But with the start of the final quarter of the year, Morgan Stanley warns that the delayed effects of tariffs remain "ahead of us, not behind us," and are poised to significantly impact growth, inflation, corporate margins, and labor demand.

Recent data revisions show that consumer spending and GDP are holding up better than feared, but Morgan Stanley cautions that this resilience may be temporary, as tariffs are expected to rise to nominal levels of around 10-20% by the end of the year. So far, companies have largely absorbed tariff costs by reducing profits and labor expenses rather than passing them on to consumers. However, this is unlikely to last long. "Continued behavior by non-financial corporations in the second quarter of 2025 will further weaken labor demand and increase downside risks to inflation," the analysts wrote.

Data on retail sales, producer prices, and imports indicate that tariff-related pressures are accelerating. PCE core inflation is expected to slightly exceed 3 percent, with goods that are most affected by tariffs already showing price increases, while service prices remain stable. Morgan Stanley emphasizes that new car prices may face the most significant inflationary pressures, with prices expected to rise by several percentage points by the end of the year. Meanwhile, sectors such as auto parts and household goods may be more resilient.

Household spending continues to be supported by rising wealth in the upper segment, but real labor income growth is approaching "stall speed," with weaker hiring and firmer inflation expected to dampen consumer momentum by the end of the year. While a recession is not Morgan Stanley's baseline scenario, "the risk of a recession is alive" due to a tariff-driven slowdown and a substantially slower labor market.

Among imported goods, new car prices could face the strongest inflationary pressures by the end of 2025, rising by several percentage points, although sectors such as auto parts and home goods could show greater resilience. Investments and exports in other regions, such as Europe and Asia, also reflect the weakness associated with tariffs, while slowing PMI data in manufacturing and declining exports point to global headwinds.

Morgan Stanley expects the Federal Reserve to continue its easing cycle with two more rate cuts this year and three in 2026, bringing the rate down to 2.75-3%. However, the bank warns that stronger spending or persistent inflation could limit the extent of the cuts.