Morgan Stanley shares a 3-part cocktail that could rescue stocks from alarming price swings

• Donald Trump's tariffs have caused historic stock market volatility, rivaling past financial crises.
• Morgan Stanley pointed out that the S&P 500 has been swinging between 5,000 and 5,500.
• The firm laid out three things that need to happen for the index to break out of that range.

Donald Trump's tariffs have sparked historic levels of volatility in the stock market.

The S&P 500 fell 11% in just two days recently, a drawdown rivaled only by the onset of the pandemic in 2020, the global financial crisis in 2008, and the Black Monday crash in 1987.

On the flip side, the index's 10% single-day gain last week was one of the biggest upward moves in history, and it's fresh off its best week since 2023.

In new research, Morgan Stanley noted that amid these wild swings, the S&P 500 has been oscillating between 5,000 and 5,500.

"The equity market will likely remain in a wide trading range with high volatility until we have more certainty on the depth of the growth slowdown and the timing of a recovery," Mike Wilson, the firm's chief investment officer, told clients in a Monday note.

He and his fellow strategists elaborated on that by highlighting three things that need to happen for the S&P 500 to break out above 5,500.

1. A more dovish Fed

The Federal Reserve is likely to keep interest rates unchanged for the year as it grapples with the potential for higher inflation from tariffs and an expected economic slowdown, economists at Morgan Stanley said.

A shift in Fed policy to cut interest rates aggressively could ultimately boost stock prices, though there would be some pain in the short term.

That's because a dovish move would likely require weak jobs data or stress in the credit markets.

"While both of these scenarios would likely be equity market negative initially, that adverse reaction function could be short lived if the Fed responds aggressively and a recession is not imminent," Wilson said.

The markets got a taste of a potential Fed put last week when the Boston Fed president, Susan Collins, told the Financial Times that the central bank is ready to help stabilize markets if stresses occur.

"We have had to deploy quite quickly, various tools" Collins told the Financial Times, referring to past interventions during periods of market instability. "We would absolutely be prepared to do that as needed."

2. A decline in 10-year Treasury yields

The 10-year Treasury yield has risen as much as 50 basis points since April 4 to 4.49%.

Worries of inflation stemming from the Trump tariffs and foreign investors selling their US bonds have put upside pressure on yields.

But if that were to reverse, it would be more than welcomed by the stock market.

"A drop in the 10-year yield back toward 4% would also be helpful for equities as long as it's not accompanied by recessionary growth data," Wilson said.

3. A larger trade deal with China

Trump has said he's looking to make trade deals.

If he can strike one with China, it would likely be a big upside surprise to the stock market.

"A larger trade deal with China that significantly reduces tariffs still in place at high rates is also not in the price in terms of an upside catalyst," Wilson said.

For its part, the Trump administration has expressed a willingness to strike a deal with China.

"The president has made it very clear he's open to a deal with China," the White House press secretary Karoline Leavitt said on Friday.

Perhaps an olive branch for a potential deal was the Trump administration's decision to exempt smartphones, semiconductors, and other consumer electronics from being subject to tariffs, at least temporarily.

Risks abound

While there is upside potential for stocks, there are still plenty of risks to consider.

Wilson said if the 10-year Treasury jumps above 5%, it could lead to a breakdown in the S&P 500, with the index likely to drop below 5,000 and retest its lows.

Earnings season is also a risk.

"On the downside, we think the main risk to equities is a further deterioration in earnings and/or corporate confidence that leads to a labor cycle," Wilson said.