Welcome to Thoughts on the market. I'm Michael Zesis, head of Public Policy and Municipal Strategy for Morgan Stanley.

Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets.

We're recording this on Tuesday, May 28th at 11 a.m. Eastern.

President Trump's just completed trip to Japan and the recent announced delay in EU auto tariffs

are examples of lessen trade tensions.

So why are investors still so concerned with US trade policy?

Because escalation with China is approaching a critical point.

If you ever study game theory, you might remember something called the Prisoner's

Dilemma.

Applied to the U.S. and China on trade, it means that compromising leaves both sides better

off, but it also means both sides perceive greater benefits for escalating

than to risk making an agreement on the others' terms.

That's what seems to be happening right now is the US and China, since May 5th, have outlined

key remaining differences on issues of

intellectual property, enforcement, and how quickly existing tariffs can be

removed. The benefits of cooperation only become easier to realize once the

downsides become apparent either through weaker economic data or falling markets.

And that's what should happen over time, especially if the next round of tariffs comes into play next month.

Those tariffs, on the remaining 300 billion or so of U.S. imports from China

largely fall on finished consumer goods. So the impact of prices, consumer behavior, and the broader economy should be more apparent than in previous rounds.

So that drives a key rule of thumb for investors.

You should act as if the next escalation will happen until markets price it in.

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