If the U.S. puts tariffs on the rest of China's imports, there could be especially dire consequences, Wilson said. Trump told reporters at the White House on Monday that he has not made the decision yet on whether to put tariffs on the additional $325 billion in Chinese goods.

Wilson, the bank's chief U.S. equity strategist, told clients in a note that higher U.S. tariffs on Chinese goods will become a headwind for corporate earnings as companies struggle to offset the negative effect of those levies on their bottom lines.

The U.S. economy could fall into a recession if the country's trade war keeps escalating, Morgan Stanley's Michael Wilson said Monday.

"Given other cost pressures and stubbornly low inflation, we are unconvinced that companies will generally be able to fully offset tariff costs through raising prices or through cost efficiencies elsewhere, meaning tariffs will press on margins," Wilson wrote. "In the case of 25% tariffs on all of China's exports to the US, we are inclined to think this has the potential to tip the US economy into recession given the cost issues companies are already dealing with."

Wilson's note came the same day that China hiked tariffs on $60 billion worth of U.S. products. China's levies mainly target U.S. agricultural goods like beef and peanuts.

The and Dow Jones Industrial Average posted their worst day since Jan. 3 while the Nasdaq Composite had its biggest one-day fall of 2019.

China's move came after the U.S. raise tariffs on $200 billion worth of Chinese goods to 25% from 10% last week. The tariff hike, which President Donald Trump had threatened on May 5, has led to a massive re-pricing of global trade expectations. Prior to last week, investors largely expected the two sides to strike a deal that would do away with tariffs. Both countries indicated they had made progress in trade negotiations.

Trump said in a tweet Monday that Chinese President Xi Jinping "had a great deal" lined up but then he "backed out."

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"With trade resolution now looking like a 'show me' story for US corporates and the market, lack of resolution will be a material potential drag on earnings growth that will be harder to mitigate than the market expects as other costs rise in tandem," Morgan Stanley's Wilson said. "While at some point a market "circuit breaker" may make concessions more likely on both sides, this path requires market stress and volatility precede de-escalation … and add to an already difficult earnings growth environment."

WATCH: U.S.-China negotiations still in an 'end game,' says Morgan Stanley