Thoughts on the Market

Our Chief Europe Equity Strategist explains why she is forecasting a 23 percent total return for European equities over the next year.

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Welcome to Thoughts on the Market. I’m Marina Zavolock, Morgan Stanley’s Chief European Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why our mid-year outlook extends our bullish view on European equities.

It’s Tuesday, May 28, at 10am in London.

We have recently updated our outlook for the year ahead, maintaining our bullish view on European equities as we fully incorporate and roll forward our mid-1990s “soft landing” playbook. Like today, the mid-1990's was a period where markets focused on rates, inflation, and related data above anything else. The US and Europe saw soft and “softish” landings, the Fed’s cutting cycle was slower than investors initially expected, and there was an undercurrent of technological innovation. European equities, in particular, are following the mid-1990s path closely, and that means both a mid-cycle extension and a strong market set-up.

We have high conviction in our constructive European equities view and have recently raised our one year forward MSCI Europe Index target to 2,500 – 18 percent potential upside. This brings potential total return upside – if we incorporate dividends and buybacks – to 23 percent.

So why do we remain bullish? Over the second half of this year in particular we anticipate European equities ongoing re-rating is likely to combine with an emerging European equities earnings recovery. We’ve just come out of one of the strongest earnings seasons Europe has had in several quarters and we anticipate this is only the beginning. Our earnings model projects 7.5 percent earnings growth by year end for MSCI Europe, which is almost double consensus estimates. On top of this, we think the market underappreciates a number of significant thematic tailwinds that benefit European equities. These include rising corporate confidence, an M&A cycle recovery that is leading the global trend, an imminent start to rate cuts, high and rising capital distributions including buybacks, and underappreciated AI diffusion.

In terms of our sector preferences, structurally, we continue to prefer Europe’s quality growth sectors. These include Software, Aerospace & Defense, Pharma, and Semiconductors, along with the Banks sector.

Shorter-term, we also believe a recovery in bond yield-sensitive stocks has begun, which is expected at this stage in our mid-1990s playbook. We expect this rally to be tactical and bumpy but ultimately more powerful than a similar rotation that occurred around the Fed pivot late last year. We recently upgraded Building & Construction to overweight to play this rotation.

Although we believe European equities are in the sweet spot over the second half of 2024, we expect the bar for continued performance to become tougher by the time we get into first half of 2025. Also, our bear case incorporates rising geopolitical risks and lower-than-expected economic growth – the latter in line with our economists' bear case. A US election scenario that would bring a change in the status quo is also a risk for European equities, albeit it’s far more idiosyncratic than broad-based according to our in-depth analysis.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Head of Corporate Credit Research explains why moderate economic growth offers opportunities in credit markets – if investors choose carefully.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley, along with my colleagues, bring you a variety of perspectives Today, I'll be talking about our outlook for credit markets over the next 12 months.

It's Friday, May 24th, at 9 a. m. in New York. Morgan Stanley's global economic and strategy teams have recently published our mid year outlook. Twice a year, all of us get together to take a step back, debating what we think the outlook could look like over the 12 months ahead. For credit, we think that backdrop still looks pretty good.

Corporate credit, in representing lending to companies, is an asset class that loves moderation and hates extremes. An economy that's too weak raises the risk that companies fail, and has been consistently bad for returns. But an economy that's too strong also causes challenges, as companies take more risks, the rewards of which often go to stockholders, not their lenders.

The good news for credit is that Morgan Stanley's latest economic forecasts are absolutely full of moderation for economic growth. We see the U.S. growing at about 2 percent this year and next and Europe growing at about 1%. Right in that temperate zone, the credit usually finds optimal.

We see inflation falling, with core inflation back to 2 percent in the U. S. and Europe over the next 12 months. And monetary policy should also moderate, with the Federal Reserve, European Central Bank, and the Bank of England All lowering interest rates as this inflation comes down.

For credit, forecasts that expect moderate growth, moderating inflation, and moderating interest rates are exactly that down the fairway outcome that we think markets generally like. The challenge, of course, is that spreads have narrowed and lower risk premiums are discounting a lot of good news. So how do investors navigate richer valuations within what we think is still a very supportive economic backdrop?

One thing we continue to like is leveraged loans, where yields and spreads we think are more attractive. In the U. S., yields on loans are still north of 9%. We like short dated investment grade bonds, which we think offer a good mix of income and stability, and also happen to correspond to the maturity range that our interest rate colleagues expect yields to see the largest decline.

That should help total returns. And in Europe, we don't think spreads are particularly tight. And that should be further supported by relatively upbeat views on the European stock market from our equity strategies. Morgan Stanley's macroeconomic backdrop, which is full of moderation, is supportive for credit.

Tighter valuations are a challenge, but given this moderate backdrop, we think they can stay expensive. We still think there are good opportunities within credit, but investors will have to pick their spots. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen, and share thoughts on the market with a friend or colleague today.

With cooling inflation and an expected drop for mortgage rates, will more affordable housing lead to a big spike in sales? Our Co-Heads of Securitized Product Research take stock of the US housing market. 

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Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.

James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley.

Jay Bacow: And on this episode of the podcast, we'll discuss our outlook for mortgage rates and the housing market over the next 12 months.

It's Thursday, May 23rd, at 1pm in New York.

James Egan: Jay, I want to talk about mortgage rates. From November through January, mortgage rates decreased over 120 basis points. But then from February to May, they've given back more than half of that decline. Where are mortgage rates headed from here?

Jay Bacow: So, day to day, week to week, it's hard to have a lot of conviction, a lot of things can happen. But, over the next 12 months, we think mortgage rates are coming down. We estimate that by summer 2025, the 30-year fixed rate mortgage will be roughly 6.25 per cent.

James Egan: Alright, that is a significant amount lower than about 7 per cent where we are right now. And that's good news for affordability in the US housing market. What gets us there?

Jay Bacow: We think inflation is going to cool, and our economists are forecasting that the Fed is going to cut their policy rate by 75 basis points this year and 100 basis points next year. In fact, our economists are forecasting eight of the G10 central banks to cut rates next year.

Now, mortgage rates are 30 year fixed rate products, so they're based more on where the longer end of the treasury curve is than the front end. But our rate strategists think ten year notes are going to rally to 375 by next summer.

When you combine all of that with our expectation for secondary mortgage rates to tighten versus treasuries, that's how we end up with that forecast for the primary rate to rally.

James Egan: All right, I want to dig in there. I really like how you highlighted the secondary mortgage rates tightening versus treasuries. One thing I know that we've both gotten a lot of questions on over the course of the past year plus is how wide mortgages are trading versus treasuries right now. So, what do you think drives that tightening basis?

Jay Bacow: There’s a lot of factors -- but in end, two of them that are always going to drive things are supply and demand. One of the interesting things is that while housing activity has picked up, we're near the decade high in the percentage of homes that are bought with all cash, which means that the supply of mortgages to the market is actually not that high.

On the demand front, we think you're going to get demand from a broad spread of investors. We think there's been some money manager supported inflows into the mortgage market. We think that as the Fed cuts rates and you get the Basel III endgame resolution, domestic banks are going to come back to the market as they get more regulatory clarity.

And then also as the Fed cuts rates, that means that FX (foreign exchange) hedging costs for overseas investors will be improved and so you think Japanese life insurance companies can go back to the market and we think there's going to be continued demand from Chinese commercial banks. But, if you get all of this support, then as mortgage rates come down, that should be good news on the affordability front in the housing market, right Jim?

James Egan: Exactly. When we combine that decrease in mortgage rates with what our US economics team is saying will be about mid-single digit growth in nominal incomes, we get an improvement in affordability over the next 12 months that we've only seen a handful of times over the past 30 years.

Jay Bacow: Now this six and a quarter forecast is certainly good news versus spot rates. It's almost two per cent below the peaks we saw last year, but I don't really think it solves the lock-in effect that we've discussed on this podcast previously.

Close to 80 per cent of homeowners have a mortgage rate below 5 per cent. So, they're still out of the money versus our expectations for our mortgage rates going next year.

James Egan: Right, and we think that's a very important point. You made the point earlier about thinking about supply and demand with respect to mortgage rates versus treasuries, and we're going to talk about it here in the housing market. We have to think about affordability improvement in terms of both that supply and demand piece.

If we look back towards the start of this year, I'd say that demand increased a little bit faster, a little bit stronger than we thought. Typically, when you see sharp improvements in affordability, it doesn't always lead to immediate increases in sales volumes. However, what we saw from November to January seemed to be a little bit quicker to stir animal spirits, perhaps because of how healthy this improvement in affordability was. Home prices were still climbing. Mortgage rates weren't even coming down because the Fed was cutting; it was because of market expectations for future fed cuts in a soft landing environment. But on the supply side, while we expect for sale listing volumes to increase as rates come down, they aren't going to race higher because of that lock-in dynamic that you just described.

Jay Bacow: So, Jim, you think more people will list their homes; but what will actually happen to sales volumes? Will people buy them?

James Egan: Right. So, I think we have to delineate between existing home sales and new home sales here. Yes, we think existing listings are going to increase on the margins. New home inventory has already increased.

Historically, new homes make up about 10 to 20 per cent of the for-sale inventory on a monthly basis. Right now, they're between 30 and 35 per cent, and that's been the case for a little while. So, when we think about our forecasts for sales volumes, we're confident that new home sales will increase more than existing home sales. And that that growth in new home sales will spur single unit starts to increase more than both of them. 

Our specific spot forecasts, 10 per cent growth in new home sales, 5 per cent growth in existing home sales, with single unit starts edging out a double digit return of about 15 per cent growth. 

Jay Bacow: Do you have specific spot forecasts for home prices as well? 

James Egan: We do. As supply increases, the pace of home price growth should slow from where it is right now. It's been accelerating for the past several months, but the absolute level of supply is still pretty tight. We're at 3.8 months of supply as we're recording this podcast. Any reading below 6 is really associated with home price growth, not just today, but at least over the course of the next 6 months -- and we're well below 6 months of inventory.

Right now, home prices are growing at about 6.5 per cent. We think they're growing to slow to about 2 per cent by the end of 2024, before accelerating to 3 per cent in 2025. So, while growing inventory leads to deceleration, tight inventory keeps home price appreciation positive.

Jay Bacow: Alright so, home sale activity is going to pick up. It's going to be led by starts, which we think will be up 15 percent and more new home sales than existing home sales. There’s new home sales up 10 per cent. Home prices we now think will end the year positive; up 2 per cent in 2024 and up 3 per cent in 2025.

Jim, always a pleasure talking.

James Egan: Great speaking with you, Jay.

Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Why is the US economy poised for a strong second half of the year, despite slowing GDP growth? Our Chief US Economist points to population growth, housing demand and anticipated Fed rate cuts. 

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Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief US Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our mid-year outlook for the US economy. 

As we near the midpoint of this year, we refresh our outlook for the second half of the year. In our base case, the US economy remains strong, but US GDP growth is slowing, and slowing from 3.1 percent on a fourth quarter over fourth quarter basis last year, to 2.1 percent this year and in 2025.

Okay, so what's behind the continued strength? Well, it's something we've been intensely following this year. Faster immigration and population growth will continue to expand the labor supply and support economic activity, and all without increasing inflationary pressures. So, whereas the mid-pandemic labor market was characterized by persistent shortage of labor, the supply of labor is now increasing, and we think will outstrip demand this year.

This will drive the unemployment rate higher, which we expect will end this year half a point above 2023 at 4.2 per cent and rise further to 4.5 per cent in 2025. And wage gains should moderate further as the unemployment rate rises. We think consumer activity will continue to slow this year and into 2025 as that cooling labor market weighs on growth in real disposable income and elevated interest rates keep borrowing costs high.

Tight lending standards also limit credit availability. That said, we do think lower rates are on the horizon, and this should spur a pickup in housing demand and goods spending around the middle of next year. In fact, after substantial reflation numbers in the first quarter of 2024, we expect lower inflation numbers ahead. We've already seen that in the April data, as rents, goods, and services prices decelerate. 

The Fed has held the policy rate steady at a range of 5.25 to 5.5 per cent since July 2023, and we expect it will deliver the first quarter point cut in September this year. In total, we expect three quarter point cuts this year, and four more by the middle of next year, which lowers the policy rate to around 4.5 per cent in the fourth quarter this year to about 3.5 per cent in the fourth quarter of 2025. But even before rate cuts, the Fed has announced it will start phasing out Quantitative Tightening, or QT, in June. We expect QT to end around March 2025, when the Fed's balance sheet is a little above 3 trillion.

Finally, let's talk about housing. We expect continued growth in residential investment through 2025, with a rapid rise in housing starts, solid new home sales, and a bit more turnover in existing home sales as mortgage rates fall. Home building and increased brokerage commissions should keep residential investment on the boil, posting a 4.6 per cent rise on a 4th quarter over 4th quarter basis this year and 3.2 per cent in 2025. Our residential investment forecasts are a good deal stronger than we expected in the year ahead outlook we published last November. Booming first quarter growth probably reflected a combination of the warm winter and the temporary downswing in mortgage rates. We don't expect the same outperformance later in the year. But at the same time, housing demand is greater than we had anticipated amid that faster population growth. 

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Global Cross-Asset Strategist and Global Chief Economist discuss the state of asset markets at the midway point of 2024, and why the current backdrop suggests positive directions for several key markets.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross Asset Strategist.

Seth Carpenter: And yesterday, Serena, you and I discussed Morgan Stanley's global economic mid-year outlook. And today, I'm going to turn the tables on you, and we'll talk about asset markets.

It's Tuesday, May 21st, at 10am in New York.

Okay, so yesterday we talked about all sorts of different parts of the macro environment. Disinflation, inflation, central bank policy, growth. But when you think about all of that -- that macro backdrop -- what does it mean to you for markets across the world?

Serena Tang: Right, I think the outlook laid out by your team of stable growth, disinflation, rate cuts. That is a great backdrop for risk assets, one of the reasons why we got overweight in global equities. Now, there will likely be low visibility and uncertainty beyond year end, and why we recommend investors should focus on the triple C's of cheap optionality, convexity, and carry.

That very benign backdrop suggests more bullish possibilities. Your team has noted several times now that the patterns we're seeing now and what we expect have parallels to what happened in the mid 1990s -- when the Fed cut in small increments, US growth was sustained at high levels, and the labor market was strong. And now I'm not suggesting that this is 1990s and we should party like it. But just that the last time we found ourselves in this kind of benign macro environment, risk assets -- actually most markets did really well.

Seth Carpenter: So, I will say the 1990s was a pretty good decade for me. However, you mentioned some uncertainty ahead, low visibility. We titled our macroeconomic outlook ‘Are we there yet?’ Because I agree, we do feel like we're on a path to something pretty good, but we're not out of the woods yet. So, when you say there's some low visibility about where asset markets are going, maybe beyond year end, what do you mean by that?

Serena Tang: I think there's less visibility going into 2025. And specifically, I'm talking about the US elections. When I think about the range of possible outcomes, all I can confidently say is that it's wide, which I think you can see reflected in our strategist's latest forecast. Most teams actually have relatively constructive forecast returns for their assets in the base case, but there's an unusually wide gap between their bull and bear cases for bond and equity markets.

Seth Carpenter: Let me narrow it down a little bit because equity markets have actually performed pretty well during the first half of the year. So what do you think is going to happen specifically with equities going forward? How should we be thinking about equity markets per se?

Serena Tang: Equities have rallied a lot, but we've actually gotten more bullish. I talked about the three Cs of cheap optionality, convexity, and carry earlier, and I think European and Japanese equities really tick these boxes. Both of these markets also have above average dividend yields, especially for a dollar-based FX hedge investor.

Serena Tang: Where we think there might be some underperformance is really in EM equities, but it's a bit nuanced. Our China equity strategy team thinks that consensus mid-teens earnings growth expectation for this year will still likely to disappoint given the Chinese growth forecast that you talked about yesterday.

Seth Carpenter: Alright, in that case. Let me flip over to fixed income. A lot of that is often driven by central banks. Around the world, you just mentioned EM equities may be struggling a little bit. A lot of EM central banks are either cutting a little bit ahead of the Fed, but being cautious, worrying about not getting too far ahead of the Fed. So, if that's what's going on with policy rates at the very front end of the curve, what's happening in fixed income more broadly?

Serena Tang: We generally see government bond yields lower over the forecast horizon for two reasons. On your team's forecast of central banks cutting rates and also in the US, an optical rise in the unemployment rate, our macro strategy team forecasts for the 10 year U.S. Treasury yields to fall to just above 4 per cent by the end of this year. And because government bond yields will be coming down, we also expect yields for spread products like agency MBS, investment grade, etc. to also come down. But I think for these spread products, returns can be positive beyond that duration piece.

Serena Tang: So, credit loves moderation, and I think the mild growth backdrop your team is forecasting for is exactly that. US fixed income more generally should also see renewed flows from Japanese investors as FX hedging costs come down over the next six months. All of this supports tighter than average spreads.

Seth Carpenter: Okay, so we talked about equities, we talked about fixed income. Big asset class that we haven't talked about yet are commodities. How bullish are you going into the summer? What do you think is going to go on and can that bullish view that you guys have last even longer?

Serena Tang: So for crude oil, our strategists see market tightness over the summer, which could drive Brent to about $90 per barrel. You have demand coming in stronger than expected, and of course OPEC has extended its production agreement.

But we also don't really expect prices to hold over the medium term. Non-OPEC supply should meet most of the global demand growth later this year and into 2025, which sort of leaves very little room for OPEC to unwind production cuts. We expect Brent to revert back steadily to its long-term anchor, which is probably somewhere around $80 per barrel.

Serena Tang: For copper, it’s actually our metal strategist's top pick right now, and it's very much driven by, I think, tightening supply and demand balance. You've had significant mine supply disruptions, but also better than expected demand and new drivers such as -- we've talked about AI a lot, data centers and increasing participation.

Serena Tang: And on gold, in our view, pricing is likely to remain pretty choppy as investors have to weigh inflation risk, incoming data, and the Fed path. But historically, that first rate cut tends to be a very positive catalyst for gold. And we see risks more skewed to our bull case at the moment.

Seth Carpenter: Okay, so talked about equities, talked about fixed income, talked about commodities. These are global markets, and often when investors are looking around the world and thinking about what it means for them, currencies come into it, and everybody's always going to be looking at the dollar. So why don't you run us through the Morgan Stanley view on where the US dollar is going to go over the rest of this year, and maybe over the next 12 months.

Serena Tang: The short answer is we see the dollar staying stronger for longer. Yes, we expect central banks to begin cutting this year. But the pace of cuts and ultimate destinations are likely to vary widely. Now another potential dollar tailwind is an increased risk premium being priced for the 2024 US elections. We think that investors may begin to price in material risks to dollar positive changes in US foreign and trade policy as the election approaches, which we assume will sort of begin ramping up in the third quarter.

Seth Carpenter: All right, let's step back from the details. I want you to bring us home now. Give me some strategy. So where should people lean in, where should we be looking for the best returns and where do we need to be super cautious?

Serena Tang: In our asset allocation recommendation, we recommend overweight in global equities, overweight in spread products, equal weight in commodities, and underweight in cash.

We really like European and Japanese equities on the back of pretty strong earnings revision, attractive relative valuations, and good carry for a dollar based investor. We like spread products. Not so much that our strategists are not expecting duration to do well. We are still expecting yields to come down.

Serena Tang: Where we are most cautious on, really, continues to be EM equities. From a very top down perspective, the outlook we have is constructive stable growth, continued disinflation, rate cuts. These make for a good environment for risk assets. But uncertainties beyond year end, that really argues for investors to look for assets which have those triple Cs, cheap optionality, convexity, and carry.

And we think Japanese and European equities and spread products within fixed income take those boxes.

Seth Carpenter: Alright, looking at the clock, I'm going to have to cut you off there. I could talk to you all day. Thank you for coming in and letting me turn the tables relative to yesterday when you were asking me all the questions.

Serena Tang: Great speaking with you, Seth. And yes, I know we can go on forever.

Seth Carpenter: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you get your podcasts. And share this episode with a friend or a colleague today.

Our Global Chief Economist and Global Cross-Asset Strategist discuss the state of the global economy at the midpoint of 2024, including how the U.S. and Europe are on growth trajectories despite volatile economic data.

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Serena Tang: Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's chief global cross-asset strategist.

Seth Carpenter: And I’m Seth Carpenter. Morgan Stanley's global chief economist.

Serena Tang: And on this two-part episode of the podcast, we'll discuss Morgan Stanley's global mid-year outlook. Today we'll focus on economics, and tomorrow we'll turn our attention to strategy.

It's Monday, May 20th, at 10am in New York.

So, Seth, we've seen a lot of volatile economic data since you published your 2024 year ahead outlook last November. The US has gone through a few months of downside inflation and upside growth surprises, followed by renewed inflationary pressures; and in China, real growth surprise to the upside, but deflation deepened. In contrast, India and Japan, your two strongest conviction bullish views, have played out so far.

So, with all this in mind, Seth, what is your outlook for the global economy and its growth trajectory for the second half of this year and into 2025?

Seth Carpenter: So, we're pretty optimistic. We see some mild deceleration in the US relative to last year's particularly strong growth but not collapsing. And I think that part is really important. The euro area growth, all the signs that we've had since we wrote the outlook in November, updating now it says that growth is actually bottomed out there and we're starting to see the initial recovery. Now, don't get carried away. It's not that it's gonna be this massive rebound. But there should be now a bottoming out gradual growth as inflation keeps coming down. That means that real wage growth is actually going to get stronger, and we think consumption starts to lead the way.

China though, there we've surprised the upside but just an inflation adjusted growth because fiscal policy has been adding to capacity they're adding to the ability. And so, deflation has stayed. It's one of the longest and deepest deflationary episodes China has had. We think that's actually going to be exporting deflation to the rest of the world. But in terms of real growth, they're actually hanging in there around 5 per cent.

Serena Tang: I'm glad you kind of highlighted the difference between what we're expecting for the US and Europe and what we're expecting for China, because one of the themes that I think you touched on in this outlook is divergence that you see some slowing in the US -- even though it's very stable, while the rest of the world really is where growth starts to pick up. 

So, what is driving this divergence? How persistent do you think it will be? And what does it mean for central bank policy?

Seth Carpenter: Let me start with Europe and the US, the way you framed it. Like I said, European growth is probably bottom. They had more adverse shocks than the US did. So, the energy shock -- that was particularly damaging to German manufacturing, really slowed the European economy down. Whereas in the US, we had a lot of strong growth last year. Last year we had growth in the US at just over three per cent. Non-trivial amount of that growth was enabled by the surge of immigration, but we still see some residual impetus from fiscal policy.

And so, where are we now? Inflation in the euro area is continuing to fall. In fact, it's clearer signal down than it has been, at least for the fourth quarter this year in the US. Growth is picking up, but not so much that it's going to re-spark inflation. So, we think the ECB is going to start to cut rates as soon as next month, as soon as the June meeting. Whereas for the US, we still have strong growth. Inflation sort of gave us that head fake in the first quarter, so the Fed's going to have to wait, we think probably until September.

Serena Tang: And on the point of inflation, can you actually give us a snapshot of where we are right now and what your projections from here will be? You know, you talked about disinflation in the US. What's gonna be driving that?

Seth Carpenter: I think the first thing to keep in mind is that just globally we see further disinflation and so the run up in inflation that was, by and large, a global phenomenon, we do see as abating. For the US specifically, though, I think there are a few parts that are really important and always the conversation has to deal with housing. 

There, in the United States, we measure housing inflation through rents, and we know various things. One recent readings on rents in the market right now have actually been moving roughly sideways. The statistical agency, the Bureau of Labor Statistics, that creates the CPI, takes those market-based rents and then spreads it through an algorithm. And the official statistics reflect what's going on now over the next couple of quarters. So, for that reason alone, we think rent inflation, which is 40 per cent of core CPI, we think that keeps trending down over the rest of the year.

We see some deflation in consumer goods. That's especially in automobiles. The deflation that we see in China, that's probably being exported to the rest of the world, contributes a little bit more to that downward pressure. So, we feel pretty convicted that the high inflation that we saw in the first quarter was more noise than signal, and we get greater disinflation as the year goes on.

Serena Tang: So finally, I want to ask you about Japan specifically. It's the region where we're actually expecting rate hikes. Since it has gone through a structural shift recently, decades of deflation are now over, seems to be over. And so, what are your expectations there?

Seth Carpenter: I think it is a fundamental shift here. We did have decades of essentially zero nominal growth and that is now clearly, in the rear-view mirror. We see wage inflation; we see price inflation. When I talk to our colleagues in research in Tokyo who cover the consumer sector, the mindset has shifted, and consumers are willing to accept these higher inflation prints.

And so, in that regard, we do think very much we've shifted from that zero nominal growth, that sort of disinflationary-deflationary equilibrium, to one where inflation will be sustained above target. As a result, the Bank of Japan got rid of negative interest rate policy. And we think they're gonna hike into positive territory in July of this year. Probably again in the beginning of next year.

All, as long as we're right, that inflation is here to stay and that seems very much the case. Now, why only two rate hikes then as opposed to more if the world is fundamentally different? And this, I think, is critical. Governor Ueda, the BOJ, is committed to making sure that we have shifted to this reflationary environment. And so, I do think he's going to be cautious and only hike as much as he can be confident that inflation stays high for the foreseeable future.

Serena Tang: Seth, thanks so much for taking the time to talk.

Seth Carpenter: Serena, it's always great to talk to you.

Serena Tang: And thanks for listening. Please be sure to tune in for Part Two of this episode, where Seth and I will discuss our mid-year strategy outlook. If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.

Our Head of Corporate Credit Research explains why the debt of high-rated EM countries is a viable alternative for investors looking for high yields with longer duration.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why – for buyers of investment grade bonds – we see better value in Emerging Markets. 

It's Friday May 17th at 2pm in London.

This is a good backdrop for corporate credit. The asset class loves moderation and our forecasts at Morgan Stanley see a US soft landing with growth about 2 percent comfortably above recession, but also not so strong that we think we need further rate increases from the Federal Reserve. Corporate balance sheets are in good shape, especially in the financial sector and the demand for investment grade corporate bonds remains high – thanks to yields, which hover around five and a half percent.

For all these reasons, even though the additional yield that you currently get on corporate bonds, relative to say government bonds is low, we think that spread can remain around current levels, given this unusually favorable backdrop. But we're less confident about longer maturity bonds. Here, credit spreads are much more extreme, near their lowest levels than 20 years. So, what can investors do if they're looking to get some of the advantages of this macro backdrop but still access higher risk premiums.

For investors who are looking for high rated yield with longer duration, we see a better alternative: the debt of high rated countries in the Emerging Markets, or EM. Adjusting for rating, high grade Emerging Market debt currently trades at a discount to corporate bonds. That is for bonds of similar ratings, the spreads on EM debt are generally higher. And this is even more pronounced when we're looking at those longer dated borrowings; the bonds with the maturity over 10 years. In investment grade credit, you get paid relatively little incremental risk premium to lend to a company over 30 years, relative to lending it to 10. But that's not the case in Emerging Market sovereigns. There, these curves are steep. The incremental premium you get for lending at a longer maturity is much higher. 

So, what's driving this difference? Well one has been relatively different flows between these different but related asset classes. Corporate bonds have been very popular with investors, enjoying strong inflows year to date. But Emerging Market bond funds have not, and have seen money come out. Relatively weaker flows may help explain why risk premiums in the EM debt market are higher.

Another reason is that the same EM investors who are often seeing outflows have been asked to buy an unusually large amount of EM bonds. Issuance from Emerging Market sovereigns has been unusually high year to date and unusually focused on longer dated debt. We think this may help explain why Emerging Market risk premiums are even higher for longer dated bonds. 

The good news? Our EM strategy team thinks some of this issuance surge will moderate in the second half of the year. It's a good backdrop for high rated credit and this week's CPI number, which showed continued moderation. And inflation is further reinforcing the idea that the US can see a soft landing. The challenge is that – that good news has tightened spreads in the corporate market.

While we think those risk premiums can stay low, we currently see better relative value for investors, looking for yield and risk premium in high-rated EM sovereigns – especially for those looking at longer maturities. 

Thanks for listening. Subscribe to Thoughts on the Market wherever you get your podcasts and leave us a review. We'd love to hear from you. 

Our research shows travelers are willing to spend more this summer than last. U.S. Thematic Strategist Michelle Weaver explains how this will impact the airline, cruise and lodging industries. 

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Welcome to Thoughts on the Market. I’m Michelle Weaver, Morgan Stanley’s US Thematic Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the summer travel trends we’re expecting to see this year. 

It’s Thursday, May 16th at 10am in New York. 

With Memorial Day just around the corner, most of us are getting really excited about our summer vacation plans. We recently ran a survey, and our work shows that nearly 60 percent of US consumers are planning to travel this summer. This figure though skews significantly higher for upper income consumers. 75 percent of consumers making $75,000 to $150,000 are planning to travel and this figure rises to 78 percent for those who make more than $150,000. 

And travel remains a key spending priority for higher-income consumers. They place travel as one of their top priorities when compared to other discretionary purchases. This picture reverses though when you look at lower-income consumers making less than $50,000 a year. Travel tends to be among their lowest priorities when they are thinking about their discretionary purchases.

What really matters for companies though is if consumers are going to spend more this year than they did last year. And consumers who are planning a vacation are inclined to spend more this year, with 49 percent expecting to spend more and 16 percent intending to spend less. So that yields a net plus-32 percent increase in spending intentions for summer travel.

And what does this mean for key players in the travel industry? For starters, let’s look at airlines, where demand no longer seems to be a market debate within the space. It’s remained very resilient so far in 2024, contrary to what many had feared when we were going into this year. Our Transportation Analyst also has a positive view of US Airlines, especially Premium carriers. And the reason: This category caters to high-end consumers who are more likely to fly regardless of the state of the economy. Since the pandemic, Premium air travel has been one of the fastest growing and likely most resilient parts of the US Airlines industry, with premium cabin outperforming the main cabin consistently. 

And then what’s in store for cruise companies this summer? The outlook seems to be broadly positive, according to our analysts. The largest cruise operators source the majority of their guests from the US. And these companies provide leisure travel – as opposed to business travel – almost exclusively, so their revenues are closely tied to the health of the US consumer. Of the 60 percent of consumers who are planning to travel this summer, 6 percent are planning a cruise. That’s a little bit lower than pre-COVID, but cruise passengers tend to skew older and more affluent. So, they take more than one vacation frequently. This keeps the outlook broadly supportive for cruise companies. 

Finally, let’s think about Gaming and Lodging. These are your hotels and casinos. Investor sentiment is generally cautious for this space, but our analyst believes the data is encouraging. Yes, there’s been a slowdown in demand, compounded by continued – but moderating – labor inflation. This has created margin pressure for companies with higher operating leverage but the data suggests that upscale and luxury operators are outpacing midscale and economy ones. In addition, the Las Vegas strip, which tends to skew higher end, has outpaced regional casinos. And even when you look within the Las Vegas strip, baccarat is outpacing slot demand and luxury properties are outpacing more affordable options.

So, all in all, the summer looks bright for travel operators, especially those who have more exposure to the high-end consumer. 

Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Global Head of Fixed Income and Thematic Research explains that the Biden administration’s new tariffs on Chinese imports are narrower than those of 2018 and 2019, but still send a signal about the economic relationship between the US and China.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of newly announced tariffs by the United States. 

It's Wednesday, May 15th at 10:30am in New York.

Yesterday, the Biden administration announced new tariffs on the import of certain goods from China. These include semiconductors, batteries, solar cells and critical minerals among other products. For investors, this might remind them of the tariff escalation in 2018 and 2019 that led to global economic concerns. But we’d caution investors not to arrive at similar conclusions from this latest action.

Consider that the scope of this action is far more muted than the tariffs actions from a few years ago. New tariffs will affect a projected $18 billion of imports, or only about 0.5 percent of all China’s exports. And as our chief Asia economist Chetan Ahya has explained in his recent work, the sectors in scope for this round are areas where China has substantial spare capacity. Said differently, the tariffs are narrowly scoped and appear to be targeted at areas where the US perceives specific risk of imbalanced trade and market conditions. That contrasts with tariffs on roughly $360 billion of imports from China in the 2018-2019 period – a much broader approach that was in part aimed at forcing broad trade concessions from China but carried greater economic consequences by crimping corporate’s capital spending globally as they re-evaluated their production strategies. 

There is some signal for investors here though. While the scope of the Biden administration's efforts here are more narrow, it does signal something we’ve known for a few years now. There’s continuity across presidential administrations and across political parties in the US on the topic of the economic relationship with China. While each party has different tactics, there’s clear overlap in their goals, in particular on the idea that the US must continue taking steps to protect critical and emerging technologies in order to preserve its economic and national security. 

This suggests that the laws of gravity won’t apply to US tariffs any time soon, regardless of the US election outcome. So, the rewiring of the global economy in the emerging multipolar world will continue, and investors can still focus on some key regional beneficiaries of this secular trend – namely Mexico, India, and Japan.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Retail Analyst discusses the key strategies that have propelled a select few companies in U.S. consumer retail amid a challenging demand backdrop. 

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Welcome to Thoughts on the Market. I’m Simeon Gutman, Morgan Stanley’s Hardlines, Broadlines & Food Retail Analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss how some retail businesses are responding to daunting consumer challenges. 

It’s Tuesday, May 14th at 10am in New York.

There have been dramatic shifts within the consumer sector over the past three years. During the pandemic, we all had to redirect our spending away from services, such as travel and leisure, to various goods, which we were able to purchase online and have delivered at home. Consumer packaged goods, for example, experienced two years of outsized growth during the pandemic. But since 2022, consumption has been declining across the value chain. 

For some categories, this dynamic may not be a temporary, post-COVID phenomenon, but rather a continuation of a longer-standing secular trend that had started prior to the pandemic. For example, non-durable goods – such as clothing, footwear and food at home – were already losing wallet share pre-COVID. Grocery spend was losing to dining out, as consumers placed more value on convenience. And although some sectors experienced unprecedented pricing power between 2020 and 2023, they’re now seeing this pricing power decline as inflation moderates. 

Against this backdrop, Consumer Packaged Goods companies and retailers are attempting to find new growth levers in the face of stagnating – or even declining – sales and decreasing pricing power. A select few companies in US consumer retail, automotive, communication services and IT hardware have been able to navigate the current consumer environment of slowing growth. We believe there’s a powerful lesson in the combination of strategies these successful outliers have deployed to reposition themselves in the face of tepid demand. 

For example, these companies are shifting their value proposition by focusing on products in faster-growing markets. They are also exiting underperforming areas to optimize their core brand and product portfolios. They’re streamlining their internal operations by changing organizational structures, revamping their supply chains, and using AI to automate processes. All of this helps to reduce costs and enhance productivity. Successful retail companies are also looking to alternative revenue sources and profit pools to grow their businesses, focusing on higher growth areas within their industries. Discount retail is a prime example as it focuses on high margin digital media, which has the potential to lift operating profit margins for the entire sector. Furthermore, a shift to omni-channel has revolutionized Retail, by capturing greater consumer wallet share and reducing delivery costs. And finally, successful companies have prioritized free cash flow by divesting non-core assets in less profitable areas. 

Businesses that have been able to deploy these strategies have been rewarded by the market. They have seen their average 12-month price to earnings multiples expand more than 35 percent over the past five years, meaning that the market's outlook for these companies is considerably better than it was previously. Several of these strategies have also led to stronger top-line growth and margin expansion, which our US equity strategists identify as the two major drivers of shareholder value across consumer staples and consumer discretionary.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our experts highlight their biggest takeaways from the International Monetary Fund’s recent meetings, including which markets around the globe are on an upward trajectory.

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Simon Waever: Welcome to Thoughts on the Market. I'm Simon Waever, Morgan Stanley's Global Head of Emerging Markets, Sovereign Credit and Latin America Fixed income strategy. 

Neville Mandimika: And I'm Neville Mandimika from the Emerging Markets Credit Strategy team with a focus on Central and Eastern Europe, Middle East and Africa.

Simon Waever: And on this episode of Thoughts on the Market, we'll discuss what we believe investors should take away from the International Monetary Fund’s Spring Meetings in Washington, DC. 

It's Monday, May 13th at 10am in New York.

Neville Mandimika: And it's 3 pm in London.

To give some context, every year, the Spring Meetings of the International Monetary Fund (IMF) and the World Bank provide a forum for country officials, private sector market participants and academics to discuss critical global economic issues. This time around, the meetings were held against a backdrop, as you might imagine, of rising geopolitical tensions, monetary policy pivots, and limited fiscal space.

Simon, we were both at the event, and I wanted to discuss what we took away from our own meetings, as well as discussions with other market participants. How would you describe the mood this time around compared to the annual meetings in October last year?

Simon Waever: So, I would say sentiment was cautiously optimistic. Of course, it did happen in the backdrop of inflation; the first quarter not being as well behaved as everyone had hoped for. So that really put the focus on central banks being more cautious in their easing paths, which is actually a point the IMF also made back in October.

But away from that, growth has held up better than expected. In the US for sure, but also more globally. So, I would say it could have been a lot worse.

Neville Mandimika: Was it just me or there was a particular focus on fiscals this time around? What did you make of this?

Simon Waever: No, there was for sure and interestingly it was focused on both developed economies and developing economies, which isn't usually the case. And I think it's clear that not only the IMF but also the markets are worried that we're still some distance away from stabilizing debt in most countries. And not only that but that it's going to be hard to close that gap due to lower growth and spending pressures. So that meant that there was a lot of discussions on how much term premier there needs to be in government bond curves and whether they need to be steeper.

Neville Mandimika: It's often very difficult to talk about, you know, the global economic dynamics without talking about AI, which seems to be the catchphrase this year. How is the fund viewing this in light of the potential for the global economy?

Simon Waever: So, the issue is that the IMF has often had to revise down medium-term growth outlook; something that it pretty much had to do every year since 2010, actually. And today it stands at only 2.8 globally. If you look at the IMF's publications, they attribute the key reasons to this to misallocation of capital and labor.

But what they also did this time around was look at what could turn it around; and maybe unsurprisingly structural reforms that reduces that misallocation would be the larger potential factor that could boost this up again. They estimate about around 1.2 per cent of GDP. But then to your point the adoption of AI is seen as another new driver.

Of course, it's also a lot more uncertain because there needs to be a lot of a lot more work done around it. But they think it could add nearly one percentage point to global growth in a positive scenario. 

But Neville, with that, let's dig deeper into the issues of developing countries which, after all, is the focus of the meetings. The cost of debt is rising, which has led to some countries experience debt distress. But from our side, we've also frequently pushed back against the idea that there is a growing debt crisis. So, coming back from the meetings, what kind of debt restructuring progress has been made? And how do you see it playing out for the remainder of the year? 

Neville Mandimika: Yeah, interestingly, there was still plenty of talk in the meetings about EM (emerging market) debt crisis, but the backdrop to the conversation was significantly better this time around compared to October 2023.

Since last year, we've seen progress from Suriname, which is a small part of the Emerging Market Bond Index, close its restructuring, Zambia reaching a deal with private bondholders with the expectation that all of this could be buttoned up by June this year, multiple proposals in Sri Lanka and Ukraine making some progress.

This gives me some hope that the number of sovereigns in default will be lower by the end of this year. And I think more importantly, we don't expect any country, any new country, to get into default -- as countries like Pakistan and Tunisia have made some progress in avoiding restructuring its own debt.

The other important thing that came out from my vantage point is that the Global Sovereign Debt Roundtable seems to be making some progress, particularly on outlining the structure of EM debt crises, which is, you know, emphasizing parallel negotiations between official and private creditors and, of course, timely sharing of information between stakeholders.

Simon Waever: Then another focus has been that the IMF has been making some concessions to try to increase financing for countries that need it. Do you think there was progress on this front? 

Neville Mandimika: Yeah, it certainly seems so. You know, there seems to be some momentum on that front. You'd remember that last year, there was a resolution to increase the IMF's lending capacity by increasing country quotas by 50 per cent. Once this is buttoned up, heavy borrowers like Egypt and Argentina would greatly benefit, I think.

Until this is done, the fund extended its temporary higher access limits to allow countries to borrow more in the meantime. There was also increased dialogue on reducing surcharges, which is the additional interest payments the IMF imposes on borrowers. The reduction of these would greatly help the likes of Argentina and Ecuador. Unfortunately, not much concrete progress has been made on this front.

Simon Waever: And then finally, across all the meetings we held, which countries did you come away more positive on and which ones would still be of concern?

Neville Mandimika: Yeah, I certainly came out a lot more positive on Senegal, as fears of large policy changes like leaving the CFA franc were eased. Egypt was also another clear positive, given the commitment to reforms, despite large financing that was received earlier this year. Nigeria, there was also some momentum on this front as reforms is still very much front and center from the political authorities. And lastly, Turkey saw authorities affirming their commitment to fighting inflation and loosening the grip on the foreign exchange market.

And I'll throw the same question to you, Simon. Which countries are you positive on?

Simon Waever: Yeah, I mean, it was pretty hard to take away the excitement from Egypt, but I would say that Argentina is another country where people came away pretty positive. The imbalances are significant, but they're just making very good headway in unwinding them; and they have the support of the IMF to do so. Ecuador would be the other one where sentiment in general is positive. On the more cautious side, I would point towards those countries where fiscal deficits are heading in the wrong direction, which goes back to the worries about fiscals we spoke about earlier -- and Colombia is one such example.

But with that, let's wrap it up. Neville, thanks for taking the time to talk.

Neville Mandimika: Great speaking with you, Simon.

Simon Waever: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to the podcast. It helps more people find the show.

Morgan Stanley’s Chief Latin America Strategist explains the importance of Mexico’s upcoming presidential election, laying out the possible investment implications of potential policy reforms.

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Welcome to Thoughts on the Market. I’m Nik Lippman, Morgan Stanley’s Chief Latin America Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll talk about why Mexico’s upcoming election matters for markets. 

It's Friday, May 10, at 10am in Sao Paulo. 

Voters in Mexico will choose a new president in less than a month, on June 2. The two leading candidates – Claudia Sheinbaum and Xóchitl Gálvez – have presented strong campaigns amidst a tense political backdrop. And yet, asset prices have not yet begun to react to potential election outcomes. 

There’s significant policy differences between Sheinbaum and Galvez – thus an important investment debate around each of them. However, polls suggest a strong lead for Sheinbaum, who is the candidate from the ruling party Morena. In fact, it seems that the key debate that markets are focused on right now is not so much who wins, but rather what type of president Sheinbaum would be, if she does get elected.

If she does indeed win, the expectation is for policy continuity post-election—particularly as it relates to Mexico’s nearshoring – or moving industrial supply chains from Asia to North America. This trend has been a major driver of the country’s economy and major asset classes. 

And so the market seems to be focusing squarely on policy decisions that may be taken by the incoming administration. Mexico is in a strong position to benefit from its relationship with the United States and as well as the nearshoring opportunities. We see a positive skew for both equities and credit, and think the election can act as a catalyst for assets that have traded cheaply.

Yet, significant reforms are necessary to take full advantage of this setup. Indeed, we would argue that rapid and deep structural reforms would be crucial, especially when it comes to fiscals and the energy space. For example, we think there could be a need for stronger partnership between the public and the private sector and a rethink of parts of Mexico’s electricity model. If Mexico solves its electricity supply-side challenges, it can build on its favorable nearshoring position. But on the other hand, there’s no industrial revolution without electricity. 

However, the risk-reward for the Mexican peso is slightly different. It has already benefited from the rise in foreign investment - and the high interest rate differential between Mexico and the United States.

With all that said, there are risks from the elections, too. If any political party wins two-thirds majority, it opens the possibility for changes to the constitution. And current proposals by Mexico’s sitting president could open the door for larger fiscal deficits; and potentially some more unorthodox policies down the road. We will continue to keep you posted on Mexico’s election outcomes.

Thank you for listening. If you enjoy Thoughts on the Market, take a moment to rate and review us wherever you listen. It helps more people find the show.

Our Chief Fixed Income Strategist explains why the Federal Reserve’s most recent meeting was so consequential, and the likeliest path ahead for interest rates.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about last week’s FOMC meeting and its impact on fixed income markets.  

It's Thursday, May 9th at 1pm in New York.

Last week’s Fed meeting was consequential. It had a clear and unambiguous messaging about the path ahead for Fed’s monetary policy. Fed’s next move in policy rate is unlikely to be a hike. The Fed’s focus now is on how long the current target range for the fed funds rate will be maintained; and the next move, whenever it happens, is likely a cut. Importantly, the FOMC’s decision was unanimous and their statement maintained an overall easing bias.

In the aftermath of recent upside surprises to inflation and the reaction in the rates market, many market participants, yours truly included, were apprehensive that the FOMC’s tone might be overtly hawkish. Turns out, that was not the case. By setting a very high bar for the next move to be a hike, the Fed’s message has meaningfully narrowed the distribution of outcomes for policy rates, at least in 2024 As our economists led by Ellen Zentner note, the two likely policy outcomes now are keeping the rates on hold or cutting. 

Given the prospect that policy rates may remain in the current target range, the negative carry of an inverted yield curve keeps us from pounding the table to move to outright long in duration, although the direction of travel does suggest that. We would note that Guneet Dhingra, our head of US interest rate strategy, sees better risk/reward in duration longs through 3 month 10 year receivers than in the very crowded curve steepener trade. In general, spread products in fixed income – agency MBS, corporate credit and securitized credit – stand to benefit the most from this notably less hawkish messaging, in our view.

As Jay Bacow, our head of agency MBS strategy, observes, the backdrop in which tail risks of higher policy rates are much more remote than they were before the FOMC meeting is supportive for agency MBS. At current valuations, agency MBS offers an attractive expression for investors seeking to play for lower interest rates, lower interest rate volatility or both. 

Their high all-in yields have bolstered strong inflows and sustained demand for corporate credit across a wide range of investor types. If policy rates remain in the current range, we expect the demand for corporate credit to accelerate. If policy rates stay in the current range or go lower, pressures on interest coverage are unlikely to get worse going forward. Given their high single-digit all-in yields, we see an attractive risk/reward calculus favoring leveraged loans. We like expressing this view directly in loans as well as in securitized credit through CLO tranches.  

In sum, the message from the Fed was clear and unambiguous. The policy rate path ahead is for rates to remain in the current range or decline, and the bar for the next move to be a hike is very high. This bodes well for a wide range of instruments in fixed income.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our expert panel explains the U.S. dollar’s current status as the primary global reserve currency and whether the euro and renminbi, or even crypto currencies are positioned to take over that role.

Digital assets, sometimes known as cryptocurrency, are a digital representation of a value that function as a medium of exchange, a unit of account, or a store of value, but generally do not have legal tender status. Digital assets have no intrinsic value and there is no investment underlying digital assets. The value of digital assets is derived by market forces of supply and demand, and is therefore more volatile than traditional currencies’ value. Investing in digital assets is risky, and transacting in digital assets carries various risks, including but not limited to fraud, theft, market volatility, market manipulation, and cybersecurity failures—such as the risk of hacking, theft, programming bugs, and accidental loss. Additionally, there is no guarantee that any entity that currently accepts digital assets as payment will do so in the future. The volatility and unpredictability of the price of digital assets may lead to significant and immediate losses. It may not be possible to liquidate a digital assets position in a timely manner at a reasonable price.

Regulation of digital assets continues to develop globally and, as such, federal, state, or foreign governments may restrict the use and exchange of any or all digital assets, further contributing to their volatility. Digital assets stored online are not insured and do not have the same protections or safeguards of bank deposits in the US or other jurisdictions. Digital assets can be exchanged for US dollars or other currencies, but are not generally backed nor supported by any government or central bank.

Before purchasing, investors should note that risks applicable to one digital asset may not be the same risks applicable to other forms of digital assets. Markets and exchanges for digital assets are not currently regulated in the same manner and do not provide the customer protections available in equities, fixed income, options, futures, commodities or foreign exchange markets. 

Morgan Stanley and its affiliates do business that may relate to some of the digital assets or other related products discussed in Morgan Stanley Research. These could include market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking.

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Michael Zezas: Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research.

James Lord: I'm James Lord, Head of FX Strategy for Emerging Markets.

David Adams: And I'm Dave Adams, head of G10 FX Strategy.

Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss whether the US status as the world's major reserve currency can be challenged, and how.

It's Wednesday, May 8th, at 3pm in London.

Last week, you both joined me to discuss the historic strength of the US dollar and its impact on the global economy. Today, I'd like us to dive into one aspect of the dollar's dominance, namely the fact that the dollar remains the primary global reserve asset.

James, let's start with the basics. What is a reserve currency and why should investors care about this?

James Lord: The most simplistic and straightforward definition of a reserve currency is simply that central banks around the world hold that currency as part of its foreign currency reserves. So, the set of reserve currencies in the world is defined by the revealed preferences of the world's central banks. They hold around 60 percent of those reserves in U.S. dollars, with the euro around 20 percent, and the rest divided up between the British pound, Japanese yen, Swiss franc, and more recently, the Chinese renminbi.

But the true essence of a global reserve currency is broader than this, and it really revolves around which currency is most commonly used for cross border transactions of various kinds internationally. That could be international trade, and the US dollar is the most commonly used currency for trade invoicing, including for commodity prices. It could also be in cross border lending or in the foreign currency debt issuance that global companies and emerging market governments issue. These all involve cross border transactions.

But for me, two of the most powerful indications of a currency's global status.

One, are third parties using it without the involvement of a home country? So, when Japan imports commodities from abroad, it probably pays for it in US dollars and the exporting country receives US dollars, even though the US is not involved in that transaction. And secondly, I think, which currency tends to strengthen when risk aversion rises in the global economy? That tends to be the US dollar because it remains the highly trusted asset and investors put a premium on safety.

So why should investors care? Well, which currency would you want to own when global stock markets start to fall, and the global economy tends to head into recession? You want to be positioning in US dollars because that has historically been the exchange rate reaction to those kinds of events.

Michael Zezas: And so, Dave, what's the dollar's current status as a reserve currency?

David Adams: The dollar is the most dominant currency and has been for almost a hundred years. We looked at a lot of different ways to measure currency dominance or reserve currency status, and the dollar really does reign supreme in all of them.

It is the highest share of global FX reserves, as James mentioned. It is the highest share of usage to invoice global trade. It's got the highest usage for cross border lending by banks. And when corporates or foreign governments borrow in foreign currency, it's usually in dollars. This dominant status has been pretty stable over recent decades and doesn't really show any major signs of abating at this point.

Michael Zezas: And the British pound was the first truly global reserve currency. How and when did it lose its position?

David Adams: It surprises investors how quick it really was. It only took about 10 years from 1913 to 1923 for the pound to begin losing its crown to king Dollar. But of course, such a quick change requires a shock with the enormity of the First World War.

It's worth remembering that the war fundamentally shifted the US' role in the global economy, bringing it from a large but regional second tier financial power to a global financial powerhouse. Shocks like that are pretty rare. But the lesson I really draw from this period is that a necessary condition for a currency like sterling to lose its dominant status is a credible alternative waiting in the wings.

In the absence of that credible alternative, changes in dominance are at most gradual and at least minimal.

Michael Zezas: This is helpful background about the British pound. Now let's talk about potential challengers to the dollar status as the world's major reserve currency. The currency most often discussed in this regard is the Chinese renminbi. James, what's your view on this?

James Lord: It seems unlikely to challenge the US dollar meaningfully any time soon. To do so, we think China would need to relax control of its currency and open the capital account. It doesn't seem likely that Beijing will want to do this any time soon. And global investors remain concerned about the outlook for the Chinese economy, and so are probably unwilling to hold substantial amounts of RNB denominated assets. China may make some progress in denominating more of its bilateral trade in US dollars, but the impact that that has on global metrics of currency dominance is likely to be incremental.

David Adams: It’s an interesting point, James, because when we talk to investors, there does seem to be an increasing concern about the end of dollar dominance driven by both a perceived unsustainable fiscal outlook and concerns about sanctions overreach.

Mike, what do you think about these in the context of dollar dominance?

Michael Zezas: So, I understand the concern, but for the foreseeable future, there's not much to it. Depending on the election outcome in the US, there's some fiscal expansion on the table, but it's not egregious in our view, and unless we think the Fed can't fight inflation -- and our economists definitely think they can -- then it's hard to see a channel toward the dollar becoming an unstable currency, which I believe is what you're saying is one of the very important things here.

But James, in your view, are there alternatives to the US led financial system?

James Lord: At present, no, not really. I think, as I mentioned in last week's episode, few economies and markets can really match the liquidity and the safety that the US financial system offers. The Eurozone is a possible contender, but that region offers a suboptimal currency union, given the lack of common fiscal policy; and its capital markets there are just simply not deep enough.

Michael Zezas: And Dave, could cryptocurrency serve as an alternative reserve currency?

David Adams: It's a question we get from time to time. I think a challenge crypto faces as an alternative dominant currency is its store of value function. One of the key functions of a dominant currency is its use for cross border transactions. It greases the wheels of foreign trade. Stability and value is important here. Now, usually when we talk to investors about value stability, they think in terms of downside. What's the risk I lose money holding this asset?

But when we think about currencies and trade, asset appreciation is important too. If I'm holding a crypto coin that rises, say, 10 per cent a month, I'm less likely to use that for trade and instead just hoard it in my wallet to benefit from its price appreciation. Now, reasonable people can disagree about whether cryptocurrencies are going to appreciate or depreciate, but I'd argue that the best outcome for a dominant currency is neither. Stability and value that allows it to function as a medium of exchange rather than as an asset.

Michael Zezas: So, James, Dave, bottom line, king dollar doesn't really have any challengers.

James Lord: Yeah, that pretty much sums it up.

Michael Zezas: Well, both of you, thanks for taking the time to talk.

David Adams: Thanks much for having us.

James Lord: Yeah, great speaking with you, Mike.

Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

As the U.S. economy continues to send mixed signals, our CIO and Chief US Equity Strategist explains how markets are likely to oscillate between “soft landing” and “no landing” outcomes. 

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the higher-than-normal uncertainty in economic data and its impact on markets. 

It's Tuesday, May 7th at 1:30 pm in New York. 

So let’s get after it. 

In recent research, I’ve discussed how markets are likely to oscillate between the "soft landing" and “no landing" outcomes in today's late cycle environment. Continued mixed and unpredictable macro data should foster that back and forth, and last week was a microcosm in that respect. Tuesday's Employment Cost Index report came in stronger than expected, leading to a rise in the 10-year Treasury yield to nearly 4.7 per cent. Meanwhile, the Conference Board Consumer Confidence Index turned down, falling to its lowest level since July of 2022. 

On Friday, the equity market rose sharply as bond yields fell on the back of a weaker labor report, while the ISM Services headline series fell to its lowest level since December of 2022. 

In our view, this uncertain economic backdrop warrants an investment approach that can work as market pricing and sector/factor leadership bounces between these potential outcomes. As such, we recommend a barbell of quality cyclicals which should outperform in a "no landing" scenario and quality growth, the relative winner in a "soft landing.” One might even want to consider adding a bit of exposure to defensive sectors like Utilities and Staples in the event that growth slows further.  

Meanwhile, last week's Fed meeting materialized largely as expected. Chair Powell expressed somewhat lower confidence on the timing of the first cut given recent inflation data, but he pushed  back on the notion that the next move would be a hike which eased some concerns going into the  meeting. The April Consumer Price Index released on May 15th is the next key macro event informing the path of monetary policy and the market's pricing of that path. As usual, the price reaction on the back of this release may be more important than the data itself given how influential price action has been on investor sentiment amid an uncertain macro set up. 

On the rate front, our view remains consistent with our recent research—the relationship between the 6-month rate of change on the 10-year yield and the S&P 500 price earnings multiple implies that yields around current levels are about 10 per cent headwind to valuation through the end of June but a tailwind thereafter, all else equal.

Given the uncertainty and unpredictability of the economic data more recently, we think it's useful to look at the technicals for insight into what comes next. In early April, we highlighted that the breakdown in the S&P 500 from its well-defined uptrend was an important early warning sign that performance could become more challenged. 

Based on our analysis, this headwind to valuation is likely to remain with us through the end of June unless yields fall significantly in the near term. Assuming interest rates stay around current levels, stronger valuation support lies closer to 19 times earnings, which would also imply price support closer to the 200-day moving average or 4800.

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today. 

Lisa Shalett is a member of Morgan Stanley’s Wealth Management Division and is not a member of Morgan Stanley’s Research Department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research Department and from the views of others within Morgan Stanley.

Our CIO for Wealth Management, Lisa Shalett, and our Head of Corporate Credit Research continue their discussion of the impact of interest rates on different asset classes, the high concentration of value in equity markets and more.

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Welcome to Thoughts on the Market, and to part two of a conversation with Lisa Shalett, chief investment officer for Morgan Stanley wealth management. 

I'm Andrew Sheets, head of corporate credit research at Morgan Stanley.

Today, we'll be continuing that conversation, focusing on how higher interest rates could impact asset classes, and also some recent work about the unusually high concentration of stocks within the equity market.

We begin with Lisa's very topical question about how higher interest rates might impact credit. 

Lisa Shalett: So, Andrew, let me ask you this. From your perspective as the Global Head of Corporate Credit Research, what happens if we're, in fact, in this new regime of rates being higher for longer? 

Andrew Sheets: Yeah, thanks, Lisa. It seems more topical by the day as we see yields continuing to march higher. So I think like a lot of things in the market, it kind of depends a little bit on what the fundamental backdrop is that's driving those interest rates higher. Because if I think about the modern era for credit, which I’ll define as maybe the last 40 years, the tightest that we've ever seen corporate credit spreads was not when the Fed or the European central bank was buying bonds. It was not when you had lots of leverage building up in the financial system prior to the financial crisis. 

It was in the mid 90s when the economy was pretty good. The Fed had hiked rates a lot in [19]94 and then it cut them a little. And, you know, the mid nineties, I think, are one of the poster children for, kind of, a higher for longer rate environment amidst a pretty strong economy. 

So, if that is what we're looking at, we're looking at rates being higher for longer because the economic output of the US and other regions is generally stronger. I think that's an environment where you can have the overall credit market performing still pretty well. You'll certainly have dispersion around that as not every balance sheet, not every capital structure was planned, was created with that sort of rate environment in mind.

Overall, if you had to say, is credit more afraid of a kind of higher for longer scenario or is it more afraid of, growth being a lot weaker than expected, but that would bring low rates. I actually think a lot of credit investors would much rather have a more stable growth environment, even if that brings somewhat fewer rate cuts and higher for longer rates.

Lisa Shalett: One other thing, I know that the Global Investment Committee has been debating is this idea between the haves and the have nots that's been somewhat unique to this business cycle where, there's been a portion of the mega cap and large cap universes who have demonstrated, quite frankly, total insensitivity to interest rates because of their cash balances. Or because of their lack of need for actual borrowing. And then there's smaller midsize companies, these smaller cap or unprofitable tech companies, some of the companies that may have been born in the venture capital boom of the early 2020s. 

How is this have, have not, debate playing out in the credit markets? Are there parts of the credit markets that are starting to worry that there's a tail?

Andrew Sheets: Yeah, I think that's just a fascinating question at the moment because we’ve lived in this very macro world where it seemed like big picture questions about central banks: Will we go into recession? What will commodity prices do is driving everything. And even this week, questions about interest rates are dominating the headlines on TV and on the news.

But I think if you peel things back a little bit, this is an incredibly micro market, you know, we're seeing some of the lowest correlations and co-movement between individual stocks in the US and Europe that we haven't in 15 years. If I think about the credit market, the credit market is not just sailing into this environment, happy go lucky, no risk on the horizon. It's showing some of the highest tiering that we've seen in a very long time between CCC rated issuers, which is the lowest rated, main part of performing credit and Single-B issuers, which are still below investment grade rated, but are somewhat better. Market is charging a very high price premium between those two, which suggests that it is exactly as you mentioned, differentiating based on business model strength and level of leverage and the likes.

So, this environment of differentiation -- where the overall market is kind of okay, but you have lots of churning below the surface -- I think it's a very accurate description of credit. I think it's a very accurate description of the broader market, and it's certainly something that we're seeing investors take advantage of we see it in the data.

Andrew Sheets: Lisa, you recently published a special report on the consequences of concentration, which focuses on some of these mega cap stocks and how they may present underappreciated risks for investors. What were the key takeaways from that that we should keep in mind when it comes to market concentration and how should we think about that?

Lisa Shalett: The fundamental point we were trying to make -- and it really has to do with some of the unintended risks potentially that passive investors may be embracing that they don't fully appreciate -- is really through the end of 2023, US equity indices became extraordinarily, concentrated; where the top 10 names were accounting for greater than, a third of the market capitalization. And history has shown that such high levels of concentration are rarely sustainable. But what was particularly unique about the era of the Magnificent Seven or these top 10 mega cap tech stocks is not only were they a huge portion of the whole index, but in many ways they had become correlated to one another, right? Both, in terms of their trading dynamics and their valuations, but in terms of their factor exposures, right? 

They were all momentum oriented. They were all tech stocks. They were all moving on an AI, narrative. In many cases, they had begun competing with each other; one another directly in businesses, like the cloud, like streaming services and media, et cetera.

Andrew Sheets: And Lisa, kind of further on that idea, I assume that one counterpoint that you get to this work is that some of these very large mega cap names are just great companies. They've got strong competitive positions; they've got opportunities for future growth. As an investor, how do you think about how much you are supposed to pay up for quality, so to speak? And, you know, maybe you could talk just a little bit more about how you see the valuations of some of these larger names in the market.

Lisa Shalett: What we always remind clients is, there is no doubt that, these are great companies and they have cash flows, footprints, dominant positions, and markets that are growing. But the question is twofold. When is that story fully discounted, right?

And when do great companies cease to be great stocks? And if you look back in history, history is littered with great companies who cease to be great stocks and very often, clients quote unquote never saw it coming because they hung their hat on this idea, but it's a great company.

Andrew Sheets: Any parting thoughts as we move closer to the midpoint for 2024?

Lisa Shalett: The line that I'm using most with clients is that, I fundamentally believe that uncertainty in terms of the economic scenarios that could play out from here. Whether we're talking about a no landing, we're talking about a hard landing, we talk about a stagflation. And the policy responses to that, whether it's the timing of the Fed, and what they do. And what's their mix between balance sheet and rates, and then what happens post the presidential elections in the US. And is there a policy change that shifts some of the growth drivers in the economy. 

I just think overall uncertainty is rising through the end of the year, and that continues to argue, for a position as we've noted, where clients and their advisors are particularly active towards risk management, and where the premium to diversification is above average. 

Andrew Sheets: Lisa, thanks for taking the time to talk. Hope we can have you back again soon.

Lisa Shalett: It's great to speak with you, as always, Andrew.

Andrew Sheets: As a reminder, if you enjoy Thoughts in the Market, please take a moment to rate and review us wherever you get your podcasts. It helps more people find the show.

Lisa Shalett, our CIO for Wealth Management, and our Head of Corporate Credit Research discuss how to forecast expected returns over the long term, and whether historic cycles can help make sense of the market environment today.

----- Transcript -----

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

Andrew Sheets: And on part one of this special episode of the podcast, we'll be discussing long run expected returns across markets, how we think about cross asset correlations and portfolio construction, and what are the special considerations that investors might want to have in mind in the current environment.

It's Friday, May 3rd at 4pm in London.

Lisa Shalett: And it's 11am here in New York City.

Andrew Sheets: Lisa, you and I are both members of Morgan Stanley's Global Investment Committee, which brings together nine of our firm's market, economic, and portfolio management thought leaders to provide a strategic framework for advice that we give to clients.

Andrew Sheets: I wanted to touch on a unique aspect of that process because, you know, we're talking about estimating returns over different horizons for markets. And I think there's something that's kind of unique about that challenge. I mean, I think in most aspects of life, it's probably safe to say that the next decade is more uncertain than the next six months or next year. But when we're thinking about asset class returns, it's not quite as simple as that.

Lisa Shalett: Not at all. And very often this is where our understanding of history needs to play a big part. When we think about the future, what are the patterns that we think might be persistent? And therefore, encourage us to think about long run trends and mean reversion. And what dynamics might actually be disconnected, or one offs that are characteristic of maybe structural change in the economy or geopolitics or in policymaking stance.

Andrew Sheets: How have these latest capital market assumptions changed over the last year?

Lisa Shalett: I think one of the most profound changes has been our willingness to embrace the idea that, in fact, we are in a higher for longer inflation regime. And that has a couple of implications. The first has to do, of course, with nominal returns. A higher inflation environment suggests that nominal returns are actually likely to be higher. The second really has to do with where we are in the cycle and its implications for correlations. We've been through periods most recently, where stocks and bonds were, in fact, anti-correlated; or there was a diversifying property, if you will to the 60 40 portfolio. Most recently, as inflation and level of interest rates has had profound importance to both stock valuations and bond valuations, we have found that these correlations have turned positive. And that creates a imperative, really, for clients to have to look elsewhere beyond cash, bonds, and stocks to get appropriate diversification in their portfolios.

Andrew Sheets: Well, it's been less than a month since we updated our strategic recommendations. We've recently also published an update to our tactical asset allocation recommendations. So, Lisa, I guess I have two questions. One is, how do you think about these different horizons, the strategic versus the tactical? And can you also summarize what's changed?

Lisa Shalett: Sure. You know, we very often talk to clients about the tactical horizon as being in the 12 to 18-month time frame.

In our most recent adjustment, we moved from what had been roughly a, year old underweight in US large cap stocks, and we neutralized that, kind of quote unquote, back to benchmark. So, we added some exposure, and we funded that exposure by selling out of two other positions; one that we had had in both small cap value and small cap growth, as well as a position we had, that we had put on as a hedging oriented position and long duration treasuries.

Now, some might say well, given the move in interest rates, is now the right time to take that hedge off? Our decision was basically premised on the fact that we're just not seeing the value in holding duration today given the inversion of the yield curve, and we're not getting paid for the risk of duration. And so, you know, we thought redeploying into those large cap stocks was prudent. 

Now, the other rationale, really has to do with earnings achievability. A lot of our thoughts were premised early in the year on this idea of a soft landing -- and a soft landing that would include deceleration in top line growth. And so, we were skeptical that could produce what consensus was looking for, which was a 10 to 11 per cent bottom line in 2024. 

As it turns out, it looks like, nominal GDP in the US is going to continue to persist at levels above 5 per cent, and that kind of tailwind, suggested that our skepticism would prove too conservative; and that, in fact, in a, 10 per cent bottom line could be achievable -- especially if it were being driven by manufacturing oriented companies who are seeing a pick up from global growth.

Andrew Sheets: Lisa, maybe if I could just ask you kind of one more question related to some of these longer-term assumptions, you know, I imagine you get some skepticism to say, ‘Well, you know, is the market of today really comparable to, say, the stock market of 30 or 40 years ago? Can we really use metrics or mean reversion that's worked in the past when, you know, the world is different.’

Lisa Shalett: Yeah, no, that, that's a fantastic question. I mean, some of the bigger variables in the world that we look at have shown over very long periods of time tendencies to cycle, whether those are things around the business cycle, valuations, cost of capital. Those are the types of variables that over long periods of time tend to mean revert. Same thing volatility. There tend to be long term characteristics. And the history book is pretty convincing that even if sometimes mean reversion is delayed, it ultimately plays out. 

But we do think that there are elements that we need to continue to question, right. One of them is, you know, has monetary policy and central bank intervention fundamentally changed the rules of the game? Where central banks implicitly or explicitly are managing market liquidity as much as they are managing cost of capital; and as a result, the way markets interact with the central bank and the guidance -- is that different?

A second, factor has to do with market structure, right? And in a world where market prices were really being determined almost exclusively by fundamentals, right? There was this constant rotational shift between growth style and value style and where value could be determined in the market. As we've moved to a market that is increasingly driven by passive flows; there's a question that many market participants have raised about whether or not markets have gotten more inefficient because price discovery is actually, in the short run, not what's driving prices, but rather flows; passive flows are driving prices.

And so, you know, how do we account for these leads and lags in prices being actually remarked to fundamentals? So those are at least two of the things that I know we are constantly tossing around as we think about our methodologies and capital market assumptions.

Andrew Sheets: That was part one of my conversation with Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

Look out for part two of our conversation, where we'll be discussing the impact of higher interest rates on asset classes. And how investors should think about an unusually concentrated stock market. 

Andrew Sheets: As a reminder, if you enjoy Thoughts in the Market, please take a moment to rate and review us wherever you get your podcasts. It helps more people find the show.

Original release date April 8, 2024: Our Global Chief Economist explains why the rapid hikes, pause and pivot of the current interest rate cycle are reminiscent of the 1990s.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the current interest rate cycle and the parallels we can draw from the 1990s.

It's Monday, April 8th, at 10am in New York.

Last year, we reiterated the view that the 1990s remain a useful cycle to consider for understanding the current cycle. Our European equity strategy colleagues shared our view, and they've used that episode to inform their ‘out of consensus, bullish initiation on European equities’ in January. No two cycles are identical, but as we move closer to a Fed cut, we reassess the key aspects of that comparison.

We had previously argued that the current interest rate cycle and the mid 90s cycle differ from the intervening cycles because the goal now is to bring inflation down, rather than preventing it from rising. Of course, inflation was already falling when the 1994 cycle started, in part, because of the recession in 1991.

This cycle -- because much of the inflation was driven by COVID-related shocks, like supply chains for consumer goods and shifts in housing for shelter inflation -- inflation started falling rapidly from its peak before the first hike could have possibly had any effect. In recent months, our economic growth forecasts have been regularly revised upward, even as we have largely hit our expected path for inflation.

A labor supply shock appears to be a contributing factor that accounts for some of that forecast deviation, although fiscal policy likely contributed to the real side's strength as well. Supply shocks to the labor market are an interesting point of comparison for the two cycles. In the 1990s, labor force growth was still benefiting from this multi-decade rise in labor force participation among females. The aggregate labor force participation rate did not reach its peak until 2000.

Now, as we've noted in several publications, the surge in immigration is providing a similar supply side boost, at least for a couple of years. But the key lesson for me for the policy cycle is that monetary policy is not on a pre-set, predetermined course merely rising, peaking and then falling. Cycles can be nuanced. In 1994, the Fed hiked the funds rate to 6 per cent, paused at that peak and then cut 75 basis points over 1995 and 1996. After that, the next policy move was actually a hike, not a cut.

Currently, we think the Fed starts cutting rates in June; and for now, we expect that cutting to continue into next year. But as our US team has noted, the supply side revisions mean that the path for policy next year is just highly uncertain and subject to review. From 1994 to 1996, job gains trended down, much like they have over the past two years.

That slowing was reflective of a broader slowing in the economy that prompted the Fed to stop hiking and partially reverse course. So, should we expect the same now, only a very partial reversal? Well, it's too soon to tell, and as we've argued, the faster labor supply growth expands both aggregate demand and aggregate supply -- so a somewhat tighter policy stance could be appropriate.

In 1996, inflation stopped falling, and subsequently rose into 1997, and it was that development that supported the Fed's decision to maintain their somewhat restrictive policy. But we can't forget, afterward, inflation resumed its downward trajectory, with core PCE inflation eventually falling below 1.5 per cent, suggesting that that need to stop cutting and resume hiking, well, probably needs to be re-examined.

So, no two cycles match, and the comparison may break down. To date, the rapid hikes, pause and pivot, along with a seeming soft landing, keeps that comparison alive. The labor supply shock parallel is notable, but it also points to what might be, just might be, another possible parallel.

In the late 1990s, there was a rise in labor productivity, and we've written here many times about the potential contributions that AI might bring to labor productivity in coming years.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Our experts discuss U.S. dollar strength and its far-reaching impact on the global economy and the world’s stock markets.

----- Transcript -----

Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research.

James Lord: I'm James Lord, Head of FX Strategy for Emerging Markets.

David Adams: And I'm Dave Adams, Head of G10 FX Strategy.

Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss one of the most debated topics in world markets right now, the strength of the US dollar.

It's Wednesday, May 1st, at 3 pm in London.

Michael Zezas: Currencies around the world are falling as a strong US dollar continues its reign. This is an unusual situation. So much so that the finance ministers of Japan, South Korea, and the United States released a joint statement last month to address the effects being felt in Asia. The US dollar's dominance can have vast implications for the global economy and the world stock markets.

So, I wanted to sit down with my colleagues, James and David, who are Morgan Stanley's currency strategy experts for emerging markets and developed markets. James, just how dominant is the US dollar right now and what's driving the strength?

James Lord: So, we should distinguish between the role the US dollar plays as the world's dominant reserve currency and its value, which can go up and down for other reasons.

Right now, the dollar remains just as dominant in the international monetary system as it has been over the past several decades, whilst it also happens to be very strong in terms of its value, as you mentioned. That strength in its value is really being driven by the continued outperformance of the US economy and the ongoing rise in US interest rates, while growth in the rest of the world is more subdued.

The dollar's international role remains dominant simply because no other economy or market can match the depth of the US capital markets and the liquidity that it provides, both as a means of raising capital, but also as a store of value for investment; while also offering the strong protection of property rights, strong sovereign credit ratings, the rule of law, and an open capital account. There simply isn't another market that can challenge the US in that respect.

Michael Zezas: And can you talk a bit more specifically about the various ways in which the dollar impacts the global economy?

James Lord: So, one of the strongest impacts is through the price of the dollar, and the price of dollar debt, which have an impact beyond the borders of the US economy. Because the majority of foreign currency denominated debt that corporates outside of the US issue is denominated in US dollars, the interest rate that's set by the US Federal Reserve has a big impact on the cost of borrowing. It's also the same for many emerging market sovereigns that also issue heavily in US dollars. The US dollar is also used heavily in international trade, cross border lending, because the majority of international trade is denominated in US dollars. So, when US interest rates rise, it also tightens monetary conditions for the rest of the world. That is why the US Federal Reserve is often referred to as the world's central bank, even though Fed only sets policy with respect to the US economy.

And the US dollar strengthens, as it has been over the past 10 years, it also makes it more challenging for countries that borrow in dollars to repay that debt, unless they have enough dollar assets.

Again, that's another tightening of financial conditions for the rest of the world. I think it was a US Treasury Secretary from several decades ago who said that the US dollar is our currency, but your problem. And that neatly sums up the global influence the US dollar has.

Michael Zezas: And David, nothing seems to typify the strength of the US dollar recently, like the currency moves we're seeing with the Japanese Yen. It looks very weak at the moment, and yet the Japanese stock market is very strong.

David Adams: Yeah, weak is an understatement for the Japanese yen. In nominal terms, the yen is at its weakest level versus the dollar since 1990. And if we look in real terms, it hasn't been this weak since the late 1960s. Why it's weak is pretty easy to explain, though. It's monetary policy divergence. Theory tells us that as long as capital is free to move, a country can't both control its interest rates and control the exchange rate at the same time.

G10 economies typically choose to control rates and leave their currencies to float, and the US and Japan are no exception. So, while the while the Fed's policy rate has risen to multi-decade highs, Japan's has been left basically unchanged, consistent with its economic fundamentals.

Now, you mentioned Japanese equities, which is also increasingly important to this story. As foreign investors have deployed more cash into the Japanese stock market, a lot of them have hedged their FX [foreign exchange] exposure, which means they're buying back dollars in the forward market. The more that Japanese equities rise, the more hedges they add, increasing dollar demand versus the yen.

So, put simply, the best outcome for dollar yen to keep rising is for US rates versus Japan and Japanese equities to both keep marching higher. And for a lot of investors, this seems increasingly like their base case.

Michael Zezas: That makes sense. And yet, despite the dollar's clear dominance at the moment, the consensus view on the dollar is that it's going to get weaker. Why is that the case and what's the market missing?

James Lord: Yeah, the consensus has been on the wrong side of the dollar call for quite a few years now, with a persistently bearish outlook, which has largely been incorrect. I think for the most part this is because the consensus has underestimated the strength of the US economy. It wasn't that long ago when the consensus was calling for a hard landing in the US economy and a pretty deep easing cycle from the Fed. And yet here we are with GDP growth north of 2 per cent and murmurings of another rate hike entering the narrative. I also wonder whether this debate about de-dollarization, whereby the dollar's global influence starts to wane, has impacted the sentiment of forecasters a bit as well.

We have seen over the past three to four years much more noise in the media on this topic, and there appears to be a correlation between the extent to which the consensus is expecting dollar weakness and the number of media articles that are discussing the dollar's status as the world's major reserve currency.

Maybe that's coincidence, but it's also consistent with our view that the market generally worries too much about this issue and the impact that it could have on the dollar's outlook.

Michael Zezas: Now there've been a few notable changes to Morgan Stanley's macro forecasts over the last few weeks. Our US economist, Ellen Zentner revised up her forecast for US growth and inflation. And she also pushed back our expectations for the first Fed cut. Along with this, our US rate strategy team also revised their 10-year treasury yield expectations higher. Do these updates to the macro-outlook impact your bullish view on the dollar, both near term and longer term?

David Adams: So, higher US rates are often helpful for the dollar, but we think some nuance is required. It's not that US rates are moving; it's why they're moving. And our four-regime dollar framework shows that increases or decreases in rates can give us very different dollar outcomes depending on the reason why rates are moving.

So far this year, rates have been moving higher in a pretty benign risk environment. And in a world where US real interest rates rise alongside equities; the dollar tends to go nowhere in the aggregate. It gains versus low yielding funders like the Japanese yen, the Swiss franc, and the euro, but it tends to weaken versus those higher beta currencies with positive carry, like the Mexican peso. It's why we've been neutral on the dollar overall since the start of the year, but we still emphasize dollar strength, especially versus the euro.

If rising rates were to start weighing on equities, that would lead the dollar to start rallying broadly, what we call Regime 3 of our framework. It's not our base case, but it's a risk we think markets are starting to get more nervous about. It suggests that the balance of risks are increasingly towards a higher dollar rather than a lower one.

Michael Zezas: And finally, Dave, I wanted to ask about potential risks to the US dollar's current strength.

David Adams: I'd say the clearest dollar negative risk for me is a rebound in European and Chinese growth. It's hard for investors to get excited about selling the dollar without a clear alternative to buy. A big rebound in rest of world growth could easily make those alternatives look more attractive, though how probable that outcome is remains debatable.

Michael Zezas: Got it. So, this discussion of risk to the strong dollar may be a good time to pause. There's so much more to talk about here. We've barely scratched the surface. So, let's continue the conversation in the near future when we can talk more about the dollar status as the world's dominant reserve currency and potential challenges to that position.

James Lord: This sounds like a great idea, Mike. Talk to you soon.

David Adams: Likewise. Thanks for having me on the show and look forward to our next conversation.

Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Our analysts survey the hurdles, opportunities and investment trends in energy renovation.

Please note that Laurel Durkay is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley. We make no claim that Ms Durkay’s representations are accurate or complete.

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Cedar Ekblom: Welcome to Thoughts on the Market. I'm Cedar Ekblom, Equity Research Analyst, covering the European building and construction sector for Morgan Stanley Research.

Laurel Durkay: And I'm Laurel Durkay, head of the Global Listed Real Assets Team within Morgan Stanley Investment Management.

Cedar Ekblom: And on this special episode of Thoughts on the Market, we'll discuss the opportunities, risks, and latest investment trends when it comes to decarbonizing buildings.

It's Tuesday, April 30th, at 2pm in London.

Laurel Durkay: And 9am in New York.

Cedar Ekblom: So, let's take a step back. Picture the gleaming towers of New York, London, or Hong Kong. Now think about these buildings breathing out carbon dioxide. The built environment is responsible for about a third of all global energy consumption and CO2 emissions. And so, if we want to get to Net Zero by 2050, which means emitting as much CO2 into the atmosphere as we take out of it, decarbonizing the building stock is essential.

We've been doing a lot of work in Europe from the research side to try and understand how the investment trends are linked to this topic. But Laurel, I wanted to have you on the podcast because I wanted to understand how you're coming at it from the other side as a real estate investor and portfolio manager.

Laurel Durkay: Yeah, Cedar, so I've seen some of your notes and I actually wasn't too surprised by your conclusion that energy renovation is seeing rising investment momentum in Europe. And this is despite the high upfront costs which are driven by government regulation, build cost inflation and higher interest rates.

Cedar Ekblom: Yeah, we decided to do this work because we've had a lot of incoming from investors around what's happening from an investment perspective because we have seen a few government policy sidesteps or backtracks in the last 12 to 18 months around this topic. And so, we did some proprietary survey work in the residential, non-residential and providers of capital space. And we had some really interesting outcomes.

I think the most interesting was that despite the fact that government subsidies have been dialed back a little bit, and the cost of investment has gone up because of inflation, actually private investment is really robust. And I think it's because there is a clear economic incentive that both homeowners and non-residential building owners are actually talking to.

I mean, the first one is that homeowners are telling us that they see a 12 per cent increase in their home equity value if they green that property. And when we look at the non-residential space, what we're seeing is that renovation budgets are up 4 per cent year over year, even in a backdrop of higher interest rates.

We see a huge runway of investment to come through on this topic. It is multi-decade. It's not going to happen overnight.

You're talking about 2.8 trillion euros of investment by 2030 on our estimates, and that number extending to potentially 5 trillion euros by 2050. And that's just in Europe.

Laurel Durkay: So the scope and need for investment really is huge. What do you think are the hurdles to delivering this opportunity?

Cedar Ekblom: It's such an interesting question. I mean, there are so many. It's a little bit daunting at points when you think about it, but we're looking at really complicated projects. We're looking at skills bottlenecks. We're looking at upfront costs being really high. We're also looking at energy policy, not necessarily being aligned in every region in Europe.

So yes, it's going to cost you a lot, but basically the respondents to the surveys tend to suggest that the benefits are actually starting to outweigh those potential costs.

So, Laurel, I think that there's been some really interesting overlaps between what you and I cover, but from different angles. Let me pivot to you. How do you think about sustainability when it comes to real estate investment in your seat?

Laurel Durkay: Yeah, bottom line is that understanding and incorporating sustainability and real estate investing really is very important; and we need to be aware not only of the physical risks, but also those transition risks associated with buildings. Taking a step back, what I'm observing is that real estate is seeing the sustainability focus really play out from three different constituents, and that's from investors, from regulators, and from tenants.

So, from that investor perspective, we're seeing increasing demand for sustainable linked financing investing. Think green bonds. In some cases, you're actually seeing more favorable spreads for green financing versus traditional -- and ultimately that means better cash flows for companies.

We also have that coming from the government. What we see is a continued evolution on regulations, and there have been several real estate specific laws being adopted across the states.

All of these have the objective of providing greater transparency on carbon emissions with the ultimate goal of reducing such emissions. Now lastly, for tenants, we're seeing increasing demand for sustainable and best in class buildings.

There's actually a growing body of evidence that shows sustainability is impacting leasing decisions and resulting in rent premiums

Cedar Ekblom: So, how do we think about integrating ESG into your investment process?

Laurel Durkay: So, there's a number of different metrics that we're looking at. We've run a proprietary analysis really trying to identify the most financially material factors. And we've ultimately concluded that the most important factors to be looking at are the absolute level of emissions and then the progress towards reducing those emissions -- water and waste usage, green certified buildings -- among a number of other factors.

Ultimately, what we need to do is put together a framework that helps us assess the expenditures in order to really adhere to the regulatory requirements that I was just describing and ultimately allow the buildings to enjoy operational cost savings from implementing sustainability measures.

This is really about future proofing buildings and enhancing value.

Cedar Ekblom: So, it sounds like really a topic around trying to understand where they may or may not be stranded assets. We've spoken a lot about this topic in Europe, but maybe you could talk a little bit about what's happening from a sort of policy backdrop in the US.

Laurel Durkay: Yeah, so government really is driving a lot of this change, both at a federal and at a state level. So, from a federal perspective, it really is more of a carrot as opposed to a stick with regard to implementation and adoption, really rewarding those who embrace sustainability. Now, interestingly, from a state perspective, it's a bit more of a stick than a carrot.

Buildings not in compliance will be subject to fines and penalties. I should also mention that the SEC is getting really involved with the adoption of new climate related disclosure requirements.

Now this isn't real estate specific, but it is impactful, nonetheless. New requirements mandate companies to disclose material Scope 1 and Scope 2 greenhouse gas emissions.

Right now, less than 30 per cent of US companies even attempt to disclose Scope 3, and that's even less for real estate. Now Cedar, these scope three emissions are really where our worlds intersect most given the built environment.

So, for a typical property owner, Scope 1 emissions represent about 25 per cent. Scope 2 is about 55 per cent of their missions. And then the remainder is going to be this Scope 3. But if you look at a developer and an owner, that's where you see Scope 3 emissions range between 80 to 95 per cent of their total emissions.

Cedar Ekblom: So, if we look towards the future, what are you hearing from clients and colleagues about where sustainability investment trends go from here?

Laurel Durkay: I think the trends have to be towards reducing these Scope 3 emissions, or maybe I just I hope that's where the trend is. You really need for building developers and owners to focus on development processes, building products and materials, and you need to see innovation within that space.

Now, how about from your side, Cedar? What are you hearing from various companies you cover about the trends they foresee?

Cedar Ekblom: The building materials and products businesses are really bullish on the long-term investment horizon on this topic. And we can see that in some of the data in Europe. The new build environment is under a lot of pressure. Higher interest rates have impacted affordability, and we have some activity in new build down 20 to 30 per cent.

And yet when you look at the renovation and the refurbishment sector, we actually have a much more resilient backdrop.

So look, our companies are really bullish on this. We ultimately see this manifesting in a higher multiple for businesses linked to this theme over the medium term. In all honesty, we're really just at the beginning of this theme. We think there's a lot of runway of investment still to come and we're keeping an eye on it.

So, with that, Laurel, I'd like to say, thanks for taking the time to talk.

Laurel Durkay: It was great speaking with you, Cedar.

Cedar Ekblom: And as a reminder to our listeners, if you've enjoyed thoughts on the market, please take a moment to rate and review us wherever you listen to the podcast. It helps more people to find the show.

Our analysts find that despite the obvious differences between retail fashion and airlines, struggling brands in both industries can use a similar playbook for a turnaround.

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Ravi Shanker: Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's North American Freight Transportation and Airlines Analyst.

Alex Straton: And I'm Alex Straton, Morgan Stanley's North America Softlines, Retail and Brands Analyst.

Ravi Shanker: On this episode of the podcast, we'll discuss some really surprising parallels between fashion, retail, and airlines.

It's Monday, April 29th at 10am in New York.

Now, you're probably wondering why we're talking about airlines and fashion retail in the same sentence. And that's because even though they may seem worlds apart, they actually have a lot in common. They're both highly cyclical industries driven by consumer spending, inventory pressure, and brand attrition over time.

And so, we would argue that what applies to one industry actually has relevance to the other industry as well. So, Alex, you've been observing some remarkable turnaround stories in your space recently. Can you paint a picture of what some fashion retail businesses have done to engineer a successful turnaround? Maybe go over some of the fundamentals first?

Alex Straton: What I'll lead with here is that in my North America apparel retail coverage, turnarounds are incredibly hard to come by, to the point where I'd argue I'm skeptical when any business tries to architect one. And part of that difficulty directly pertains to your question, Ravi -- the fundamental backdrop of the industry.

So, what are we working with here? Apparel is a low single digit growing category here in North America, where the average retailer operates at a mid single digit plus margin level. This is super meager compared to other more profitable industries that Ravi and I don't necessarily have the joy of covering. But part of why my industry is characterized by such low operating performance is the fact that there are incredibly low barriers to entry in the space. And you can really see that in two dynamics.

The first being how fragmented the competitive landscape is. That means that there are many players as opposed to consolidation across a select few. Just think of how many options you have out there as you shop for clothing and then how much that has changed over time. And then second, and somewhat due to that fragmentation, the category has historically been deflationary, meaning prices have actually fallen over time as retailers compete mostly on price to garner consumer attention and market share.

So put differently, historically, retailers’ key tool for drawing in the consumer and driving sales has been based on being price competitive, often through promotions and discounting, which, along with other structural headwinds, like declining mall traffic, e-commerce growth and then rising wages, rent and product input costs has actually meant the average retailers’ margin was in a steady and unfortunately structural decline prior to the pandemic.

So, this reliance on promotions and discounting in tandem with those other pressures I just mentioned, not only hurt many retailers’ earnings power but in many cases also degraded consumer brand perception, creating a super tough cycle to break out of and thus turnarounds very tough to come by -- bringing it full circle.

So, in a nutshell, what you should hear is apparel is a low barrier to entry, fragmented market with subsequently thin margins and little to no precedent for successful turnarounds. That's not to say a retail turnaround isn't possible, though, Ravi.

Ravi Shanker: Got it. So that's great background. And you've identified some very specific key levers that these fashion retail companies can pull in order to boost their profitability. What are some of these levers?

Alex Straton: We do have a recent example in the space of a company that was able to break free of that rather vicious cycle I just went through, and it actually lifted its sales growth and profitability levels above industry average. From our standpoint, this super rare retail turnaround relied on five key levers, and the first was targeting a different customer demographic. Think going from a teens focused customer with limited brand loyalty to an older, wealthier and less fickle shopper; more reliable, but differently.

Second, you know, evolving the product assortment. So, think mixing the assortment into higher priced, less seasonal items that come with better margins. To bring this to life, imagine a jeans and tees business widening its offering to include things like tailored pants and dresses that are often higher margin.

Third, we saw that changing the pricing strategy was also key. You can retrain or reposition a brand as not only higher priced through the two levers I just mentioned, but also try and be less promotional overall. This is arguably, from my experience, one of the hardest things for a retailer to execute over time. So, this is the thing I would typically, you know, red flag if you hear it.

Fourth, and this is very, very key, reducing the store footprint, re-examining your costs. So, as I mentioned in my coverage, cost inflation across the P&L (profit and loss) historically, consumers moving online over time, and what it means is retailers are sitting on a cost base that might not necessarily be right for the new demand or the new structure of the business. So, finding cost savings on that front can really do wonders for the margins.

Fifth, and I list this last because it's a little bit more of a qualitative type of lever -- is that you can focus on digital. That really matters in this modern era. What we saw was a retailer use digital driven data to inform decision making across the business, aligning consumer experience across channels and doing this in a profitable way, which is no easy feat, to say the least.

So, look, we identified five broad enablers of a turnaround. But there were, of course, little changes along the way that were also done.

Ravi Shanker: Right.

Alex Straton: So, Ravi, given what we've discussed, how do you think this turnaround model from fashion retail can apply to airlines?

Ravi Shanker: Look, I mean, as we discussed, at the top here, we think there are significant similarities between the world of fashion retail and airlines; even though it may not seem obvious, at first glance. I mean, they're both very consumer discretionary type, demand environments. The vicious circle that you described, the price deflation, the competition, the brand attrition, all of that applies to retail and to airlines as well.

And so, I think when you look at the five enablers of the turnaround or levers that you pull to make it happen, I think those can apply from retail to airlines as well. For instance, you target a different customer, one that likes to travel, one that is a premium customer and, and wants to sit in the front of the plane and spend more money.

Second, you have a different product out there. Kind of you make your product better, and it's a better experience in the sky, and you give the customer an opportunity to subscribe to credit cards and loyalty program and have a full-service experience when they travel.

Third, you change your distribution method. You kind of go more digital, as you said. We don't have inventory here, so it'd be more of -- you don't fly everywhere all the time and be everything to everyone. You are a more focused airline and give your customer a better experience. So, all of those things can drive better outcomes and better financial performance, both in the world of fashion retail as well as in the world of airlines.

Alex Straton: So, Ravi, we've definitely identified some pretty startling similarities between fashion retail and airlines. Definitely more so than I appreciated when you called me a couple months ago to explore this topic. So, with that in mind, what are some of the differences and challenges to applying to airlines, a playbook taken from the world of fashion retail?

Ravi Shanker: Right, so, look, I mean, they are obviously very different industries, right? For instance, clothing is a basic human staple; air travel and going on vacations is not. It's a lot more discretionary. The industry is a lot more consolidated in the airline space compared to the world of retail. Air travel is also a lot more premium compared to the entire retail industry. But when you look at premium retail and what some of those brands have done where brands really make a difference, the product really makes a difference. I think there are a lot more similarities than differences between those premium retail brands on the airline industry.

So, Alex, going back to you, given the success of the turnaround model that you've discussed, do you think more retail businesses will adopt it? And are there any risks if that becomes a norm?

Alex Straton: The reality is Ravi, I breezed through those five key enablers in a super clear manner. But, first, you know, the enablers of a turnaround in my view are only super clear in hindsight. And then secondly, one thing I want to just re-emphasize again is that a turnaround of the nature I described isn't something that happens overnight. Shifting something like your consumer base or changing investor perception of discounting activity is a multi year, incredibly difficult task; meaning turnarounds are also often multi year affairs, if ever successful at all.

So, looking ahead, given how rare retail turnarounds have proven to be historically, I think while many businesses in my coverage area are super intrigued by some of this recent success; at the same time, I think they're eyes wide open that it's much easier said than done, with execution far from certain in any given turnaround.

Ravi Shanker: Got it. I think the good news from my perspective is that hindsight and time both the best teachers, especially when put together. And so, I think the learnings of some of the success stories in your sector can not only be lessons for other companies in your space; they can also be lessons in my space. And like I said, I think some airlines have already started embarking on this turnaround, others are looking to see what they can do here. And I'm sure again, best practices and lessons can be shared from one sector to another. So, Alex, thanks so much for taking the time to talk to us today.

Alex Straton: It was great to speak with you, Ravi.

Ravi Shanker: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

Our Head of Europe Thematic Research discusses revolutionary “Longshot” technologies that can potentially alter the course of human ageing, and which of them look most investible to the market.

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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Head of Thematic Research in London. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the promise of technology that might help us live longer and better lives.  

It’s Friday, the 26th of April, at 2pm in London.

You may have heard me discuss Moonshots and Earthshots on this podcast before. Moonshots are ambitious solutions to seemingly insurmountable problems using disruptive technology, predominantly software; while Earthshots, by contrast, are radical planet-focused technologies to accelerate decarbonization and mitigate global warming, predominantly hardware challenges.

But today I want to address a third group of revolutionary solutions that I call Longshots. These are the most promising Longevity technologies. And in terms of the three big secular themes that Morgan Stanley is focused on – which are Decarbonization, Tech Diffusion, and Longevity – Longshots straddle the latter two. 

Unlike software-based Moonshots or hardware-based Earthshots, these Longshots face some of the greatest challenges of all. First, we know remarkably little about the process of ageing. Second, these are both hardware and software problems. And third, the regulatory hurdles are far more stringent in healthcare, when compared to most other emerging technology fields.      

We believe the success of Longshots depends on a deep understanding of Longevity. And loosely speaking, you can think of that as a question of whether someone's phenotype can outweigh their genotype. In other words, can their lifestyle, choices, environment trump the genetics that are written into their DNA.

Modern medicine, by focusing almost exclusively on treating disease rather than preventing it, has succeeded in keeping us alive for longer – but also sicker for longer. Preventing disease increases our health spans and reduces morbidity, and its associated costs.

So, in this regard, can we learn anything from the centenarians - the people who live to a hundred and beyond? They number around 30 people in every 100,000 of the population. And many of them live healthy lives well into their eighties. And what makes them so rare is they are statistically better at avoiding what the medical industry calls the Four Horsemen: coronary disease, diabetes, cancer and Alzheimer’s. So, can Longshots help to replicate that successful healthy ageing story for a larger slice of the population?

We look to technology for ways to delay the onset of these chronic diseases by 10 to 30 years, giving healthy life extension for all. That’s not an outlandish goal in theory; but in practice we need a new approach to medical research. And we will be watching how the ten key Longshots we have identified play into this.

Two of these Longshots are already familiar to our listeners: Diabesity medication and Smart Chemotherapy treatments, with a combined addressable market – according to our analysts – of a quarter of a trillion dollars. The other eight Longshots include AI-enabled drug discovery, machine vision embryo selection dramatically increasing the odds of fertility via IVF, bioprinting of organs, brain-computer Interfaces, CRISPR, DNA synthesis, robotics and psychedelics. 

In assessing the maturity and investibility of these ten Longshots, we find that obesity medication, smart chemo, and AI-assisted drug discovery are better understood by the market and look more investible. Many of the others are seeing material outcome- and cost-improvements but they remain earlier-stage, more speculative, particularly for public market investors.

In contrast to Moonshots and Earthshots, where venture investors make up the lion's share of most of the early-stage capital, Longshots have substantially higher exposure to government agencies that make investments in early-stage healthcare projects. Governments are making hundreds of bets on Longshots in searches for solutions to reduce overall healthcare spending – or at the very least get a better return on that investment – which in 2023 amounted to $4.5 trillion in the US, and a whopping $10 trillion globally.

Clearly, the stakes are very high, and the market opportunity is vast, particularly as AI technologies advance in tandem. And so, we’ll keep you updated on the promise of these Longshots. 

Thanks for listening. If you enjoy the show, please leave a review and share Thoughts on the Market with a friend or a colleague today.

With interest in anti-obesity medications growing significantly, the head of our European Pharmaceuticals Team examines just how large that market could become.

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Welcome to Thoughts on the Market. I’m Mark Purcell, head of Morgan Stanley’s European Pharmaceuticals Team. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the enormous ripple effects of anti-obesity drugs across the global economy. 

It’s Thursday, April the 25th, and it’s 2pm in London. 

Obesity is one of the biggest health challenges of our time. More than a billion people are living with obesity worldwide today, with 54 per cent of adults expected to be either overweight or obese by 2035. Growing rates of obesity worldwide combined with rising longevity are putting a heavy burden on healthcare systems.

Our Global Pharma team has covered obesity extensively over the last 18 months. When we wrote our original report in the summer of 2022, the whole debate centered on establishing the patient-physician engagement. The historic precedent we looked at was the hypertension market in the 1980s when high blood pressure was considered a disease caused by stress rather than a chronic illness. And obesity was seen as the result of genetics or a lack of willpower.

But through the influence of social media and an increasingly weight-centric approach to treating diabetes, demand for anti-obesity medications skyrocketed. Back in July 2022, we saw obesity as a $55 billion market. And at that point the key question was if and when these drugs would be reimbursed. 

If you fast-forward to July 2023, what we saw was reimbursement kicking in the U.S. much more quickly than we anticipated. There were almost 40 million people who had access to these medicines, and 80 percent of them were paying less than $25 out of pocket. 

By the end of 2023 we had the first landmark obesity trial called SELECT, and that finally established that weight management saves lives in individuals not living with diabetes. These SELECT data supported the cardiac protection GLP-1 medicines have already established for individuals living with diabetes. We expect weight management with anti-obesity medicines will improve the outlook for more than 200 chronic diseases, or so-called co-morbidities, including heart failure and kidney disease, as well as complications like sleep apnea, osteoarthritis, and even potentially Alzheimer's disease.

Now the debate is no longer about demand for these medicines, but it’s about supply. The major pharma companies in the space are investing almost $60 billion of capital expenditure in order to establish a supply chain that can satisfy this vast demand. 

And beyond supply, the other side of the current debate is the ripple effects from anti-obesity drugs. How will they impact the broader healthcare sector, consumer goods, food, apparel? And how do lower obesity rates impact life expectancy? 

So, with all this in mind, our base case, we estimate the global obesity market will now reach $105 billion in 2030. Right now, supply is being primarily diverted to the U.S., but in the long term we think that the market opportunity will become bigger outside the US. 

Furthermore, the size of the obesity market will be determined by co-morbidities and improved supply. So, if all these factors play out, our bull scenario is a $144 billion total addressable market. However, if supply constraints continue, then we can see a market more restricted to $55 billion as of 2030. So, things are developing fast, and we will continue to keep you updated. 

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

As the U.S. presidential election remains closely contested, our experts discuss what a change in administration could mean for European equities in terms of trade, China relations and other key issues.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research.

Marina Zavolock: And I'm Marina Zavolock, Chief European Equity Strategist.

Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss how the U.S. election could impact European markets.

It's Wednesday, April 24th at 10am in New York.

Marina Zavolock: And 3pm in London.

Michael Zezas: As the U.S. presidential election gets closer and the outcome remains highly uncertain, we're exploring the impact of a potential departure from the current status quo of President Biden in the White House. Today, my colleague Marina and I want to discuss just what that would mean for European equity markets.

Marina, how closely is Europe following the election, and why?

Marina Zavolock: So, European equities derive about 25 percent of their market cap weighted revenues from the U.S. And the U.S. is the largest export market for European firms outside of Europe. So, of course, interest in U.S. elections here is very high; and this is in terms of the exposures of European stocks, sectors, asset classes, and economics as a whole. European investors, I would say that their peak interest in U.S. elections was around the Republican primaries, and it's stayed elevated ever since.

And Mike, I know you want to dig in specifically on how European markets would react in a change in status quo scenario. But first let's talk about your outlook on some of the key policies that may change if Biden loses the election. What are your thoughts on trade policy and tariffs?

Michael Zezas: Trump's been clear about his view that countries levying higher tariffs on U.S. imports than the US levies on their imports is unfair, and he's willing to correct it with tariffs. And while in his term as president he focused more on China, he was interested in tariff escalation with Europe. But he reportedly was moved off that position by advisors and members of his own party who were wary of creating more noise in the transatlantic alliance. But this time around, the Republican party's views are much more aligned with Trump's. So, imports on European goods like autos could easily come into scope.

Marina, how are you thinking about the impact of potentially higher tariffs on the European market? What sectors might be most affected?

Marina Zavolock: The initial reaction to recent tariff related headlines we've been fielding from investors is around the risks to our bullish European equities view in particular. The general investor feedback we get is that European equities may continue to rally for now, but as we approach November and as we approach US elections, the downside risks from this event start to build.

What our in-depth analysis demonstrates, however, is that it's far more nuanced than that. As I mentioned, Europe derives about 25 per cent of its weighted revenues from the US. But, when we've dug into that number, most of these revenues are in the form of services or local to local goods, meaning goods produced locally in the US and sold in the US -- but by European companies. Only about 6 per cent of Europe's overall weighted revenue exposure is to goods exported into the US. So, we find the risk is far more idiosyncratic from a change in tariff policy than broad based. And in terms of individual sectors most exposed to tariff risks, these include a lot of healthcare sectors -- med tech, life sciences, pharma, biotech -- aerospace as well, metals and mining; of course, autos as you mentioned, and a number of others.

After tariffs, the Inflation Reduction Act (IRA) is the next most common policy area we get asked about in Europe, given relatively high exposures for European utilities, construction materials, and the capital goods sector.

Overall, we find European equities aggregate exposure to IRA is also low, is less than 2 percent of weighted revenues, so even lower than that of tariffs. But the stocks most exposed in Europe to IRA are underperforming the rest of the market. What are your scenarios around the IRA if Trump wins, Mike?

Michael Zezas: Well, we think the money appropriated in the IRA is here to stay. Many of that program's investments overlap with geographies represented by Republicans in Congress, which means repealing the IRA may be a better talking point than a political strategy -- similar to how Republicans in 2017 failed to repeal the Affordable Care Act despite campaigning on that as a priority. But Trump could certainly slow the spending of that money through regulatory means such as ratcheting up the rules about how much of the materials involved have to be sourced from within the US.

Now switching gears, Marina, you mentioned the performance of European stocks related to our election scenarios. Based on your recent work, you have very granular stock level data on relative exposure to potential administration policies. How are stocks with the greatest exposures behaving overall?

Marina Zavolock: Yeah, this was a very interesting conclusion from our work. We thought that it's still fairly early ahead of US elections for stocks to start to diverge on the basis of potential policy changes. But what we found when we surveyed our analysts and collected data for over 350 European stocks with material US exposure is that when we break out these exposures and we aggregate them, the stocks with the highest level of potential risk exposure to Trump administration policies are underperforming the overall market. And the stocks with the greatest potential positive exposure, to Trump administration policies are outperforming.

And then you have groups like moderate exposure that are in the middle, and these groups, no matter how we slice the data for different policies, are lining up. Exactly as you might expect, depending on their level of exposure as the market starts to price in some probability of either scenario coming through. We're also starting to see the volatility of the stocks most exposed start to rise. But this is a very early trend.

The other big area that we get asked about is China. So, Europe has about 8 per cent of its weighted revenues exposed to China. It's the highest of any major developed market region in the world. What are your expectations about China policy under a new Trump administration?

Michael Zezas: Well, it's bipartisan consensus now that China is a rival and that more protective barriers to trade are needed to protect the US' tech advantage in order to safeguard US national and economic security. But like with Europe, Trump appears more willing to use tariffs as a tool in this rivalry, which can create more rhetorical and fundamental noise in the economic relationship.

Marina, how do you think this would impact Europe?

Marina Zavolock: So, we've been talking about China as a risk factor for some time for a variety of reasons, and recently when I mentioned that European stocks are starting to react to potential change in administration policies. This hasn't so much been the case on China exposures. China exposures are behaving as they were before. We're not seeing any great divergences as we approach elections; though in our overall model, we do favor sectors with lower exposure to China.

Mike, and how are you thinking about Ukraine? We have a huge amount of interest in the defense sector, and it's one of the best performing sectors in Europe this year.

Michael Zezas: Yeah. So here Trump's been pretty clear that he'd like to push for a rapid reconciliation between Russia and Ukraine. What investors should pay attention to is that a Trump attempt at rapid reconciliation, perhaps in contrast with the European approach. And then when you couple that with potential tariffs on Europe from the US, it can send a signal to Europe that they have to shift their own defense and economic strategy. And one manifestation of that could be greater security spending, particularly defense spending in Europe and globally. It's a key reason why defense is a sector we favor in both the US and Europe.

So, Marina, what are some of the bottom-line conclusions for investors?

Marina Zavolock: I think there's two main conclusions from our work. First, the aggregate exposures in Europe to potential changes in policy from a Trump administration are pretty low and quite idiosyncratic by stock. We talked about a few of the greatest exposure areas, but in aggregate, if we take all the policy areas that we've analyzed, net exposure of Europe's revenues is about 7 per cent.

Second, the stocks that are most exposed, either positively or negatively, are already moving based on those relative exposures, and we think that will continue, and these groups of stocks will also have increased volatility as we get closer to November.

Michael Zezas: Marina, thanks for taking the time to talk.

Marina Zavolock: Great speaking with you, Mike.

Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts; and share Thoughts on the Market with a friend or colleague today.

Important note regarding economic sanctions. This research references country/ies which are generally the subject of comprehensive or selective sanctions programs administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Any references in this report to entities, debt or equity instruments, projects or persons that may be covered by such sanctions are strictly informational, and should not be read as recommending or advising as to any investment activities in relation to such entities, instruments or projects. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.

New data on both immigration and inflation defied predictions and may have shifted the Fed’s perspective. Our Chief U.S. Economist and Head of U.S. Rates Strategy share their updated outlooks.  

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Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief US Economist.

Guneet Dhingra: And I'm Guneet Dhingra, Head of US Rates Strategy.

Ellen Zentner: And today on the podcast, we'll be discussing some significant changes to our US economic outlook and US rates outlook for the rest of this year.

It's Tuesday, April 23rd at 10am in New York.

Guneet Dhingra: So, Ellen, last week you put out an updated view on your outlook -- with some substantial forecast changes. Can you give us the headlines on GDP, inflation and the Fed forecast path? And what has really changed versus your last update?

Ellen Zentner: Sure Guneet. So, our last economic outlook update was in November last year. And since that time, really, the impetus for all of these changes came from immigration. So, we got new immigration data from the CBO, and just to give you a sense of the magnitude of upward revision, we thought we had an increase of 800,000 in 2023. It turns out it was 3.3 million. And so far, the flows of immigrants suggest that we're going to get about as many as last year, if not a little bit more. And so, what does that mean? Faster population growth, those are more mouths to feed. You've got a faster labor force growth. They can work. They are working. And data historically shows that their labor force participation rates are higher than native born Americans.

So, you've got to take all this into account. And it means that you've got this big positive supply side shock. And so, when the labor market has been about balance now between demand and supply, as Chair Powell's been noting, you're now going to have supply outrun demand this year.

And so, you basically got much more labor market slack. You've got -- and I'm going to steal Chair Powell's words here -- you've got a bigger economy, but not a tighter economy. So, it's faster GDP growth. We have taken out one Fed cut, and I know we're going to talk about that because inflation has surprised the upside recently. But you've got slower wage growth. More labor market slack. And so, we did not change our overall inflation numbers on the back of this better growth and better labor force growth.

Guneet Dhingra: That's very helpful. That's a very interesting read in the economy, Ellen. Do you think the Fed is reading the supply side story the same way as you are? And said differently, is the Fed on the same page as you? And if not, when do you think they could be?

Ellen Zentner: Yeah. So, you know, Chair Powell, if you go back to his speeches and the minutes from the Fed. They've been talking about immigration. I think we've known for a while that the numbers were bigger than previously thought. But how you interpret that into an outlook can be different. And it takes some time. It even took us some time -- about a month -- to finally digest all the numbers and figure out exactly what it meant for our outlook. So, here's the biggest, I think, change for them in terms of what it means. The break-even level for payrolls is just that much higher.

Now what does break even mean? It means it's the pace of job gains you need to generate each month in order to just keep the unemployment rate steady. And six months ago, we all thought it was 100, 000, including the Chair. And now we think it's 265,000. That is eye popping. And it means that when you see these big labor market numbers -- 250, 000; 300,000. That's normal. And that's not a labor market that's too tight.

And so, I think the easiest thing the Fed, has realized is that they don't need to worry about the labor market. There's a lot more slack there. There's going to be a lot more slack there this year. Wage growth has come down because of it. ECI, or Employment Cost Index, is going to come down for this year. The unemployment rate is going to be higher. They do still need to reflect that in their forecast. And that means that we could show, sort of, this flavor of bigger but not tighter economy when we get their forecast updates in June.

Guneet Dhingra: I think the medium-term thesis is very compelling, Ellen, but how do you fit the three back-to-back upside surprises in CPI here? How does that fit with the labor supply story?

Ellen Zentner: So, that is sort of disconnected from the bigger but not tighter economy, because we did have to take into account that inflation has surprised to the upside. I mean, these have been some real volatile prints in the last three months, and we're now tracking March core PCE at 0.25 per cent and we're going to get that number later this week. And so that's above the threshold that we think the Fed needs in order to gain confidence that that pace of deceleration we saw late last year, is not in danger of slowing down for them to gain further confidence.

Ellen Zentner: And so, the way I would characterizes this is that it's a bigger but not tighter economy. But we also had to take into account these inflation upside surprises, which is really what led us to push the June cut off to July.

So, after we get that March, core PCE print, let's see what that data holds, but we think a few prints around 0.2 per cent are needed to satisfy Chair Powell, and gain that consensus to cut. So, I want to stress to the listeners that, you know, our conviction that inflation will head toward target remains high.

And it was also helped last week by fresh data on new tenant rents. So that is a leading indicator for rental inflation in our models. And it's slowed again. And suggests an even faster pace of deceleration ahead.

But here's where I think it matters for the Fed. Whereas before, they were very convicted that this rental inflation story was going to play out, that rent inflation was going to come down. They used similar models to us. But because of the inflation data being so volatile over the past three months, rather than providing forward guidance on what you're going to do around rental inflation coming down, you want to see it. You want to see it in the data. And so that's why they've been so willing to say, you know what, we're just going to, we're going to hold longer here.

Guneet Dhingra: Perfect. So just to get the Fed call on the record, what exactly are you calling for the Fed? And I know investors love the hypothetical question. What is the probability in your mind that the Fed doesn't cut at all in 2024?

Ellen Zentner: Yeah, they do love scenario analysis. So here we go. So, our baseline is they cut in July. They skip September. By November, the inflation data is coming down to monthly prints that tell them they're on track for their 2 per cent goal and at risk of falling below it. So, from November to June next year, they're cutting every meeting to roughly around three and a half percent.

Now, as you asked, what if inflation doesn't go down? So, inflation doesn't go down, you know, then the Fed's forecast and our forecast are going to be wrong and the three rate cuts they envision is predicated on that inflation forecast coming true. So, you know, the most important takeaway from that scenario is that the result would be a Fed on holder for longer. But as opposed to a hike being the next move -- and I think that's really important here. The Fed is still very strongly convicted on they will cut this year. This is about the timing. Now, the hold period could last into 2025, I mean, we don't know, but what happens if inflation accelerates from here?

So, I'm going to provide another scenario here. So, there is a scenario where inflation accelerates on a backdrop of strong growth, which would suggest it might be sustained, and perhaps begins to lift inflation expectations. Now, you know, that's a recipe for a hold that then turns into additional hikes as the Fed realizes neutral is just higher than where rates currently sit. But at this point, I would put quite a low probability on that scenario. But from a risk weighted perspective, I suppose it should be taken into account.

So, given all this and the changes that we've made, what is your expectation for rates for the rest of the year?

Guneet Dhingra: Yeah, I think we also, based on the forecast revision you guys have, we also revised up our treasury yield forecast. We earlier had 10 year yields ending slightly below 4 per cent by the end of 2024. Now we have them at about 4.15 percent which again is a 20-basis point uplift from our forecast before this. But still, I think it's not the higher for longer number that people are expecting because when I look at the forecast you have on the Fed, I think Fed path you have is well below what the markets expect.

I think the forecast you have has about seven cuts from July this year to the middle of next year. The market for contrast is only four. There's a pretty massive gap that opens up, I think, between the way we see it -- and ultimately that does come down to the interpretation of the data that we're seeing so far.

So, for us, the forecast numbers are slightly higher than before, but the message still is: we are not in the hire for longer camp, and we do expect rates to end up below the market applied forwards.

Ellen Zentner: All right. So, you know, I've talked a lot about immigration. One could say I've been pretty obsessed with it over the last couple of months. But from a rates perspective, you know, what are the broader implications of the immigration story for that? You know, this, this bigger but not tighter economy. How do you translate that into rates?

Guneet Dhingra: Yeah, let me say your obsession has been contagious. You know, I've caught on to that bug, the immigration bug. And, you know, I've been I've been discussing this thesis with investors, quite a lot. And I think it seems to me as you framed it pretty nicely. It's a bigger but not a tighter economy. I don't think investors have caught on to that page yet. I think most investors continue to think of these inflation prints is telling you that this is a tighter economy. Bigger, yes -- maybe on the margin. But the tighter part is still very much in people's minds. And when I look at the optics off the CPI numbers, the payroll numbers, investors have just been very conditioned, very reflexively conditioned to look at a 250K number on payrolls as a very strong number. They look at the 3 per cent number of GDP as a very strong number.

And as you laid out earlier, these numbers may not be necessarily telling you about an overheating economy. But simply a bigger economy. So, I think the disconnect is there, pretty pervasive. And I think for me, most investors will take a lot of time to get over the optics. The optics of three strong points of inflation, the optics of 250K payrolls. I think it's gradually seeping in. But for now, I think the true impact or the true learnings from the immigration story is not very well understood in the investment community.

Ellen Zentner: Okay, but is there, is there anything else missing in your view?

Guneet Dhingra: Yeah, quite a few things. I think you can add more nuances to this immigration story itself. For example, when I think about last year, when rates were going up massively in third quarter, fourth quarter, one of the focal points was Atlanta Fed GDP Now. My GDP now was tracking close to four and a half, five per cent, and inflation was cooling pretty clearly in the second half of last year. And so investors had a choice to make. Do we actually trust the GDP growth numbers? Because they are probably an inflation risk in the future. And the markets very clearly chose to focus on growth with the belief that this growth is eventually going to lead to high inflation. And so, I think that disconnect has really translated into, sort of, what I would call like a house of cards where investors have built the entire market level on growth upside, and growth upside, and growth upside.

So, I think the market level -- when I do the math and try and suss out the counterfactual -- the market level of 4.6 per cent tenure should have and could have been a market level of 3.8 per cent tenure based on my calculations. And so, there's an 80-basis point gap from where we are to where we could have been based on a misunderstanding of the supply story and the immigration story.

Ellen Zentner: Yeah, I certainly wish the volatility was a lot lower here. It would make it easier for the Fed and for us to separate signal from noise. Certainly difficult for market participants to do that. But Guneet, thanks for taking the time to talk.

Guneet Dhingra: Great speaking with you, Ellen.

Ellen Zentner: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to podcasts and share the podcast with a friend or colleague today.

Recent data indicates the economy may avoid either a soft or hard landing for now. Our Chief U.S. Equity Strategist explains why investors should seek out quality as the economy stays aloft.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of better economic growth and stickier inflation on stocks.

It's Monday, April 22nd at 11:30am in New York. 

So let’s get after it.

In our first note of the year, I cited three potential macro-outcomes for 2024 with similar probability of occurring.

First, a soft landing with slowing, below potential GDP growth and falling inflation toward the Fed's target of 2 per cent. Second, a no landing scenario under which GDP growth re-accelerated with stickier inflation. And third, a hard landing, or recession. 

Of course, each scenario has very different implications for asset prices generally and equity leadership, specifically. Just a few months ago, the consensus view skewed heavily toward a soft landing. However, the macro data have started to support the no landing outcome with recent growth and inflation data exceeding most forecasters' expectations – including the Fed’s. 

Over the past year, consensus views have gone from hard landing in the first quarter of 2023 to soft landing in the second quarter, back to hard landing in the third quarter to soft landing in the fourth quarter, and now to no landing currently. This shift has not been lost on markets with assets that benefit from higher inflation doing well over the past few months. However, while cyclically sensitive stocks and sectors have started to outperform, quality remains a key attribute for the leaders. 

We think this combination of quality and cyclical factors makes sense in the context of what is still a later, rather than early cycle re acceleration in growth. If it was more the latter, we would not be observing such persistent under performance of low-quality cyclicals and small caps. Furthermore, we continue to believe much of the upside in economic growth over the past year has been the result of government spending, funded by growing budget deficits. 

This has led to a crowding out of many smaller and lower quality businesses – and the lowest small business sentiment since 2012. As with most fiscal stimulus packages, the plan is for the bridge of support to buy time until a more durable growth outcome arrives – driven by organic private income, and consumption and spending. 

Until this potential outcome is more solidified, the equity market should continue to trade with a quality bias. The largest risk for stocks more broadly is higher 10-year Treasury yields as investors begin to demand a larger term premium due to higher inflation and the growing supply of bonds to pay for the endless deficits. 

While leadership within the equity market continues to broaden toward cyclicals it still makes sense to stay up the quality curve. Our recent upgrade of large cap Energy fits the shifting narrative to the no landing outcome, and it remains one of the cheapest ways to get exposure to the reflation theme. Other reflation trades are more extended in our view. Our primary concern for equities at this point is that aggressive fiscal spending has led to better economic growth. But it keeps upward pressure on inflation and prevents the Fed from cutting interest rates that many economic participants desperately need at this point. 

In short, a no landing outcome may make the crowding out problem even worse for smaller businesses, many consumers and even regional banks. This is all in-line with our 2024 outlook that suggests the major equity indices are overvalued while the best opportunities are likely beneath the surface in underappreciated sectors like energy that are positively levered to stickier inflation and higher interest rates. 

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to podcasts and share the podcast with a friend or colleague today.

Japan and India are currently set to lead growth in these markets, but a higher-for-longer rate environment in the U.S. could favor China, Hong Kong and others, according to our analyst.

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Daniel Blake: Welcome to Thoughts on the Market. I'm Daniel Blake from Morgan Stanley's Asia & Emerging Market Equity Strategy Team. Along with my colleagues bringing you a variety of perspectives, today I'll discuss whether U.S. macro resilience is too much of a good thing when it comes to its impact on Asia's equity markets.

It's Friday 19th of April at 10am in Singapore.

Our U.S. economics team has substantially lifted its forecast for 2024 and 2025 GDP growth following strong migration boosted activity and employment trends. Recent inflation readings have been bumpy, but our team still sees it moderating over the summer as core services and housing prices cool off. While the market has been focused on this silver lining of stronger global growth, the clouds are rolling in from expectations of a shallower and later easing of global monetary policy.

Our team now believes that the first Fed rate cut won't come until July but does see two additional cuts coming in November and December. We've made similar adjustments in our outlook for Asia-ex-China's monetary policy easing cycle, seeing it coming later and shallower. Meanwhile, in Japan, our economists now expect two further hikes from the Bank of Japan -- in July this year, and again in January next year -- taking policy rates up to 0.5 per cent.

But how does all this leave the Asia and EM equity outlook? In a word, mixed.

We see this driving more divergence within Asia and EM, depending on how exposed each market is to stronger global growth, a stronger U.S. dollar or impacted by higher interest rates. On the positive side, Taiwan, Japan, Mexico, and South Korea have the most direct North American revenue exposure. And for Japan, the strong US dollar is also positive through the translation of foreign revenues back at this historically weak yen. However, in the short run, we do need to be mindful of any price momentum reversal as April is normally seasonally weak, and we do see dollar-yen approaching 155. So, any FX (foreign exchange) intervention could sharpen a price momentum reversal.

Next up, we're paying close attention to India's equity market, where we have a secularly bullish view. India has remained resilient to date, consistent with our thesis that macro stability has become a key driver of the bull market. And this is in sharp contrast to prior cycles. For example, during the Taper tantrum of 2013, where India saw a sudden and sharp bear market as Fed expectations shifted.

On the negative side then, we are seeing a breakdown in correlations of some markets with these higher Fed funds expectations, including in Indonesia and Brazil where policy space is being constrained, and in Australia where valuations were pushed up on hopes of an RBA easing cycle that won't come until next year in our view.

So, this is indeed a mixed picture for Asia and EM, but we retain our core views that market leadership will continue coming from Japan and India through 2024. And so, what's the risk from here? The larger risk to Asia and EM markets, we think, comes from an even more inflationary and hawkish scenario where the Fed is forced to recommence rate hikes, ultimately bearing the risk of driving a hard landing to bring inflation back to target.

In this scenario, we could see a pivot in leadership away from markets with high US revenue exposure, such as Taiwan and Japan, towards more domestically oriented and resilient late cycle markets, such as an emerging ASEAN partner, and potentially China and Hong Kong -- if additional stimulus is forthcoming there.

Thanks for listening. If you enjoyed the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

GenAI will likely drive the exponential growth of data centers. Listen as our Capital Goods Analyst shares key takeaways on the electrical equipment central to the data center market.

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Welcome to Thoughts on the Market. I’m Max Yates from the European Capital Goods team. Along with my colleagues bringing you a variety of perspectives, today I'll focus on the critical element of the AI revolution. 

It's Thursday, April 18, at 2pm in London. 

Over the last few weeks, several of my colleagues have come on to the show to talk about the exponential growth of data centers and just what it will take to power the GenAI revolution. Stephen Byrd, Morgan Stanley's Head of Global Sustainability, forecasts that in 2027 data center power consumption just from GenAI will equal 80 percent of the consumption from all data centers in 2022.

This shows the sheer scale of necessary additions and upgrades. And it also makes clear that the AI push provides very significant opportunities for Electrical Equipment companies. It’s these businesses that are the picks and shovels of the AI revolution. These companies provide key solutions such as Data Center Infrastructure Management software, connected equipment, racks, switchgears, and last but not least, cooling. 

Keep in mind that in this breakneck AI race, ever-increasing efficiency is essential. So, imagine we’re inside an actual data center. What you’d see is a huge number of racks, the steel frameworks that house the servers, cables, and other equipment. The power needed to run GenAI then creates a lot of heat.

Our recent work on the data center market suggests two key takeaways when it comes to the electrical equipment.

First, there’s a significant imbalance in supply-demand. Data center vacancy rates and rental prices all point to an intensifying capacity shortage. This explains why the top 10 cloud providers have increased their capital expenditures this year by 26 per cent. Equipment shortages and lead times are still an issue in the industry and large electrical equipment suppliers have a clear competitive advantage at the moment, with their stronger supply chains and ability to actually deliver this equipment. 

The second thing we found from our work, there are well-known and less well-known ways to deal with increasing power density. Now why is power density rising? Because what we’re trying to do is cram more high-power chips into the same amount of space. There’s more power per rack, higher computing workload that all has to be accommodated into less floor space. This higher power density, however, requires more powerful cooling solutions. 

But there’s also smaller changes that can support airflow management that are less talked about in the industry. This is things like busways, to reduce cable density and promote airflow. Smart equipment provides information on power consumption. And another key element is rear-door cooling, which pushes airflow through the servers.

The other theme that’s gaining traction in the industry to facilitate a faster ramp up is the idea of modular data centers. This helps equipment suppliers plan supply chains but also customers to quickly ramp up and meet the new data center demand with more standardized data center offerings. However, there’s not yet an industry standard to manage higher data center power and rack density for AI. There will be new builds. There will also be data center upgrades. However, there’s no consensus yet on exactly how the power equipment will be configured, and when the data centers will be upgraded. And in what style and what way.      

This is clearly a dynamic space to watch, and we’ll be keeping you updated.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to your podcasts. It helps more people to find the show.

As global conflicts escalate, our Global Head of Fixed Income and Thematic Research unpacks the possible market outcomes as companies and governments seek to bolster security. 

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about current geopolitical tensions and their impact on markets.

It's Wednesday, April 17th at 10:30 am in New York.

Continued tensions in Middle East kept geopolitics in focus with clients this week. But markets seem to be shrugging off the recent escalation in the conflict, with relative stability in oil prices and equities. This implies some faith in the idea that the involved parties benefit from no further escalation – and will design responses to one another that won’t lead to a broader conflict with bigger consequences. 

But obviously, this tricky dynamic bears watching, which we’ll be doing. In the meantime, there’s a key market theme that’s underscored by these tensions. And that’s the idea of Security as a secular market theme.

This is a topic we’ve been collaborating with many research teams on, including Ed Stanley, our thematics analyst in Europe, and defense sector research teams globally. The idea here boils down to this. Russia’s invasion of Ukraine, the US’ increased rivalry with China, questions about the future of NATO, and of course the Middle East conflict, all reminds us that we’re in a transition phase to a multipolar world where security is more tenuous. That requires a lot of spending by companies and governments to cope with this reality. In fact, we estimate that supply chains, food and health systems, IT, and more will require about $1.5 trillion of investment across the US and EU to protect against rising geopolitical risks. This means a lot more demand for global tech and industrials.

And of course it means more demand for the defense sector. Regardless of whether US military aid plans continue to stall, there’s news of increased spending in China, Canada, and Europe. Our head defense analyst in Europe, Ross Law, and our head European Economist Jens Eisenschmidt have looked at this in recent weeks. They argue there’s scope for tens of billions of euros in extra spend annually in Europe, with a greater geopolitical shock putting that number into the hundreds of billions. It’s a key reason our equity research colleagues favor the US and EU defense sectors.

Bottom line, geopolitical events continue to reflect the transition to a multipolar world. And as companies and governments seek security in this world, there will be market impacts. We’ll be tracking them here.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

Our Global Head of Sustainability Research and U.S. Utilities Analyst discuss the rapidly growing power needs of the GenAI enablers and how to meet them.

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Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research.

David Arcaro: And I'm Dave Arcaro, Head of the US Power and Utilities team.

Stephen Byrd: And on this episode of the podcast, we'll discuss just what it would take to power the Gen AI revolution.

It's Tuesday, April 16th at 10am in New York.

Last summer, scientists used GenAI to find a new antibiotic for a nasty superbug. It took the AI system all of an hour and a half to analyze about 7,000 chemical compounds; something that human scientists would have toiled over for months, if not years. It's clear that GenAI can open up breathtaking possibilities, but you have to stop and think. What kind of compute power is needed for all of this?

A few weeks ago, our colleague Emmet Kelly, who covers European Telecom, discussed the exponential growth of European data centers on this podcast. And today, Dave and I want to continue the conversation about this critical moment of powering the GenAI revolution.

So, Dave, what is your current assessment of the global power demand from data centers?

David Arcaro: Yeah, Stephen, we're expecting rapid growth in the power demand coming from data centers across the world. We're currently estimating data centers consume about one and a half per cent of global electricity today. We're expecting that to grow to almost four percent in 2027. And in the US, data centers represent roughly three percent of total electricity consumption now, and we expect that to escalate to eight per cent of the total US by 2027.

And there will be even more dramatic impacts at the local and regional level. The data center landscape tends to be highly concentrated, and the next wave of GenAI data centers is likely to be much larger than the previous generation.

So, the impact on specific regions will be magnified. To give an example, in Georgia, the utility there has previously forecasted just half a percent of annual growth in electricity use but is now calling for nine per cent of annual growth in electricity consumption, and that's largely driven by data centers.

It's a dynamic that we haven't seen in decades in the utility space.

Stephen Byrd: You know, what I find interesting about what you just said, Dave, is -- it is impressive to see growth go from one and a half to four per cent, but it's really these local dynamics where what we're seeing is just much more concentrated, and that's where we start to see the real issues with the infrastructure growing quickly enough.

So, it's becoming obvious that the existing power grid infrastructure is not meeting the growth and capacity needs of data centers. And that's something that you refer to as the tortoise and the hare. How big of a mismatch are we exactly talking about here, Dave?

David Arcaro: It's definitely a big mismatch. To your point before, the US electricity growth across the country has been flattish over the last 10 years.

So, this is a step change in expectations now, from the impact from Gen AI going forward. And we're looking at over 100 per cent annual growth in the power consumed by data centers now in the US over the next four years. And for comparison, the US utility industry is growing at about 8 per cent a year.

These data centers that are coming are huge. They can be 10 to 50 times as big as the last generation of data centers in terms of their power consumption. And this means it takes time to connect to the electric grid and get power. 12 to 18 months in the best case, three to five years plus in other locations, often because they might need to wait for the electric utility grid to catch up, waiting for grid upgrades and assessments and new power plants to get built.

Stephen Byrd: Well, I think those delays are going to be fairly problematic for the fast-moving GenAI sector. So essentially there's a lot of pressure on data center developers to secure a power source as quickly as possible. And in our note, we described the mathematics around that. The time value to get these data centers online is absolutely enormous. But you've just described the power grid infrastructure as a tortoise.

So, are there any other alternatives? How about nuclear power plants in this context?

David Arcaro: There's a lot of urgency, as you can tell from the data center companies, to get online as fast as possible. It's a fast-moving market, very competitive, they need the power, they need to run these GenAI models as soon as possible. And the utility industry is not used to responding to demand that's coming this quickly.

It's a slower moving industry. There's policies and processes and regulation that all utilities have to get through. They're not prepared strategically to move as quickly as the data center industry is moving. So, data center developers are getting creative and they're looking at all options to get power.

And one that has an appealing value proposition is nuclear plants. By placing a data center at an existing nuclear plant, this can avoid the need to go through that lengthy electric grid connection process, providing a much faster timeline to get the data center powered up.

And that has big benefits for the data center companies, as you can imagine. Nuclear plants also have other advantages. They have land available on site. They have water for cooling, security. It's 24x7 clean power with no emissions, and it's already up and running, so you don't have to go and build much.

Over time, we do expect renewables to play a major role as well in powering data centers along with traditional power from the electric grid and even new gas plants, but the benefits of coming online quickly in this market we think, give nuclear an edge.

So, Stephen, as much as I can talk about the massive power needs of Gen AI, we can't ignore the issue of sustainability. So, what have you been thinking about when it comes to assessing the potential carbon footprint of powering data centers? What concerns are you seeing?

Stephen Byrd: You know, Dave, this field is evolving so quickly that we've had to evolve our assessment of the carbon footprint of GenAI quite quickly as well. You know, traditionally what we would have seen is a data center gets connected to the grid. And then that data center developer would often sign a power contract with a renewable developer. And that results in a very low carbon footprint, if zero in many cases. But going forward, we do see the potential for increased natural gas usage in power plants, higher than we had originally forecast.

And that's driven really by two dynamics. The first is the increased potential to site data centers directly at nuclear power plants, which you described, and there are a lot of benefits to doing so. In effect, what's going to happen then is, those data centers will siphon away that nuclear power, so less nuclear power goes to the grid. Something has to make up that deficit. That something is often going to be natural gas fired power plants.

The second dynamic that we could see happening is an increased potential for just onsite natural gas fire power generation at the data centers that could provide shorter time to power, and also provide quite good power reliability.

Now, when we sum these up and we look at the projected carbon footprint of data centers going forward, we could see an additional 70 million tons a year. We're about half a per cent of 2022 global CO2 emissions for data centers. That is quite a bit higher than we had previously forecast.

Now that said, a wild card would be the hyperscalers and others who may decide to consciously offset this by signing additional power contracts with new renewables that could reduce this quite a bit. So, it's very much in flux right now. We frankly don't know what the carbon footprint is really going to look like.

David Arcaro: You know, there's so much urgency to bring data centers online quickly that in the past many of these big hyperscalers especially have had quite ambitious sustainability goals and decarbonization goals. I'd say it's an open question on our end as to how flexible they might get in the near term or how strictly they do apply those decarbonization …

Stephen Byrd: Exactly…

David Arcaro: … targets going forward as they, y’know, also try to compete in an urgent grab for power in the near term.

Stephen Byrd: That's exactly right. That's… You laid that tension out quite well.

David Arcaro: And finally, from your global perspective, what regions are best positioned to keep pace with the power needs of Gen AI?

Stephen Byrd: You know, Dave, I am thinking a lot about what you said a minute ago, about the size of these datacentres moving from, you know, quite small – often we would see datacentres at just 10 or 15 megawatts. Now the new designs are often above 100 megawatts.

And now we're starting to hear and see some signs of truly mega data centers, essentially massive supercomputers that could be a thousand megawatts, a couple of thousand megawatts, and could cost tens of billions of dollars to build. So, when we think about that dynamic, that's a lot of power for any one location. So, to go back to your question, we think about the locations. It's very local specific.

The dynamics all have to line up correctly, for this to work. So, we see pockets of opportunity around the world. Examples would be Pennsylvania, Texas, Illinois, Malaysia, Portugal -- these are locations for a variety of reasons where policy support is there, the infrastructure growth potential is there, and for a number of reasons, just it's the right confluence of dynamics. Most of the world doesn't have that confluence, so it's going to be very specific. And I think we're also setting up for a lot of concentration in those locations where all these dynamics line up.

David Arcaro: You know, historically, the data center industry in the US has been highly concentrated, like you say, in Northern Virginia, in Northern California, they've been data center hubs, but we're running into infrastructure constraints there, we've got to look elsewhere. And some of these factors, geographically, are going to be extremely important.

Where is their local support? And one of the dynamics we think could happen is that as you build more data centers that are very power hungry, that could push up the price of power. And what kind of local pushback might you get in that situation? What's the local desire to have a data center from an employment perspective and property tax and local benefit perspective? And how does the cost benefit weigh against the potential for higher power prices in those regions?

Stephen Byrd: That's a great point. I mean, in places like Northern Virginia, to your point about property taxes, the value of all this data center equipment is in the tens of billions, which does help local tax revenue quite a bit. That said, there are offsetting impacts such as higher power prices. And this is why I think your original point about the local dynamics mattering so much is so critical because you really do need to see political support, policy support. You need to see the infrastructure that's available.

So that's a fairly precious lineup, a fairly rare lineup of all the attributes you need to see to support new giant data center development.

David Arcaro: Definitely a delicate balance that the industry needs to tread here as these huge data centers start to come online.

Stephen Byrd: Well, I think a delicate balance is a good place to end this discussion. Dave, thanks so much for taking the time to talk.

David Arcaro: Great to speak with you, Stephen.

And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show, and share the podcast with a friend or colleague today.

Markets are suggesting that spirits consumption will return to historical growth levels post-pandemic, but our Head of European Consumer Staples Research disagrees.

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Welcome to Thoughts on the Market. I’m Sarah Simon, Head of the European Consumer Staples team. Along with my colleagues bringing you a variety of perspectives, today I'll talk about a surprising trend in the global spirits market.

It's Monday, April 15, at 2pm in London. 

We all remember vividly the COVID-19 period when we spent much more on goods than services, particularly on goods that could be delivered to our homes. Not surprisingly, spirits consumption experienced a super-cycle during the pandemic. But as the world returned to normal, the demand for spirits has dropped off. The market believes that after a period of normalization, the US spirits market will return to mid-single-digit growth in line with history; but we think that’s too optimistic.

Changes in demographics and consumer behavior make it much more likely that the US market will grow only modestly from here. There are several key challenges to the volume of US alcohol consumption in the coming years. Sobriety and moderation of alcohol intake are two rising trends. In addition, there’s the increased use of GLP-1 anti-obesity drugs, which appear to quell users' appetite for alcoholic beverages. And finally, there’s stiffer regulation, including the lowering of alcohol limits for driving.

A slew of recent survey data points to consumer intention to reduce alcohol intake. A February 2023 IWSR survey reported that 50 per cent of US drinkers are moderating their consumption. Meanwhile, a January 2024 NCSolutions survey reported that 41 per cent of respondents are trying to drink less, an increase of 7 percentage points from the prior year. And importantly, this intention was most concentrated among younger drinkers, with 61 per cent of Gen Z planning to drink less in 2024, up from 40 per cent in the prior year's survey. Meanwhile, 49 per cent of Millennials had a similar intention, up 26 per cent year on year.

Why is all this happening? And why now? Perhaps the increasingly vocal commentary by public bodies linking alcohol to cancer is really hitting home. Last November, the World Health Organization stated that "the higher the amount of alcohol consumed, the higher the risk of developing cancer" but also that "half of all alcohol-attributable cancers in the WHO European Region are caused by ‘light’ and ‘moderate’ alcohol consumption. A recent Gallup survey of Americans indicated that young adults are particularly concerned that moderate drinking is unhealthy, with 52 per cent holding this view, up from 34 per cent five years ago. 

Another explanation for the increased prevalence of non-drinking among the youngest group of drinkers may be demographic makeup: the proportion of non-White 18- to 34-year-olds has nearly doubled over the past two decades.

And equally, the cost of alcohol, which saw steep price increases in the last couple of years, seems to be a reason for increased moderation. Spending on alcohol stepped up materially over the COVID-19 period when there were more limited opportunities for spending. With life returning to normal post pandemic, consumers have other – more attractive or more pressing – opportunities for expenditure.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts. It helps more people to find the show.

The math of ‘bond-equity correlation' is complicated. Our head of Corporate Credit Research breaks it down, along with the impact of bond rates on other asset classes.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why the same factors can have different outcomes for interest rates and credit spreads.

It's Friday, April 12th at 2pm in London.  

Most of 2024 remains to be written. But so far, the financial story has been a tale of two surprises. First, the US Economy continues to be much stronger and hotter than expected, with growth and job creation exceeding initial estimates. Then second, due in part to that strong economy, interest rates have risen materially, with the yield on the US 10-year government bond about half-a-percent higher since early January. 

More specifically, market attention over the last week has refocused on whether these higher interest rates are a problem for other markets. In math terms, this is the great debate around bond-equity or bond-spread correlation, the extent to which assets move with bond yields, and a really important variable when it comes to thinking about overall portfolio diversification. 

But this somewhat abstract mathematical idea of correlation can also be simplified. The factors that are driving yields higher might look very different for other asset classes, such as credit. That could argue for a different correlation. Let’s think about how.

Consider first why yields have been rising. Economic data has been good, with strong job growth and rising Purchasing Manager Indices or PMIs, conditions that are usually tough for government bonds. Supply has been heavy, with the issuance of Treasuries up substantially relative to last year. The so-called carry on government bonds is bad as the yield on government bond yields is generally lower, much lower, than the yield on cash. And the time-of-year is unhelpful: since 1990, April has been the worst month of the year for government bonds.

But take all those same things thought the eyes of a different asset class, such as credit, and they look – well – different. 

Good economic data should be good for credit; historically, low-but-rising PMIs, as we’ve been seeing recently, is the most credit-friendly regime. Corporate bond supply hasn’t risen nearly as much as the supply for government bonds. The carry for credit is positive, thanks to still-steep credit curves. And the time of year looks very different: over that same period since 1990, April has been the best month of the year for corporate credit – as well as broader stock markets.

Government bonds are currently being buffeted by multiple headwinds. Hot economic data, heavy supply, poor yields relative to cash, and unhelpful seasonality. The good news? Well, Morgan Stanley’s interest rate strategists expect these headwinds to be temporary, and still forecast lower yields by year-end. But for other asset classes, including credit, it’s also important to note that that same data, supply, carry and seasonality debate – fundamentally look very different in other asset classes.

We think that means that Credit spreads can stay at historically tight levels in April and beyond, even as government bond yields have risen.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

With global temperatures rising and an increasing urgency to speed progress on the energy transition, our Head of Sustainability Equity Research examines the key materials needed—and the risks of disruption from US-China trade tensions.

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Welcome to Thoughts on the Market. I’m Laura Sanchez, Head of Sustainability Equity Research in the Americas. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss a highly topical issue: the impact of US-China trade tensions on the energy transition. 

It is Thursday, April 11, at 12 pm in New York.

Last week, you may have heard my colleagues discuss the geopolitics at play around US-China trade tensions and the energy transition. Today I’m going to elaborate on that discussion, spearheaded by my team, with a deeper dive into the materials and minerals at risk and exactly what is at stake for several industries in the US.

When we talk about clean technologies such as electric vehicles, energy storage and solar, it is important to note that minerals such as rare earths, graphite, and lithium — just to name a few — are crucial to their performance. 

At present, China is a dominant producer of many of those key minerals, whether at the mining level – which is the case with gallium, rare earths and natural graphite; at the refining level – the case for cobalt and lithium; or at the downstream level – that is, the final product, such as batteries and EVs.

If trade tensions between the US and China rise, we believe China could implement new or incremental export bans on some of these minerals that are key for western nations’ energy transition as well as for their broad economic and national security.

So, we have analyzed over 10 materials and found that the highest risks of disruption exist for rare earths and related equipment, as well as for graphite, gallium, and cobalt. Some minerals have already seen certain export bans but given the lack of diversification across the value chain, we actually see the potential for incremental restrictions.

So, this led us to ask our research analysts: how should investors view rising trade tensions in the context of clean technologies’ penetration, specifically?

While electric vehicles appear most at risk, we see the largest negative impacts for the clean technology sector as well as for large-scale renewable energy developers. This has to do with China dominating around 70 per cent of the battery supply chain and still having strong indirect ties in the solar supply chain. But there are important nuances to consider for renewable energy developers, such as their ability to pass the higher costs to customers, whether this higher cost could hurt the economics of projects and therefore demand, and the unequal impacts between large and small players – where large, tier 1 developers could actually gain share in the market as they have proven to navigate better through supply chain bottlenecks in the past.

On the Autos side, slower EV adoption would naturally impact sentiment on EV-tilted stocks; but as our sector analyst highlights, this could also mean lighter losses near term, as well as market share preservation for the largest EV players in the market. US Metals & Mining stocks would likely see positive moves as further trade tensions incentivize onshoring of mining and increase demand for US-made equipment.

Given strong bipartisan support in the US for a more hawkish approach to China, our policy experts believe that the US presidential election is unlikely to lead to easing trade restrictions. Nonetheless, in terms of the energy transition theme, a Republican win could create volatility for trade and corporate confidence, while a Democrat administration would be more sensitive to the balance between protectionism and achieving global climate goals.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Our Global Chief Economist joins our Head of Fixed Income Research to review the most recent Consumer Price Index data, and they lay out potential outcomes in the upcoming U.S. elections that could impact the course of inflation’s trajectory.  

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

Seth Carpenter: And I'm Seth Carpenter, Global Chief Economist.

Michael Zezas: And on this special episode of Thoughts on the Market, we'll be taking a look at how the 2024 elections could impact the outlook for inflation.

It's Wednesday, April 10th at 4pm in New York.

Seth, earlier this morning, the US Bureau of Labor Statistics released the Consumer Price Index (CPI) data for March, and it's probably an understatement to say it's been a much-anticipated report -- because it gives us some signal into both the pace of inflation and any potential fed rate cut path for 2024. I want to get into the longer-term picture around what the upcoming US election could mean for inflation. But first, I'd love your immediate take on this morning's data.

Seth Carpenter: Absolutely, Mike. This morning's CPI data were absolutely critical. You are right. Much anticipated by markets. Everyone looking for a read through from those data to what it means for the Fed. I think there's no two ways about it. The market saw the stronger than expected inflation data as reducing the likelihood that the Fed would start cutting rates in June.

June was our baseline for when the Fed would start cutting rates. And I think we are going to have to sharpen our pencils and ask just how much is this going to make the Fed want to wait? I think over time, however, we still see inflation drifting down over the course of this year and into next year, and so we still think the Fed will get a few rate hikes in.

But you wanted to talk longer term, you wanted to talk about elections. And when I think about how elections could affect inflation, it's usually through fiscal policy. Through choices by the President and the Congress to raise taxes or lower taxes, and by choices by the Congress and the President to increase or decrease spending.

So, when you think about this upcoming election, what are the main scenarios that you see for fiscal policy and an expansion, perhaps, of the deficit?

Michael Zezas: Yeah, I think it's important to understand first that the type of election outcome that historically has catalyzed a deficit expansion is one where one party gets complete control of both the White House and both chambers of Congress.

In 2025, what we think this would manifest in if the Democrats had won, is kind of a mix of tax extensions, as well as some spending items that they weren't able to complete during Biden's first term -- probably somewhat offset by some tax increases. On net, we think that would be incremental about $500 billion over 10 years, or maybe $40 [billion] to $50 billion in the first year.

If Republicans are in a position of control, then we think you're looking at an extension of most of the expiring corporate tax cuts -- expire at the end of 2025 -- that is up to somewhere around a trillion dollars spread over 10 years, or maybe a hundred to $150 billion in the first year.

Seth Carpenter: So, what I'm hearing you say is a wide range of possible outcomes, because you didn't even touch on what might happen if you've got a split government, so even smaller fiscal expansion.

So, when I take that range from a truly modest expansion, if at all, with a split government, to a slight expansion from the Democrats, a slightly bigger one from a Republican sweep, I'm hearing numbers that clearly directionally should lead to some inflationary pressures -- but I'm not really sure they're big enough to really start to move the needle in terms of inflationary outcomes.

And I guess the other part that we have to keep in mind is the election’s happening in November of this year. The new president, if there's a new president, the new Congress would take seats in the beginning of the year next year. And so, there's always a bit of a lag between when a new government takes control and when legislation gets passed; and then there's another lag between the legislation and the outcome on the economy.

And by the time we get to call it the end of 2025 or the beginning of 2026, I think we really will have seen a lot of dissipation of the inflation that we have now. So, it doesn't really sound like, at least from those baseline scenarios that we're talking about a huge impetus for inflation. Would you think that's fair?

Michael Zezas: I think that's fair. And then it sort of begs the question of, if not from fiscal policy, is there something we need to consider around monetary policy? And so around the Fed, Chair Powell's term ends in January of 2026 -- meaning potential for a new Fed chair, depending on the next US president.

So, Seth, what do you think the election could mean for monetary policy then?

Seth Carpenter: Yeah, that's a great question, Mike. And it's one that, as you know well, we tend to get from clients, which is why you and I jointly put out some research with other colleagues on just what scope is there for there to be a -- call it particularly accommodative Fed chair under that Republican sweep scenario.

I would say my take is -- not the biggest risk to worry about right now. There are two seats on the Federal Reserve Board that are going to come open for whoever wins the election as president to appoint. That's the chair, clearly very important. And then one of the members of the Board of Governors.

But it's critical to remember there's a whole committee. So, there are seven members of the Board of Governors plus five voting members, across the Federal Reserve Bank presidents. And to get a change in policy that is so big, that would have massive inflationary impacts, I really think you'd have to have the whole committee on board. And I just don't see that happening.

The Fed is set up institutionally to try to insulate from exactly that sort of, political influence. So, I don't think we would ever get a Fed that would simply rubber stamp any president's desire for monetary policy.

Michael Zezas: I think that makes a lot of sense. And then clients tend to ask about two other concerns; with particularly concerns with the Republican sweep scenario, which would be the impact of potentially higher trade tariffs and restrictions on immigration. What's your read here in terms of whether or not either of these are reliable in terms of their impact on inflation?

Seth Carpenter: Yeah, super topical. And I would say at the very least, we have some experience now with tariff policy. And what did we see during the last episode where there was the trade war with China? I think it's very natural to assume that higher tariffs mean that the cost of imported goods are going to be higher, which would lead to higher inflation; and to some extent that was true, but it was a much smaller, much more muted effect than I think you might otherwise assume given numbers like 25 per cent tariffs or has been kicked around a few times, maybe 60 per cent tariffs. And the reason for that change is a few things.

One, not all of the goods being brought in under tariffs are final consumer goods where the price would just go straight through to something like the CPI. A lot of them were intermediate goods. And so, what we saw in the last round of tariffs was some disruption to US manufacturing, disruption to production in the United States because the cost of production went up.

And so, it was as much a supply shock as it was anything else. For those final consumer goods, you could see some pass through; but remember, there's also the offset through the exchange rate, that matters a lot. And, consumers, they have a willingness to pay, or maybe a willingness not to pay, and so, sellers aren't always able to pass through the full cost of the tariffs. And so, as a result, I think the net effect there is some modestly higher inflation, but really, it's important to keep in mind that hit to economic activity that, over time, could actually go in the opposite direction and be disinflationary.

Immigration, very different story, and it has been very much in the news recently. And we have seen a huge surge in immigration last year. We expect it to continue this year. And we think it's contributing to the faster run rate that we've seen in the economy without continued inflationary pressure. So, I think it's a natural question to ask -- if immigration was restricted, would we see labor shortages? Would that drive up inflation? And the answer is maybe.

However, a few things are really critical. One, the Fed is still in restrictive territory now, and they're only going to start to lower rates if and when we see inflation come down. So the starting point will matter a lot. And second, when we did our projections, we took a lot of input from where the CBO's estimates are, and they've already been assuming that immigration flows really start to normalize a bit in 2025 and a lot more in 2026. Back to run rates that are more like pre-COVID rates. And so, against that backdrop, I think a change in immigration policy might be less inflationary because we'd already be in a situation where those flows were coming down.

But that's a good time for me to turn things around, Mike, and throw it right back to you. So, you've been thinking about the elections. You run thematic research here. I've heard you say to clients more than once that there is some scope, but limited scope for macro markets to think about the outcome from the election, but lots of scope from a micro perspective. So, if we were thinking about the effect of the election on equity markets, on individual sectors, what would be your early read on where we should be focusing most?

Michael Zezas: So we've long been saying that the reliable market impacts from this election, at least this far out, appear to be more micro than macro. And so, for example, in a Republican sweep scenario, we feel pretty confident that there would be a heavier skew towards extending corporate tax cut provisions that are expiring at the end of 2025.

And if you look at who benefits fundamentally from those extensions, it tends to be companies that do more business domestically in the US and tend to be a bit smaller. Sectors that tend to come in the scope include industrials and telecom; and in terms of size of company, it tends to skew more towards small caps.

Seth Carpenter: So, I can see that, Mike, but let me make it even more provocative because a question I have got from clients recently is the Inflation Reduction Act (IRA), which in lots of ways is helping to spur spending on infrastructure, is helping to spur spending on green energy transition. What's the chance that that gets repealed if the outcome, if the election goes to Trump?

Michael Zezas: We see the prospects for the IRA to get repealed is quite limited, even in a Republican sweep scenario. The challenge for folks who might not want to see the law exist anymore is that many of the benefits of this law have already been committed; and the geographic area where they've been committed overlays with many of the districts represented by Republicans, who would have to vote for its repeal. And so, they might be voting against the interests of their districts to do that. So, we think this policy is a lot stickier than people perceive. The campaign rhetoric will probably be, pretty elevated around the idea of repealing it; but ultimately, we think most of the money behind the IRA will be quite durable. And this is something that should accrue positively to the clean tech sector in particular.

Seth Carpenter: Got it. Well, Mike, as always, I love being able to take time and talk to you.

Michael Zezas: Seth, likewise, thanks for taking the time to talk. And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple podcast app. It helps more people find the show.

Our Chief Fixed Income Strategist surveys the latest big swings in the oil market, which could lead to opportunities in equities and credit around the energy sector.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the implications of recent strong moves in oil markets.

It's Tuesday, April 9th at 3pm in New York.

A lot is going on in the commodity markets, particularly in the oil market. Oil prices have made a powerful move. What is driving these moves? And how should investors think about this in the context of adjacent markets in equities and credit?

Morgan Stanley's Global Commodity Strategist and Head of European Energy Research, Martijn Rats, raised crude oil price forecast for the third quarter to $94 per barrel. The rally in recent weeks is a result of positive fundamental news and rising geopolitical tensions.

On the fundamental side, we've had better than expected demand from China and steeper than forecast fall in US production. Further, oil prices have also found support from growing potential for supply uncertainty in the Middle East. Martijn thinks that the last few dollars of rally in oil prices should be interpreted as a premium for rising geopolitical risks. The revision to the third quarter forecast should therefore be seen to reflect these growing geopolitical risks.

Our US equity strategists, led by Mike Wilson, have recently upgraded the energy sector. The underlying rationale behind the upgrade is that the energy sector relative performance has really lagged crude oil prices; and unlike many other sectors within the US stock world, valuation in energy stocks is very compelling.

Furthermore, the relative earnings revisions in energy stocks are beginning to inflect higher and the sector is actually exhibiting best breadth of any sector across the US equity spectrum. Higher oil prices are also important for credit markets. To quote Brian Gibbons, Morgan Stanley's Head of Energy Credit Research, for credit bonds of oil focused players, flat production levels and strong commodity prices should support free cash flow generation, which in turn should go to both shareholder returns and debt reduction.

In summary, there is a lot going on in the energy markets. Oil prices have still some room to move higher in the short term. We find opportunities both in equity and credit markets to express our constructive view on oil prices.

Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts or wherever you listen to this podcast. And share Thoughts on the Market with a friend or colleague today.

Our Global Chief Economist explains why the rapid hikes, pause and pivot of the current interest rate cycle are reminiscent of the 1990s.

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Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the current interest rate cycle and the parallels we can draw from the 1990s.

It's Monday, April 8th, at 10am in New York.

Last year, we reiterated the view that the 1990s remain a useful cycle to consider for understanding the current cycle. Our European equity strategy colleagues shared our view, and they've used that episode to inform their ‘out of consensus, bullish initiation on European equities’ in January. No two cycles are identical, but as we move closer to a Fed cut, we reassess the key aspects of that comparison.

We had previously argued that the current interest rate cycle and the mid 90s cycle differ from the intervening cycles because the goal now is to bring inflation down, rather than preventing it from rising. Of course, inflation was already falling when the 1994 cycle started, in part, because of the recession in 1991.

This cycle -- because much of the inflation was driven by COVID-related shocks, like supply chains for consumer goods and shifts in housing for shelter inflation -- inflation started falling rapidly from its peak before the first hike could have possibly had any effect. In recent months, our economic growth forecasts have been regularly revised upward, even as we have largely hit our expected path for inflation.

A labor supply shock appears to be a contributing factor that accounts for some of that forecast deviation, although fiscal policy likely contributed to the real side's strength as well. Supply shocks to the labor market are an interesting point of comparison for the two cycles. In the 1990s, labor force growth was still benefiting from this multi-decade rise in labor force participation among females. The aggregate labor force participation rate did not reach its peak until 2000.

Now, as we've noted in several publications, the surge in immigration is providing a similar supply side boost, at least for a couple of years. But the key lesson for me for the policy cycle is that monetary policy is not on a pre-set, predetermined course merely rising, peaking and then falling. Cycles can be nuanced. In 1994, the Fed hiked the funds rate to 6 per cent, paused at that peak and then cut 75 basis points over 1995 and 1996. After that, the next policy move was actually a hike, not a cut.

Currently, we think the Fed starts cutting rates in June; and for now, we expect that cutting to continue into next year. But as our US team has noted, the supply side revisions mean that the path for policy next year is just highly uncertain and subject to review. From 1994 to 1996, job gains trended down, much like they have over the past two years.

That slowing was reflective of a broader slowing in the economy that prompted the Fed to stop hiking and partially reverse course. So, should we expect the same now, only a very partial reversal? Well, it's too soon to tell, and as we've argued, the faster labor supply growth expands both aggregate demand and aggregate supply -- so a somewhat tighter policy stance could be appropriate.

In 1996, inflation stopped falling, and subsequently rose into 1997, and it was that development that supported the Fed's decision to maintain their somewhat restrictive policy. But we can't forget, afterward, inflation resumed its downward trajectory, with core PCE inflation eventually falling below 1.5 per cent, suggesting that that need to stop cutting and resume hiking, well, probably needs to be re-examined.

So, no two cycles match, and the comparison may break down. To date, the rapid hikes, pause and pivot, along with a seeming soft landing, keeps that comparison alive. The labor supply shock parallel is notable, but it also points to what might be, just might be, another possible parallel.

In the late 1990s, there was a rise in labor productivity, and we've written here many times about the potential contributions that AI might bring to labor productivity in coming years.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Oil demand has been higher than expected so far in 2024. Our Global Commodities Strategist explains what could drive oil to $95 per barrel by summer.

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Welcome to Thoughts on the Market. I’m Martijn Rats, Morgan Stanley’s Global Commodities Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss recent developments in the oil market. It is Friday, April the 5th at 4 PM in London. 

At the start of the year, the outlook for the oil market looked somewhat unexciting. With the recovery from COVID largely behind us, growth in oil demand was slowing down. At the same time, supply from countries outside of OPEC (Organization for Petroleum Exporting Countries) had been growing strongly and we expected that this would continue in 2024. In fact, at the start of the year it looked likely that growth in non-OPEC supply would meet, or even exceed, all growth in global demand. When that occurs, room in the oil market for OPEC oil is static at best, which in turn means OPEC needs to keep restraining production to keep the balance in the market. Even if it does that, it results in a decline in market share and a build-up of spare capacity. History has often warned against such periods.

Still, by early February, the oil market started to look tighter than initially expected. Demand started to surprise positively – partly in jet fuel, as aviation was stronger than expected; partly in bunker fuel as the Suez Canal issues meant that ships needed to take longer routes; and partly in oil as petrochemical feedstock, as the global expansion of steam cracker capacity continues. At the same time, production in several non-OPEC countries had a weak start of the year, particularly in the United States where exceptionally cold weather in the middle of January caused widespread freeze offs at oil wells, putting stronger demand and weaker supply together, and the inventory builds that we expected in the early part of the year did not materialise. 

By mid-February, we could argue that the oil market looked balanced this year, rather than modestly oversupplied; and by early March, we were able to forecast that oil market fundamentals were strong enough to drive Brent crude oil to $90 a barrel over the summer.

Since then, Brent has honed in on that $90 mark quicker than expected. Over the last week or so, the oil market has shown a powerful rally that has the hallmarks of simply tightening fundamentals but also with some geopolitical risk premium creeping back into the price. For now, our base-case forecast for the summer is still for Brent to trade around $90 per barrel as that is where we currently see fundamental support. 

However, the oil market typically enjoys a powerful seasonal demand tailwind over the summer. And that still lies ahead. And, geopolitical risk is still elevated, for which oil can be a useful diversifier. With those factors, our $95 bull case can also come into play.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Experts from our research team discuss how tensions with China could limit US access to essential technologies and minerals.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research.

Ariana Salvatore: And I'm Ariana Salvatore from the US Public Policy Research Team.

Michael Zezas: And on this episode of the podcast, we'll discuss how tensions in the US-China economic relationship could impact US attempts to transition to clean energy.

It's Thursday, April 4th at 10am in New York.

Ariana, in past episodes, I've talked about governments around the world really pushing for a transition to clean energy, putting resources into moving away from fossil fuels and moving towards more environmentally friendly alternatives. But this transition won't be easy. And I wanted to discuss with you one challenge in the US that perhaps isn't fully appreciated. This is the tension between US climate goals and the goal of reducing economic links with China. So, let's start there.

What's our outlook for tensions in the near term?

Ariana Salvatore: So, first off, to your point, the world needs over two times the current annual supply of several key minerals to meet global climate pledges by 2030. However, China is a dominant player in upstream, midstream, and downstream activities related to many of the required minerals.

So, obviously, as you mentioned, trade tensions play a major role in the US ability to acquire those materials. We think friction between the US and China has been relatively controlled in recent years; but we also think there are a couple factors that could possibly change that on the horizon.

First, China's over-invested in excess manufacturing capacity at a time when domestic demand is weak, driving the release of extra supply to the rest of the world at very low prices. That, of course, impacts the ability of non-Chinese players to compete. And second, obviously a large focus of ours is the US election cycle, which in general tends to bring out the hawk in both Democrats and Republicans alike when it comes to China policy.

Michael Zezas: Right. So, all of that is to say there's a real possibility that these tensions could escalate again. What might that look like from a policy perspective?

Ariana Salvatore: Well, as we established before, both parties are clearly interested in policies that would build barriers protecting technologies critical to US economic and national security. These could manifest through things like additional tariffs, as well as incremental non-tariff barriers, or restrictions on Chinese goods via export controls.

Now, importantly, this could in turn cause China to act, as it has done in the recent past, by implementing export bans on minerals or related technology -- key to advancing President Biden's climate agenda, and over which China has a global dominant position.

Specifically on the mineral front. China dominates 98 per cent of global production of gallium, more than 90 per cent of the global refined natural graphite market, and more than 80 per cent of the global refined markets of both rare earths and lithium. So, we've noted that those minerals are at the highest risk of disruption from potential escalation intentions.

But Michael, from a market's perspective, are there any sectors that stand out as potential beneficiaries from this dynamic?

Michael Zezas: So, our research colleagues have flagged that traditional US autos would see mostly positive implications from this outcome as EV penetration would likely stagnate further in the event of higher trade tensions. Similarly, US metals and mining stocks would likely benefit on the back of increased support from the government for US production, as well as increased demand for locally sourced materials.

On the flip side, Ariana, any clear risks that our analysts are watching for?

Ariana Salvatore: Yeah, so a clear impact here would be in the clean tech sector, which faces the greatest risk of supply chain disruption in an environment with increasing trade barriers in the alternative energy space. And that's mainly a function of the severe dependencies that exist on China for battery hardware. Our analysts also flagged US large scale renewable energy developers for potential downside impacts in this scenario -- again, specifically due to their exposure to battery and solar panel supply chains, most of which stems from China domiciled industries.

Michael Zezas: Makes sense and clearly another reason we’ll have to keep tracking the US-China dynamic for investors. Ariana, thanks for taking the time to talk.

Ariana Salvatore: Great speaking with you Mike.

Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

Consumers are increasingly sensitive about where their personal data is being processed and stored. The head of our European Telecom team explains the complexity around data sovereignty and why investors should care about the issue.

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Welcome to Thoughts on the Market. I’m Emmet Kelly, Head of Morgan Stanley’s European Telecom team. Today I’ll be talking about data sovereignty. 

It’s Wednesday, April 3rd, at 5pm in London.

It’s never been easier to manage your life with just a click of a button or tap on the screen. You can take a photo, upload it to social media, and share it with friends and family. You can pay your bills online – from utilities and groceries to that personal splurge. You can even renew your library card or driver’s license or access your emails from years and years ago.

But where is all this data stored? Our recent work shows that consumers are increasingly sensitive about this issue. Among European consumers, for example, more than 80 percent think it’s either very or somewhat important to know where their data is stored. And two-thirds of European consumers would like their data to be stored in their country of residence. A further 20 percent would be willing to pay more to store data locally, especially consumers in Spain and Germany. 

These results suggest that in the future, processing and storage of European data is more likely to be near shored rather than be based abroad.

A few weeks ago, I came on this podcast to talk about our expectation that European data centers will grow five-fold over the next decade. Our research showed that key drivers would include increased cloudification, artificial intelligence and data sovereignty. We believe the most under-appreciated driver of this exponential growth is the question of where data is stored and processed. This is data sovereignty; and it’s a concern for European consumers.

Data sovereignty means having legal control and jurisdiction over the storage and processing of data. It also means that data is subject to the laws of the country where that data was gathered and processed. More than 100 countries have data sovereignty laws in place, and laws governing the transfer of data between countries will only proliferate from here. 

In Europe, for example, we estimate that less than 50 per cent of cloud data is stored locally, within the European continent. The remainder is stored either in the US – notably in Virginia, which is the key data center hub in the United States; or, to a lesser extent, in lower-cost locations within Emerging Markets or in Asia.

Complicating the issue of data sovereignty further are the so-called “extraterritorial laws” or "extra-territorial jurisdiction." These dictate the legal ability of a government to exercise authority beyond its normal geographic boundaries. From a data perspective, even if data is stored and/or processed in Europe, it may also be subject to extraterritorial laws. Essentially, foreign, non-European governments could still gain access to European data.

This is something to keep in mind as we put data sovereignty in the context of the transition to a multipolar world – a major theme which Morgan Stanley Research has been mapping out since 2019. The rewiring of the global economy is well under way and data security is a key imperative for policy makers against the backdrop of accelerating tech diffusion and also geopolitical tensions. Our baseline de-risking scenario for the rewiring of global trade extends to data security and implies a robust case for the near shoring of European data and data center growth.

With so little of the European data pie stored or processed in Europe, the potential upside from near-shoring is considerable. Bottom line, we think investors should pay close attention to the issue of data sovereignty, especially as it plays out in Europe over the coming decade.  

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

We discuss how the upcoming US elections could affect trade and tax policy, and which scenarios are most favorable to retailers and brands. 

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore from Morgan Stanley's US Public Policy Research Team.

Alex Straton: And I'm Alex Straton, head of the North America Softlines Retail and Brands team.

Ariana Salvatore: On this episode of the podcast, we'll discuss some key policy issues that may play into the U.S. presidential election and their potential impact on businesses and consumers.

It's Tuesday, April 2nd, at 10 am in New York.

Election season is fully underway here in the U.S. and as in past election cycles, trade policy and tax reform are once again a big concern.

With that in mind, I wanted to discuss the potential implications on the retail space with my colleague Alex. So, let's start there. In general, Alex, how are retail stocks impacted leading up to the U.S. presidential elections?

Alex Straton: So, look, this kind of surprised us when we had looked into some of this data. But if you look at the last six elections or so, on a full year basis, trading activity can be super volatile in my coverage; and it depends on what's at stake.

But what we do broadly observe is back half underperformance to a bigger magnitude than is typical in a normal year. So, there is pressure on these stocks, in a way that you don't see in non-election years. Makes sense, right? Kind of a makes sense hypothesis that we confirmed. But I think the more interesting nugget about Softlines, Retail and Brand stocks leading into elections is that the higher frequency data can actually look worse than what actually comes to fruition in the top line or the sales numbers.

So, by that I mean, you'll see surveys out of our economics team or out of, you know, big economics forums that say, ‘Oh, sentiment is getting worse.’ And then we'll see things like traffic is getting worse, these higher frequency indicators; and they actually end up almost exacerbating the impact than what we actually see when we get the true revenue results later on.

So, my point being -- beware, as you see this degradation in the data; that doesn't necessarily mean that these businesses fundamentals are going to deteriorate to the same degree. In fact, it shows you that -- yes, maybe they're a little bit worse, but not to that extent.

Alex Straton: So, Ariana, let's look at the policy side. More specifically, let's talk about some potential changes in tax policy that's been a hot topic for companies I cover. So, what's on the horizon, top down?

Ariana Salvatore: Yeah, so, lots of changes to think about the horizon here.

Just for some quick context, back in 2017, Republicans under former President Trump passed the Tax Cuts and Jobs Act, and that included a whole host of corporate and individual tax cuts. The way that law was structured was set to start rolling off around 2022, and most, if not all, of the bill is set to expire by the end of 2025.

So that means that regardless of the election outcome, the next Congress will have to focus on tax policy, either by extending those cuts, or allowing some or all of them to roll off. So, in general, we think a Democratic sweep scenario would make it more likely that you would see the corporate rate, perhaps tick up a few points; while in a Republican sweep, we think you probably would maintain that 21 per cent corporate rate; and perhaps extend some of the other expiring corporate provisions.

So, Alex, how do you expect these potential changes in the corporate tax side to impact the retailers and the brands that you cover?

Alex Straton: Yeah. So, high level, I think about it on a sub-sector basis. And so, the headline you should hear is that my brand or wholesale coverage, which has more international revenue experience exposure, is better off than my retail coverage, which has more domestic or North America exposure.

And it all just comes back to having more or less foreign exposure. The more North America exposure you have, the more subject you are to a change in tax rate. The more foreign exposure you have, the less subject you are to a change in tax rate. So that's the high-level way to think about it.

We did run some analyses across our coverage, and if we do see the US corporate tax rate, let's say, lowered to 15 per cent hypothetically, we'll call that the Trump outcome, if you will. We calculate about a 5 per cent average benefit to 2025 earnings across our coverage. Now on the other hand, if we see something like a corporate tax rate that goes to 25 per cent, Biden outcome -- let's just label it that. We calculate 3 per cent average downside to the 2025 EPS estimates in our coverage.

So that's how we sized it. It's not a huge swing, right? And the only reason why there's what I would call more of a benefit than a downside impact of that analysis is because of where the current tax rate sits and the relative magnitudes we took around it.

Alex Straton: Now back over to you. You've highlighted trade policy as another key issue for the [20]24 election. Why is it so crucial in this election cycle compared to prior ones we've seen?

Ariana Salvatore: Right. So, in contrast to some of the tax changes that we were just talking about, those would require full congressional agreement, right?

So, you need either sweep scenario to make changes to tax policy in a really significant way. Trade policy is completely different because it is very much at the discretion of the president alone. So, to that end, we've envisioned a few different scenarios that can range from things like targeted tariffs on particular goods or trading partners, you know, something akin to the first Trump administration; to things like a universal baseline tariff scenario, and that's more similar to some of the more recent proposals that the former president has been talking about on the campaign trail.

So, there are a whole host of different circumstances that can lead to each of those outcomes, but it's critically important, that level of discretion that I mentioned before. And we think for that reason, that investors really need to contemplate each of these different scenarios and what they could mean for, you know, macro markets and their individual stocks that they cover. Because, frankly, a lot can change.

So, to that point, how do you think changes in trade policy are going to affect the side of the retail sector that you cover? Obviously, you mentioned North American exposure, so I imagine that's going to be critical again.

But what kind of businesses will be most affected under the different scenarios that I just mentioned?

Alex Straton: Yeah, so the way we examined this on our end, so from a Softlines, Retail, and Brands perspective, was looking at what a incremental China tariff means.

I do think there's important background for people to understand in my space that differs this time around versus an election cycle, you know, four or eight years ago, whatever it may have been -- in that my companies have intentionally diversified out of China.

The fact I love to give people is that US apparel imports from China has fallen from nearly 40 per cent to 20 per cent in the last, you know, decade or so; with 10 points of that in the last five years alone. So, the headline you should hear is there's not as much China exposure as there used to be. So that's good if there is a tariff put on for my companies. But with that backdrop, turning to the numbers, we have about 20 per cent cost of goods sold exposure to China on average across Softlines, Retail and Brands businesses.

So, if that goes up by an incremental 10 per cent what we calculate is about a 15 per cent impact to 2025 earnings across my coverage. One final thing I would say is that it's very rare for businesses to have a North America based supply chain. But there are some companies -- very few, but select ones -- that do have a majority domestic supply chain. You can think about some of the favorite jeans you might wear on an everyday basis. Maybe more often than not, you don't realize they're actually made in America. And that's a benefit in a scenario like that.

Ariana Salvatore: Makes sense. Alex, thanks for taking the time to talk.

Alex Straton: It was great speaking with you, Ariana. Thanks for having me.

Ariana Salvatore: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

Our Global Chief Economist surveys recent US and Australian census data to explain immigration’s impact on labor supply and demand, as well as the implications for monetary policy. 

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Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, along with my colleagues bringing you a variety of perspectives. And today, I'll be talking about immigration, economic growth, and the implications for monetary policy.

It's Monday, April 1st, at 10am in New York.

Global migration is emerging as an important macro trend. Some migration patterns change during and after COVID, and such changes can have first order effects on the population and labor force of an economy.

That fact has meant that several central banks have discussed immigration in the context of their economic outlook; and we focus here on the Fed and the Reserve Bank of Australia, the RBA.

In the US, recent population estimates from the CBO and the census suggests that immigration has been and is still driving faster growth in the population and labor supply, helping to explain some of last year's upside surprise in non-farm payrolls. In Australia, the issue is even longer standing, and accelerated migration in recent years has provided important support to consumption and inflation.

From a macro perspective, immigration can boost both aggregate demand and aggregate supply. More specifically, more immigration can lead to stronger consumption spending, a larger labor force, and may drive investment spending.

The permanence of the immigration, like some immigrants are temporary students or just visiting workers, the skill level of the migrants and the speed of labor force integration are consequential -- in determining whether supply side or demand side effects dominate. Demand side effects tend to be more inflationary and supply side effects more disinflationary.

In Australia, the acceleration in immigration has played an important driver in population growth and aggregate demand. In the decade before COVID, net migration added about a percentage point to the population growth annually. In 2022 and 2023, the growth rate accelerated beyond two percent. The pace of growth and migration and the type of migration have supported consumption spending and made housing demand outpace housing supply.

Our Australia economists note that net migration will likely remain a tailwind for spending in 2024 -- but with significant uncertainty about the magnitude. In stark contrast, recent evidence in the US suggests that the surge in immigration has had a relatively stronger impact on aggregate supply. Growth in 2023 surprised to the upside, even relative to our rosier than consensus outlook.

Academic research on US states suggests that over the period from 1970 to 2006, immigration tended to increase capital about one for one with increases in labor -- because the capital labor ratio in states receiving more immigrants remained relatively constant. That is, the inflow of immigrants stimulated an increase in investment.

Of course, the sector of the economy that attracts the immigrants matters a lot. Immigrants joining sectors with lesser capital intensiveness may show less of this capital boosting effect.

So, what are the implications for monetary policy? Decidedly, mixed. In the short run, more demand from any of the above sources will tend to be inflationary, and that suggests a higher policy rate is needed. But, as any supply boosting effects manifest, easier policy is called for to allow the economy to grow into that higher potential. So, a little bit here, a little bit there. Over the long run, though, only a persistently faster growth rate in immigration, as opposed to a one-off surge, would be able to raise the equilibrium rate, the so-called R star, on a permanent basis.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or a colleague today.

A landmark settlement with the National Association of Realtors will change the way brokers are paid commissions. How would this affect people looking to buy or sell homes? Our co-heads of Securitized Products Research discuss.

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James Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.

Jay Bacow: And I'm Jay Bacow, the other co-head of Securitized Products Research.

James Egan: And on this episode of the podcast, we'll be discussing some proposed changes to the US housing market. It's Thursday, March 28th, at 1pm in New York.

Jay Bacow: Jim, two weeks ago, the National Association of Realtors (NAR) settled a case that could fundamentally change how commissions are paid to brokers. Acknowledging that there's a few months until this is all going to get approved, it looks like sellers are no longer going to have to compensate buyers’ agents. Which means that the closing cost that sellers have to pay is going to come down from the current 5 to 6 per cent to brokers to something more in the context of 3.5 to 4 percent -- based on estimates from many economists. What does this mean for the housing market?

James Egan: So, this is certainly a settlement worth paying attention to.

There are a lot of moving pieces here, but some of our first thoughts. Look, if we're lowering the ultimate transaction costs when it comes to selling homes, we do think that -- all else equal and probably a little bit more into the future -- it's going to lead to a higher volume of transactions. Or a higher level of turnover in the housing market.

Now sellers no longer having to compensate buyers’ agents. That becoming something that buyers will need to do -- that could, at least from a perception perspective, increase the cost for buyers at a place, where we're already at one of our least affordable points in several decades. So, when we think about an increased level of transaction volumes; if that means, especially in the near term, or especially where we are right now, a little bit of an increase in for-sale inventory, combined with some of the affordability issues -- maybe it weighs a little bit on home prices. But our bottom line here is we think from a home price perspective, largely unchanged here. From a transaction volume perspective, all else equal, you could see a little bit of a pickup.

Jay Bacow: All right. But Jim, haven't you been calling for some of the story already with increased housing activity, causing home prices to end 2024 slightly below 2023. Does this then change the narrative at all?

James Egan: No, I don't think this changes the narrative. If we go back into that call just a little bit, our call for the marginal decrease in year over year home price growth was driven by growth in for-sale inventory this year. We're seeing that steady growth in existing listings over the past couple of months.

Now, the most recent housing start print was also positive from this perspective. Single unit housing starts were up for the eighth month in a row and have now increased 11 per cent from their local lows, which were in June of 2023. I think it's also worth pointing out over that same time frame, five plus unit starts, multi-unit housing, they're down in almost every single one of those months -- all but one of them. And they're down 19 per cent from that same month, June of 2023. But that's probably something for another podcast.

Jay Bacow Alright. Well, I think there's two more things we should include in this podcast. First, this settlement isn't the only factor that could increase housing activity. Recently, around the State of the Union [address], President Biden announced a number of plans that could also contribute.

Now, some of them require congressional approval, including a $10,000 middle-income first-time homebuyer tax credit. And then a separate $10,000 tax credit to middle class families that would sell their home below the median income in the county to help account for some of these lock-in effects that you mentioned.

Jay Bacow: However, he also announced a pilot program that would eliminate total insurance fees for some low-risk refinance transactions. And that one doesn't require congressional approval; it's getting put in place as we speak, and that would save homeowners about $750 in closing costs on a refinance.

James Egan: Interesting. So, if I'm hearing you correctly, the ones that would require congressional approval, they're more on the -- what we would call housing activity side: sales, purchase volumes. Whereas the one that didn't was on the refinance side. Now, presumably there's not much refinance activity going on right now.

Jay Bacow: That's a correct presumption. Right now, we estimate that only about 3 per cent of homeowners have a critical incentive to refinance 25 basis points versus a prevailing mortgage rate. So, this is going to matter a lot more if we rally in rates. Realistically, we think we need a mortgage rate to get closer to 5 per cent than the current level for this to really matter.

But I imagine that's probably a similar case with the NAR settlement as well.

James Egan: Exactly. And that's why I made a point to say, all else equal, we think this is going to lead to a higher volume of transactions or a higher turnover rate in the housing market. It's because of that lock-in effect. Right now, so much of the homeowning distribution is well below the prevailing mortgage rate, that any real impacts of this we think are just going to be on the margins.

Jay Bacow: Alright, so there's a lot of changes are coming to the housing market. They're likely to impact the market more if rates rally and are more of the back half of the year, next year event than this summer.

Jim, thanks for taking the time to talk.

James Egan: Great speaking with you, Jay.

Jay Bacow: And thanks for listening.

If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.

Consumer credit scores have ticked higher in the last two years – but so have the rate of delinquencies and defaults. Our Global Head of Fixed Income discusses “credit score migration” with the firm's Asset-Backed Security Strategist.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.

Heather Berger: And I'm Heather Berger, Asset-Backed Security Strategist.

Michael Zezas: And today, we'll be talking about the trend of migrating US consumer credit scores and the potential effect on equities and fixed income. It's Wednesday, March 27th at 10am in New York.

Heather, I really wanted to talk to you today because we've all seen some recent news reports about delinquencies and defaults in consumer credit ticking higher over the last two years. That means more people missing payments on their car loans and credit cards, suggesting the consumer is increasingly in a stressed position. But at the same time, that seems to be at odds with what's been an upward trend in consumers’ credit scores, which on its face should suggest the consumer is in a healthier position.

So, it all begs the question: what's really going on here with the consumer, and what does it mean for markets? Now, you and your colleagues have been doing some really fascinating work showing that in order to get to the truth here, we have to understand that there's a measurement problem. There’s quirks in the data that, when you understand them, mean you have a more accurate picture of the health of the consumer. And that, in turn, can clarify some opportunities in the fixed income and equity markets.

So, this measurement problem seems to center around the idea of credit score migration. Can you start by explaining what exactly is credit score migration?

Heather Berger: Sure. So, credit scores are used as a way to estimate expected default risk on consumer loans. And these scores are really the most standardized and widespread way of evaluating consumer credit quality. Scores are meant to be relative metrics at any point in time. So, a 700 score today is meant to indicate less default risk than a 600 score today, but a 700 score today isn't necessarily the same as a 700 score a few years ago.

Credit scores have been increasing throughout the past decade; most extremely from 2020 to 2021, largely due to COVID related factors such as stimulus checks. The average credit score is up 10 points in the past four years, and this trend has broadly been referred to as credit score migration.

Michael Zezas: So, just so we can have a concrete example, can you talk about how this has affected one particular consumer credit category?

Heather Berger: Well, as you mentioned earlier, delinquencies and defaults have been rising across consumer loan types, whether it's autos, credit cards, or personal loans. The macro backdrop has definitely contributed to this, as inflation has weighed on consumers real disposable income, but we do think that score migration has had an impact as well, considering the large changes over the past few years.

Looking at auto loans, for example, with the same credit scores from 2022 versus loans from 2018, we see that delinquency rates on the 2022 loans are up to 60 per cent higher than on the 2018 loans. We estimate that 30 to 50 per cent of this increase can be due to effects of credit score migration.

Michael Zezas: And is there anything we can assume here about the actual health of the US consumer? Do we see delinquencies improving or getting worse?

Heather Berger: I think one of the main takeaways here is that since score migration impacts performance metrics, we shouldn't necessarily extrapolate delinquency data to broader consumer health. Despite the high delinquency rates, our economists do expect consumers to remain afloat.

They're forecasting a modest slowdown in consumer spending this year as we move off a hot labor market and continue to face elevated interest rates.

Michael Zezas: So, let's shift to the market impacts here. Maybe you could tell us what your colleagues in equity research saw as the impact on the banks and consumer finance sectors. And in your area of expertise, what are the impacts for asset-backed securities?

Heather Berger: We think that across both of these spaces, taking into account changes in credit scores will be important to use in models moving forward; and this can help us to more accurately assess the risks of consumer loans and to predict performance. Movements in credit scores have actually been muted in the past year, which is a big change from the large increases we saw a few years ago.

So, score migration should now have a smaller impact on consumer performance and delinquency rates. This means that performance will be driven by macro factors and lending standards. As inflation comes down and with lending standards tight, we view this as a positive for asset backed securities, and our colleagues view it as a positive for their coverage of consumer finance equities.

Michael Zezas: Heather, this has been really insightful. Thanks for taking the time to talk.

Heather Berger: Great speaking with you, Michael.

Michael Zezas: And thanks for listening. If you enjoy thoughts on the market, please be sure to rate and review us on the Apple podcast app or wherever you listen. It helps more people find the show.

As investors look for clues on market durability, our Chief U.S. Equity Strategist highlights which sectors could show more widely distributed gains in the near term.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about an opportunity for energy stocks to keep working in the near term.

It's Tuesday, March 26th at 9:30 am in New York. 

So let’s get after it.

Over the past five months, global stocks are up about 25 percent while many other asset prices were up double digits or more. What’s driving this appreciation? Many factors are at work. But for stock indices, it’s been mostly about easier financial conditions and higher valuations rather than improving fundamentals. Granted, higher asset prices often beget even higher prices – as investors feel compelled to participate. From our perspective, it’s hard to justify the higher index level valuations based on fundamentals alone, given that 2024 and 2025 earnings forecasts have barely budged over this time period.  

We rolled out our “Boom-Bust” thesis in 2020 based on the shift to fiscally dominant policy in response to the pandemic. At that point, our positive view on stocks was based on the boom in earnings that we expected over the 2020-2021 period as the economy roared back from pandemic lows. Our outlook anticipated both accelerating top line growth and massive operating leverage as companies could reduce headcount and other costs while people were locked down at home. The result was the fastest earnings growth in 30 years and record high margins and profitability. In other words, the boom in stocks was justified by the earnings boom that followed. Stock valuations were also supported by arguably the most generous monetary policy in history. The Fed continued Quantitative Easing throughout 2021, a year when S&P earnings grew 48 percent to an all-time high.

Today, stock valuations have reached similarly high levels achieved back in 2020 and [20]21 – in anticipation of improving growth after the earnings deterioration most companies saw last year. While the recent easing of financial conditions may foreshadow such an acceleration in earnings, bottom-up expectations for 2024 and [20]25 S&P 500 earnings remain flat post the Fed’s fourth quarter dovish shift. Meanwhile, small cap earnings estimates are down 10 percent and 7 percent for 2024 and [20]25, respectively since October. We think one reason for the muted earnings revisions since last fall, particularly in small caps, is the continued policy mix of heavy fiscal stimulus and tight front-end interest rates. We see this crowding out many companies and consumers.  

The question for investors at this stage is whether the market can finally broaden out in a more sustainable fashion. As we noted last week, we are starting to see breadth improve for several sectors. Looking forward, we believe a durable broadening comes down to whether other stocks and sectors can deliver on earnings growth. One sector showing strong breadth is Industrials, a classic late-cycle winner and a beneficiary of the major fiscal outlays for things like the Inflation Reduction and CHIPS Act, as well as the AI-driven data center buildout. 

A new sector displaying strong breadth is Energy, the best performer month-to-date but still lagging considerably since the October rally began. Taking the Fed’s recent messaging that they are less concerned about inflation or loosening financial conditions, commodity-oriented cyclicals and Energy in particular could be due for a catch-up. The sector’s relative performance versus the S&P 500 has lagged crude oil prices, and valuation still looks compelling. Relative earnings revisions appear to be inflecting as well. Some listeners may be surprised that Energy has contributed more to the change in S&P 500 earnings since the pandemic than any other sector. Yet it remains one of the cheapest and most under-owned areas of the market.  

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We’d love to hear from you. 

Morgan Stanley’s Chief Fixed Income Strategist explains why private credit markets have expanded rapidly in recent years, and how they may fare if public credit makes an expected comeback.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the implications of the rapid growth in private credit for the broader credit markets.  

It’s Monday, March 25th at 12 noon in New York.

The evolution of private credit is reshaping the landscape of leveraged finance. Investors of all stripes and all around the world are taking notice. The rapid expansion of private credit in the last few years has come against a much different backdrop in the public credit markets – a contraction in the high yield bond market and lackluster growth in the broadly syndicated loan market. What the emergence of private credit means for the public credit and the broader credit markets is a topic of active debate.

Just to be clear, let me define what we mean by private credit. Private credit is debt extended to corporate borrowers on a bilateral basis or involving very small number of lenders, typically non-banks. Lenders originate and negotiate terms directly with borrowers without the syndication process that is the norm in public markets for both bonds and loans. These private credit loans are typically not publicly rated; they’re not typically traded in secondary markets; tend to have stronger lender protections and offer a spread premium to public markets.

Given the higher overall borrowing costs as well the need to provide stronger covenant protection to lenders, what motivates borrowers to tap private credit versus public credit? Three key factors explain the recent rapid growth in private credit and show how private credit both competes and complements the public credit markets.

First, small and medium-sized companies that used to rely on banks had to find alternative sources of credit as banks curtailed lending in response to regulatory capital pressures. A majority of these borrowers have very limited access to syndicated bond and loan markets, given their modest size of borrowings.

Second, because of the small number of lenders per deal – frequently just one – private credit offers both speed and certainty of execution along with flexibility of term. The last two years of monetary policy tightening has meant that there was a lot of uncertainty around how high policy rates would go and how long they will stay elevated – which has led investors to pull back. The speed and certainty of private credit ended up taking market share from public markets against this background, given this uncertainty in the public markets.

Third, the pressure on interest coverage ratios from higher rates resulted in a substantial pick-up in rating agency downgrades into the B- and CCC rating categories. At these distressed ratings levels, public markets are not very active, and private credit became the only viable source of financing.

Where do we go from here? With confidence growing that policy tightening is behind us and the next Fed move will be a cut, the conditions that contributed to deal execution uncertainty are certainly fading. Public markets, both broadly syndicated loan and high yield bond markets, are showing signs of strong revival. The competitive advantage of execution certainty that private credit lenders were offering has become somewhat less material. Further, given the amount of capital raised for private credit that is waiting to be deployed – the so-called dry powder – the spread premium in private credit may also need to come down to be competitive with the public markets.

So private credit is both a competitor and a complement to the public markets. Its competitive attractiveness will ebb and flow, but we expect its complementary benefit as an avenue for credit where public markets are challenged to remain as well as grow.

Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts or wherever you get this podcast – and share Thoughts on the Market with a friend or colleague today.

Our Head of Corporate Credit notes that while recent central bank meetings offered few surprises, there was still plenty to be gleaned that could affect credit valuations.  

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about this week’s central bank meetings, and why as expected outcomes can still mean new information for credit investors.

It's Friday, March 22nd at 2pm in London.

When a good friend was interviewing at Morgan Stanley, many years ago, he was asked a version of the ‘Monty Hall Problem.’ Imagine that you’re on a game show with a prize behind one of three doors. You make your guess of door 1, 2 or 3. And then the host opens one of the doors you didn’t pick, showing that it’s empty. Should you change your original guess?

While it’s a bit of a paradox, you should. Your original odds of finding the prize were 1-in-3. But by showing you a door with a wrong answer, the odds have improved. The host gave you new information. 

And that’s what came to mind this week, after important meetings from the Federal Reserve and Bank of Japan. Both banks acted in-line with our economists’ expectations. But those meetings and what came after still provided some valuable new information. Information that, in our view, was helpful to credit.

On Tuesday, the Bank of Japan raised interest rates for the first time since 2016, ended Yield Curve Control, and ended its purchases of equities. All of these measures had been previously used to help boost too-low inflation. But they have also resulted in a significant weakening of Japan’s currency, the Yen. And that, in turn, had made it attractive for Japanese investors to invest in overseas bonds in other currencies – which were gaining value as the Yen weakened.

So, one risk heading into this week was that these big changes in the Bank of Japan would reverse these other trends. It would strengthen the currency and make buying corporate bonds from the US or Europe less attractive to Japanese investors. But this meeting has now come and gone, and the Yen saw little movement. That is helpful, new information. Before Tuesday, it was impossible to know how the currency would react.

Then on Wednesday, the Fed confirmed its expectation from December that it was planning to cut interest rates three times this year. On the surface, that was another ‘as expected’ outcome. But it still contained new information. The Fed’s forecast suggested more confidence that stronger 2024 growth wouldn’t lead to higher inflation. And that endorsed the idea that the productive capacity of the US economy is improving. Solid growth and lower inflation co-existing, thanks to better productivity, will be closer to a 1990s style outcome. And that was a pretty good scenario for credit.

This week’s central bank meetings have come and gone without big surprises. But sometimes ‘as expected’ can still deliver new information. We continue to expect credit valuations to hold at richer-than-average levels, and like US leveraged loans, as a high yielding market well-suited for a mid-90s scenario.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you. 

The perspective from our recent European Financials Conference looked positive for UK markets, loan demand and M&A activity. Our European heads of Diversified Financials and Banks Research discuss.

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Bruce Hamilton: Welcome to thoughts on the Market. I'm Bruce Hamilton, head of European Diversified Financials Research.

Alvaro Serrano: And I'm Alvaro Serrano, head of European Banks Research.

Bruce Hamilton: And on this episode of the podcast, we'll discuss some of the key takeaways from Morgan Stanley's just concluded 20th European Financials Conference. It's Thursday, March 21st at 3 pm in London.

Alvaro, we were both at the European Financials Conference in London. More than 100 companies attended the event. 95 percent of the attendees were from CE level management. There was a lot to take in.

Investor sentiment heading into the conference seemed noticeably more upbeat than last year's, thanks in part to stronger-for-longer net interest income (NII), an M&A cycle that is heating up, attractive capital returns, and increasing activity in private markets.

Now you were the conference chair, Alvaro. And you have a unique overview of this event. What's, in your view, the single most important takeaway?

Alvaro Serrano: Thanks, Bruce. Look, I think for me that if I had to summarize in two words is ‘risk on.’ I think the tone of the conference has been positive almost across the board. The lower rate outlook has increased market confidence. And corporates were pointing that out. They've seen stronger activity, so far this year, in many product lines. They've called out loan demand being stronger. They've called out debt capital market activity being stronger. They've announced M&A -- we know is up strongly and asset management inflows are up strong as well. So yes, a strong start to the year - confidence is back, and I would summarize it as risk on.

Bruce Hamilton: Got it. And in terms of the other key themes and debates that emerged from company presentations at the conference.

Alvaro Serrano: Yeah, look, I think the main themes following up from what I was saying earlier are: First of all, I would say leadership change. Within the sector, we've been calling for leadership change in our outlook. And I think what we heard at the conference supports this. So, given market activities coming back, I think a lot of investors were more keen to look for more resilient revenue models; maybe less peripheral banks, less NII retail-centric banks. And looking for more fee growth that could benefit from that market recovery.

The second point I would point out is UK. There’s definitely a change in sentiment around the UK in the polling questions. It came out as a preferred region, and I think what's behind that preference is that we're seeing an inflection point in NII.

And I think the third and final theme for me is investment banking and wealth recovery. Look, wealth may not recover already in Q1. But as this confidence builds up, we definitely expect inflows to pick up in the second half, both in quantity and margin.

Bruce Hamilton: So, based on your own work and what you heard at the conference, what's your overall view on the financial sector and what drives that from here?

Alvaro Serrano: We continue positive the sector. Look, the valuation is depressed. The multiples, the PE multiples on six times. Historically, it's been much closer to double-digit. We think, recovering PMIs should help re-rate that multiple. And while we do wait for those PMIs to recover, you're being paid 11 per cent yield between dividends and buybacks.

I think the confidence build up that we're seeing in the tone of the conference suggests an early indicator of those PMIs recovering, if you ask me. And then in the panels, we've had plenty of discussions around asset quality. Obviously, commercial real estate exposure is a big theme. But we think it's a manageable problem. It's less than 5 per cent of the loan books, within that office is less than a third. And within that US office spaces is a fraction. So overall, we think it's a manageable problem and our highest single conviction in the sectors that the yields are sustainable and resilient.

So, with a strong valuation underpin, we continue, positive of the sector.

Bruce, why don't I turn it over to you? Given your focus on private markets, exchanges, and asset management sub-sectors within diversified financials, can you talk us through private markets and deal activity space?

Bruce Hamilton: Yeah, our fireside chats with panels, and with private market management teams, saw more optimistic commentary on capital markets activity. And similarly fundraising improvements are expected to be closely linked to cash flows from exit activity flowing back to institutional clients, who can then reallocate to new funds.

So there's a little delay. But overall, the direction of travel clearly feels positive and pointed to a reacceleration in the private markets’ flywheel in due course, which has been, of course, the rationale behind the more positive view we have taken on this subsector since our outlook piece in November last year.

Alvaro Serrano: AI is obviously a dominant theme across sectors and industries globally. Also, by the way, a frequent topic in the discussion of this podcast. Can you give us an update on AI and its implications for wealth and asset management?

Bruce Hamilton: Sure. I mean, our discussions with asset management CEOs highlighted the transformative potential of AI, as they see it as a source of significant efficiency potential across the value chain. From sales and marketing, through investments and research, to middle and back office -- in areas such as report writing, research synthesis and client servicing. The benefits of starting early, with leaders having been working on this for 12 months or more, seems clear given the need to manage risks, for example, ensuring data quality to avoid hallucinations.

One asset management CEO indicated that his firm had identified 85 use cases, with 35 already in production. The initial opportunities for asset managers were seen as principally in driving cost efficiencies; though in wealth management a greater revenue potential we think exists given the scope to improve the effectiveness of wealth advisors in targeting and servicing clients.

Exchanges also noted scope for AI to both support revenue momentum. For example, via chatbots, assisting clients in accessing data more effectively. And in driving efficiency in report writing, as well as in costs. So, think about scope to drive efficiencies in areas such as client servicing and data ingestion and organization where large language models (LLMs) are already driving efficiency gains for employees.

Alvaro Serrano: Finally, let's talk about private credit, another big theme. What did you hear, at the conference around the growth of private credit? And what's your outlook from here?

Bruce Hamilton: Sure. So, the players were positive on the potential for growth in private credit from here. In the near-term deployment opportunities probably look stronger in the private credit space relative to private equity, where some differences in buyer-seller expectations is still acting as a bit of a constraint. There are opportunities given bank retrenchments, even if the Basel III endgame is expected to be less negative than initial draft proposals. And the appetite from insurance -- institutional, as well as retail clients for the diversification benefits and attractive yields on offer -- remains pretty significant.

Both private market specialists and traditional asset managers continue to explore ways to extend their capabilities in the space, with some adopting an organic approach and others looking to accelerate scaling via M&A.

We expect that as we look forward, that some recovery in the bank's syndicated lending markets is likely to reduce the record market share enjoyed by private credit in private equity deals last year. However, we think a more vibrant overall deal environment is likely to drive opportunities for both bank syndicated and private credit looking forward.

The democratization theme with wealth clients increasing allocations to private markets remains an additional powerful growth theme as we look forward; both for private credit providers, as well as players active in private equity infrastructure and real estate.

I'm sure there'll be lots more to unpack from the conference in the near future. Let's wrap it up for this episode. Alvaro, thanks a lot for taking the time to talk.

Alvaro Serrano: Great speaking with you, Bruce.

Bruce Hamilton: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Our Global Head of Fixed Income and Thematic Research outlines the potential impact the upcoming U.S. elections could have on increasing treasury yields, US-China policy and Japan’s current trajectory.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about overseas investors' view on the US election.

 It's Wednesday, Mar 20th at 10:30 am in New York.

 I was in Japan last week. And as has been the case with other clients outside the US, the upcoming American elections were a key concern. To that end, we’re sharing the three most frequently asked questions, as well as our answers, about the impact of the U.S. election on markets coming from clients outside the US.

First, clients are curious what the election could mean for what’s recently been a very rosy outlook for Japan. The central bank is taking steps toward normalizing monetary policy which, combined with corporate reforms, is driving renewed investment. And it doesn’t hurt that multinationals are finding it more challenging to do new business in China due to U.S. policy restrictions. In our view, regardless of the election outcome, these positive secular trends will continue. While its true that Republicans are voicing greater interest in tariffs on US friend and foe alike, in our view there are other geographies more likely to bear the impact of stricter trade policy from the US – such as Europe, Mexico, and China; areas where there’s clearer overlap between US trade interests and the geopolitical preferences of the Republican party.

Second, clients wanted to know what the election would mean for US-China policy. The first thing to understand is that both parties are interested in policies that build barriers protecting technologies critical to US economic and national security. For Democrats, this has meant a focus on extending non-tariff barriers such as export and investment restrictions; many of which end up affecting the trade relationship between the US and China, and over time have resulted in US direct investment tilting away from China and toward the rest of the world.  Republicans support these policies too. But key party leaders, including former President and current candidate Trump, also want to use tariffs as a tool to negotiate better trade agreements; and, potentially as a fall back, to harmonize tariff levels between countries. So, the election is unlikely to yield an outcome that eases trade tension between the US and China. But an outcome where Republicans win could create more volatility for global trade flows and corporate confidence, creating more economic uncertainty in the near term. 

Third and finally, clients wanted to know if there were any election outcomes that would reliably change the trajectory of US growth, inflation, and accordingly the trajectory for treasury yields. In particular there was interest in outcomes that could cause yields to move higher. Our take here is that there’s been no solidly reliable outcome that points in that direction -- at least not yet. While it's likely that a potential Trump presidency would favor tax cuts and tariffs, it’s not clear that either of these definitively lead to inflation. Cutting taxes for companies with healthy balance sheets doesn’t necessarily yield more investment. Tariffs increase the cost of the thing being tariffed, but that could lead to prices of other goods in the economy suffering from weaker demand. Relatedly, the idea that a more dovish Fed could enable inflation is not a foregone conclusion because – as we’ve discussed on prior episodes – the President's ability to influence monetary policy is more limited than you might think.

Still, because of the pileup of these factors, it wouldn’t be surprising to see rates rise at some point this year on election risk perceptions. But it's not clear this would be a sustained move, and so it's not causing us yet to recommend clients’ position for it. For clients looking for more reliable market moves from the election, we’re still focused on key sectoral impacts: sectors like industrials and telecom which could benefit from tax cuts in a Republican win scenario; and sectors like clean tech which benefit in a Democratic win scenario, on greater certainty for the spend of energy transition money in the IRA.  

Of course, as markets change and price in different outcomes, interesting macro markets opportunities will emerge -- and we’ll be here to tell you all about it.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

Our Chief Asia and Emerging Market Equity Strategist reviews an up-and-down first quarter for markets across the region, and gives an update on which sectors investors should be eyeing. 

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Welcome to the Thoughts on the Market. I’m Jonathan Garner, Morgan Stanley’s Chief Asia and Emerging Market Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about our key investment views in Asia. It's Tuesday, Mar 19th at 9 am in Singapore.

It's been quite a first quarter in Asian equities with a wide degree of dispersion in market returns. At one end of the spectrum Japan’s Nikkei index is up 16 percent. At the other end, despite a recent rally, the Hang Seng index in Hong Kong is down 2 percent for the year. Meanwhile, the AI thematic has helped Taiwan into second place regionally, with a 10 percent gain; but Korea has risen by a lot less.

Our highest conviction views remains that we’re in the midst of multi-year secular bull markets in Japan and India, whilst at the same time China is in a secular bear market. So, let’s lay out the building blocks of those theses.

Firstly, Japan’s Return on Equity Journey. We think that markets – like stocks – reward improvement in profitability or ROE. The drivers of the ROE improvement are numerous but include domestic reflation, a weaker Yen, a productive capex cycle and improved capital management by Japan’s leading firms. And these together have led to improving net income margins in two-thirds of industries versus a decade ago. 

We forecast robust EPS growth of around 9 percent in 2024, with similar growth in 2025. Now that’s assuming our foreign exchange strategists’ USD/JPY forecast of 140 for the fourth quarter of this year is accurate. This week the BOJ – the Bank of Japan – is considering whether to exit its Negative Interest Rate Policy and abolish or flex yield curve control. If it does so, that will be a sign – along with recent strong wage gains – that Japan has definitively exited deflation.

Secondly, India’s Decade. Multipolar world trends are supporting foreign direct investment (FDI) flows and portfolio flows to India, whilst positive demographics from a rapidly growing working age population are also supporting the equity market. India is holding national elections in May, and we will be watching the policy framework thereafter. But our base case is little change; success that India has achieved in macro-stability is underpinning a strong capex and profits outlook.

Finally, China’s Deflationary Challenge. China continues to battle what we’ve termed its 3D challenge of Debt (now standing at 300 per cent of GDP), Demographics and Deflation. And profitability has fallen steadily in recent years – so going in the opposite direction from Japan; approximately halving since the middle of the last decade, whilst earnings have missed for nine straight quarters. We think more forceful countercyclical measures are needed to boost demand in China given incipient balance sheet recession due to headwinds from property and local government austerity.

Finally, to summarize some of our sector and style views. We still like Korea and Taiwan’s semiconductors, into an expected 2024 recovery in traditional product areas such as smart phone, as well as the new theme of AI related demand. We are positive on Financials in India, Indonesia and Singapore; Industrials in India and Mexico; and Consumer Discretionary in India. On the quant and style side, we’re neutral on value versus growth as we expect the path to lower yields to be bumpy – as inflation risk remains. And we have recently recommended investors to reduce momentum exposure for risk management purposes given the strong outperformance year to date.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen – and leave us a review. We’d love to hear from you.

Our CIO and Chief Equity Strategist discusses the continued uncertainty in the markets, and how investors are now looking at earnings growth and improving valuations.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the risk of higher interest rates and equity valuations. 

It's Monday, March 18th at 11:30 am in New York. 

So let’s get after it.

Long term interest rates peaked in October of last year and coincided with the lows in equities. The rally began with the Treasury's guidance for less coupon issuance than expected. This surprise occurred at a time when many bond managers were short duration. When combined with the Fed’s fourth quarter policy shift, there was a major squeeze in bonds. As a result, 30-year Treasury bonds returned 19 per cent over the October-December 2023 period, beating the 14 per cent return in the S&P 500. Nearly all of the equity return over this period was attributable to higher valuations tied to the fall in interest rates.

Fast forward to this year, and the story has been much different. Bond yields have risen considerably as investors took profits on longer term bonds, and the Fed walked back several of the cuts that had been priced in for this year. The flip side is that the growth data has been weaker in aggregate which argues for lower rates. Call it a tug of war between weaker growth and higher inflation than expected.

There is also the question of supply which continues to grow with the expanded budget deficit. From an equity standpoint, the rise in interest rates this year has not had the typically negative effect on valuations.  In other words, equity investors appear to have moved past the Fed, inflation and rates – and are now squarely focused on earnings growth that the consensus expects to considerably improve.  

As noted in prior podcasts, the consensus earnings per share (EPS) growth estimates for this year are high, and above our expectations – in the context of sticky cost structures and falling pricing power as fiscal spend crowds out both labor and capital for the average company. In our view, this crowding out is one reason why fundamentals and performance have remained relatively muted outside of the large cap, quality winners. We have been expecting a broadening out in leadership to other large cap/quality stocks away from tech and communication services; and recently that has started to happen. Strong breadth and improving fundamentals support our relative preference for Industrials within broader cyclicals.

Other areas of relative strength more recently include Energy, Materials and Utilities. Some of this is tied to the excitement over Artificial Intelligence and the impact that will have on power consumption. The end result is lower valuations for the index overall as investors rotate from the expensive winners in technology to laggards that are cheaper and may do better in an environment with higher commodity prices.  

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen --and leave us a review. We’d love to hear from you.