of world move slowly and are more subject to negotiation. Tariffs on Mexico and Canada appear, in our view, likely to be pushed out once again given progress in negotiation on harmonizing trade policy and progress in reduced border crossings.  

On the other hand, tariffs on China, already raised an incremental 10 percent a few weeks back, seem likely to step up again as there are much bigger disagreements that the two nations don’t appear close to resolving. 

But even if tariffs move according to the pace that we expect, that doesn’t mean they come without cost. The U.S.’s goal is to bring more investment onshore, with an aim toward increasing goods production, thereby reducing trade deficits, securing important supply chains, and growing industrial jobs. The theory is that higher tariff barriers might incentivize more direct investment into the U.S., as companies build supply chains in the U.S. to avoid the higher tariff costs.  

But even if that theory plays out, there’s a cost to that transition. In a recent blue paper, my colleague Rajeev Sibal led a team through an analysis demonstrating that the next phase of supply chain realignment would be considerably costlier to companies, given the complexity of production that must be shifted. So either way, companies take on new costs – tariffs, CapEx, or both. That challenges corporate margins, and economic growth, at least for a time. And there’s plenty of execution risk along the way. 

So what’s an investor to do? Our cross asset and interest rate strategy teams think it's time to lean more heavily into bonds. Equity markets may do just fine here, with investors looking through these near term costs, but the risk of something going wrong with, for example, tariffs escalation or broader geopolitical conflict, may keep a ceiling on investors’ risk appetite. 

Conversely, a growth slowdown presents a clearer case for owning bonds, particularly since it wasn’t that long ago that better economic data helped the Treasury market price out most of the expected monetary policy cuts for 2025. 

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