Thoughts on the Market

Our Chief Asia Economist Chetan Ahya discusses the early indications of India’s economic recovery and why the country looks best-positioned in the region for growth.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. 

Today I’ll be taking a look at the Indian economy amidst escalating trade tensions in Asia and around the globe. 

It’s Thursday, March 13, at 2pm in Hong Kong.

Over the last few months, investors have been skeptical about India’s growth narrative. Investors – like us – have been caught off-guard by the surprising recent slowdown in India’s growth. With the benefit of hindsight, we can very clearly attribute the slowdown to an unexpected double tightening of fiscal and monetary policy. 

But India seems to be on its way to recovery. Green shoots are already emerging in recent data. And we believe the recovery will continue to firm up over the coming months. What makes us so confident in our outlook for India? 

We see several key factors behind this trend: 

First, fiscal policy’s turning supportive for growth again. The government has been ramping up capital expenditure for infrastructure projects like roads and railways, with growth accelerating markedly in recent months. They have also cut income tax for households which will be effective from April 2025. 

Second, monetary policy easing across rates, liquidity, and the regulatory front. With CPI inflation recently printing at just 3.6 per cent which is below target, we believe the central bank will continue to pursue easy monetary policy. 

And third, moderation in food inflation will mean real household incomes will be lifted. 

Finally, the strength in services exports. Services exports include IT services, and increasingly business services. In fact, post-COVID India’s had very strong growth in business services exports. And the key reason for that is, post-COVID, I think businesses have come to realize that if you can work from home, you can work from Bangalore.

India's services exports have nearly doubled since December 2020, outpacing the 40 per cent rise in goods exports over the same period. This has resulted in services exports reaching $410 billion on an annualized basis in January, almost equal to the $430 billion of goods exports. Moreover, India continues to gain market share in services exports, which now account for 4.5 per cent of the global total, up from 4 per cent in 2020. 

To be sure there are some risks. India does face reciprocal tariff risks due to its large trade surplus with the US and high tariff rates that India imposes select imports from the U.S. But we believe that by September-October this year, India can reach a trade deal with the U.S. 

In any case, India's goods exports-to-GDP ratio is the lowest in the region. And even if global trade slows down due to tariff uncertainties, India's economy won't be as severely affected. In fact, it could potentially outperform the other economies in the region.

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.

While tariffs continue to dominate headlines, our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas suggests investors should also focus on the sectoral impacts of additional U.S. policy choices.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today, we’ll be talking about U.S. policy impacts on the market that aren’t about tariffs.

It’s Wednesday, March 12th, at 10:30am in New York.

If tariffs are dominating your attention, we sympathize. Again this week we heard the U.S. commit to raising tariffs and work out a resolution, this time all within the span of a workday. 

These twists and turns in the tariff path are likely to continue, but in the meantime it might make sense for investors to take some time to look away – instead focusing on some key sectoral impacts of U.S. policy choices that our Research colleagues have called out. 

For example, Andrew Percoco, who leads our Clean Energy Equity Research team, calls out that clean Energy stocks may be pricing in too high a probability of an Inflation Reduction Act (IRA) repeal. He cites a letter signed by 18 Republicans urging the speaker of the house to protect some of the energy tax credits in the IRA. That’s a good call out, in our view. Republicans’ slim majority means only a handful need to oppose a legislative action in order to block its enactment. 

Another example is around Managed Care companies. Erin Wright, who leads our Healthcare Services Research Effort, analyzed the impact to companies of cuts to the Medicaid program and found the impact to their sector’s bottom line to be manageable. So, keeping an in-line view for the sector. We think the sector won’t ultimately face this risk, as, like with the IRA, we do not expect there to be sufficient Republican votes to enact the cuts. 

Finally, Patrick Wood, who leads the Medtech team, caught up with a former FDA director to talk about how staffing cuts might affect the industry. In short, expect delays in approvals of new medical technologies. In particular, it seems the risk is most acute in the most cutting edge technologies, where skilled FDA staff are hard to find. Neurology and brain/computer interfaces stand out as areas of development that might slow in this market sector. 

All that said, if you just can’t turn away from tariffs, we reiterate our guidance here: Tariffs are likely going up, even if the precise path is uncertain. And whether or not you’re constructive on the goals the administration is attempting to achieve, the path to achieving them carries costs and execution risk. Our U.S. economics team’s recent downgrade of the U.S. growth outlook for this and next year exemplifies this. 

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 analysts Adam Jonas and Michelle Weaver share a glimpse into the future from Morgan Stanley’s Annual Tech, Media, and Telecom (TMT) Conference, as agentic AI powers autonomous vehicles, humanoid robots and more.

Our Head of U.S. IT Hardware Erik Woodring gives his key takeaways from Morgan Stanley’s Technology, Media and Telecom (TMT) conference, including why there appears to be a long runway ahead for AI infrastructure spending, despite macro uncertainty. 

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Welcome to Thoughts on the Market. I’m Erik Woodring, Morgan Stanley’s Head of U.S. IT Hardware Research. 

Here are some reflections I recorded last week at Morgan Stanley’s Technology, Media, and Telecom Conference in San Francisco. 

It’s Monday, March 10th at 9am in New York. 

This was another year of record attendance at our TMT Conference. And what is clear from speaking to investors is that the demand for new, under-discovered or under-appreciated ideas is higher than ever. In a stock-pickers’ market – like the one we have now – investors are really digging into themes and single name ideas. 

Big picture – uncertainty was a key theme this week. Whether it’s tariffs and the changing geopolitical landscape, market volatility, or government spending, the level of relative uncertainty is elevated. That said, we are not hearing about a material change in demand for PCs, smartphones, and other technology hardware. 

On the enterprise side of my coverage, we are emerging from one of the most prolonged downcycles in the last 10-plus years, and what we heard from several enterprise hardware vendors and others is an expectation that most enterprise hardware markets – PCs , Servers, and Storage – return to growth this year given pent up refresh demand. This, despite the challenges of navigating the tariff situation, which is resulting in most companies raising prices to mitigate higher input costs. 

On the consumer side of the world, the demand environment for more discretionary products like speakers, cameras, PCs and other endpoint devices looks a bit more challenged. The recent downtick in consumer sentiment is contributing to this environment given the close correlation between sentiment and discretionary spending on consumer technology goods. 

Against this backdrop, the most dynamic topic of the conference remains GenerativeAI. What I’ve been hearing is a confidence that new GenAI solutions can increasingly meet the needs of market participants. They also continue to evolve rapidly and build momentum towards successful GenAI monetization. 

To this point, underlying infrastructure spending—on servers, storage and other data center componentry – to enable these emerging AI solutions remains robust. To put some numbers behind this, the 10 largest cloud customers are spending upwards of [$]350 billion this year in capex, which is up over 30 percent year-over-year. Keep in mind that this is coming off the strongest year of growth on record in 2024. Early indications for 2026 CapEx spending still point to growth, albeit a deceleration from 2025. 

And what’s even more compelling is that it’s still early days. My fireside chats this week highlighted that AI infrastructure spending from their largest and most sophisticated customers is only in the second inning, while AI investments from enterprises, down to small and mid-sized businesses, is only in the first inning, or maybe even earlier. So there appears to be a long runway ahead for AI infrastructure spending, despite the volatility we have seen in AI infrastructure stocks, which we see as an opportunity for investors. 

I’d just highlight that amidst the elevated market uncertainty, there is a prioritization on cost efficiencies and adopting GenAI to drive these efficiencies. Company executives from some of the major players this week all discussed near-term cost efficiency initiatives, and we expect these efforts to both help protect the bottom line and drive productivity growth amidst a quickly changing market backdrop. 

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.

While policy noise continues to dominate the headlines, our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas points out a key theme: a transition toward a multipolar world.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today we’ll be discussing what investors need to focus on amidst all the U.S. policy headlines.

It’s Friday, March 7th, at 12:30 pm in New York.

In recent weeks the news flow on tariffs, immigration, and geopolitics has been relentless, culminating in this week’s state of the union address by President Trump and, if headlines hold, a partial reversal in course on Mexico and Canada tariffs that were just levied earlier this week. Understandably, measures of policy uncertainty, such as the Baker, Bloom, and Davis index, have reached all time highs. And this tracks with the confusion expressed by investing and corporate clients. 

In our view, this policy noise is going to continue. But, there is an important signal. These developments track with one of our four key themes of 2025. The transition toward a multipolar world. The tense White House meeting between Presidents Trump and Zelensky, played out live in front of the news cameras, was another reminder that the U.S. is evolving its role in driving international affairs. And tariffs on Mexico, Canada, and China are a reminder of the U.S.’s interest in rewiring global trade. The reasons behind this are myriad and complex, but in the near term it's about the U.S. looking more inward. Economic populism is, well, popular with voters in both parties. 

There’s a few net takeaways for investors here. One is a positive for the European defense sector. The combination of tariffs and the evolving U.S. posture on global security has long been part of our thesis on why Europe would eventually chart a new path and step up to spend more on defense. The current situation in Russia and Ukraine underscores this, with potential for another $0.9-$2.7 trillion in defense spending through 2035. Germany’s new ‘whatever it takes’ approach to defense spending is a key signpost in this trend, per our colleagues in European economics, equities, and foreign exchange. 

Another critical takeaway is around the effects of U.S. trade realignment on both macro markets and equity sector preferences. Whether these trade policy changes play out well over time or not, the attempt costs something in the near term. Tariffs are part of that cost. And while the precise path of tariff increases is unclear, what is clear is that they’re headed higher in the aggregate, a tactic in service of the administration’s goal of reducing trade deficits and creating reciprocal trade barriers in order to incentivize greater production in the U.S. 

Over the next year, our economists expect that those tariff costs will crimp economic activity. That slower growth should eventually feed through into a more dovish monetary policy. Both factors, in the view of our U.S. rates strategy team, should continue pushing yields lower – good news for bond investors, but more challenging posture for equity investors, and a key reason our cross asset team is currently flagging a preference for fixed income. 

That tariff activity should also drive supply chain realignment. But, going forward, changing those supply chains may now be more costly. Per work from our Global economics team, the supply chains that need to be moved now are complex and concentrated in geopolitical rivals. That’s a challenge for certain sectors, like U.S. IT hardware and consumer discretionary. But the investment to make it happen creates demand and is a benefit for the capital goods and broader industrials sector. 

Bottom line, the policy noise will continue, as will the market cross currents it’s driving. We’ll keep you informed on it all here. 

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.

Recorded at our 2025 Technology, Media and Telecom (TMT) Conference, TMT Credit Research Analyst Lindsay Tyler joins Head of Investment Grade Debt Coverage Michelle Wang to discuss the how the industry is strategically raising capital to fund growth.

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Lindsay Tyler: Welcome to Thoughts on the Market. I'm Lindsay Tyler, Morgan Stanley's Lead Investment Grade TMT Credit Research Analyst, and I'm here with Michelle Wang, Head of Investment Grade Debt Coverage in Global Capital Markets.

On this special episode, we're recording at the Morgan Stanley Technology, Media, and Telecom (TMT) Conference, and we will discuss the latest on the technology space from the fixed income perspective.

It's Thursday, March 6th at 12 pm in San Francisco.

What a week it's been. Last I heard, we had over 350 companies here in attendance.

To set the stage for our discussion, technology has grown from about 2 percent of the broader investment grade market – about two decades ago – to almost 10 percent now; though that is still relatively a small percentage, relative to the weightings in the equity market.

So, can you address two questions? First, why was tech historically such a small part of investment grade? And then second, what has driven the growth sense?

Michelle Wang: Technology is still a relatively young industry, right? I'm in my 40s and well over 90 percent of the companies that I cover were founded well within my lifetime. And if you add to that the fact that investment grade debt is, by definition, a later stage capital raising tool. When the business of these companies reaches sufficient scale and cash generation to be rated investment grade by the rating agencies, you wind up with just a small subset of the overall investment grade universe.

The second question on what has been driving the growth? Twofold. Number one the organic maturation of the tech industry results in an increasing number of scaled investment grade companies. And then secondly, the increasing use of debt as a cheap source of capital to fund their growth. This could be to fund R&D or CapEx or, in some cases, M&A.

Lindsay Tyler: Right, and I would just add in this context that my view for this year on technology credit is a more neutral one, and that's against a backdrop of being more cautious on the communications and media space.

And part of that is just driven by the spread compression and the lack of dispersion that we see in the market. And you mentioned M&A and capital allocation; I do think that financial policy and changes there, whether it's investment, M&A, shareholder returns – that will be the main driver of credit spreads.

But let's turn back to the conference and on the – you know, I mentioned investment. Let's talk about investment.

AI has dominated the conversation here at the conference the past two years, and this year is no different. Morgan Stanley's research department has four key investment themes. One of those is AI and tech diffusion.

But from the fixed income angle, there is that focus on ongoing and upcoming hyperscaler AI CapEx needs.

Michelle Wang: Yep.

Lindsay Tyler: There are significant cash flows generated by many of these companies, but we just discussed that the investment grade tech space has grown relative to the index in recent history.

Can you discuss the scale of the technology CapEx that we're talking about and the related implications from your perspective?

Michelle Wang: Let's actually get into some of the numbers. So in the past three years, total hyperscaler CapEx has increased from [$]125 billion three years ago to [$]220 billion today; and is expected to exceed [$]300 billion in 2027.

The hyperscalers have all publicly stated that generative AI is key to their future growth aspirations. So, why are they spending all this money? They're investing heavily in the digital infrastructure to propel this growth. These companies, however, as you've pointed out, are some of the most scaled, best capitalized companies in the entire world. They have a combined market cap of [$]9 trillion. Among them, their balance sheet cash ranges from [$]70 to [$]100 billion per company. And their annual free cash flow, so the money that they generate organically, ranges from [$]30 to [$]75 billion.

So they can certainly fund some of this CapEx organically. However, the unprecedented amount of spend for GenAI raises the probability that these hyperscalers could choose to raise capital externally.

Lindsay Tyler: Got it.

Michelle Wang: Now, how this capital is raised is where it gets really interesting. The most straightforward way to raise capital for a lot of these companies is just to do an investment grade bond deal.

Lindsay Tyler: Yep.

Michelle Wang: However, there are other more customized funding solutions available for them to achieve objectives like more favorable accounting or rating agency treatment, ways for them to offload some of their CapEx to a private credit firm. Even if that means that these occur at a higher cost of capital.

Lindsay Tyler: You touched on private credit. I'd love to dig in there. These bespoke capital solutions.

Michelle Wang: Right.

Lindsay Tyler: I have seen it in the semiconductor space and telecom infrastructure, but can you please just shed some more light, right? How has this trend come to fruition? How are companies assessing the opportunity? And what are other key implications that you would flag?

Michelle Wang: Yeah, for the benefit of the audience, Lindsay, I think just to touch a little bit…

Lindsay Tyler: Some definitions,

Michelle Wang: Yes, some definitions around ...

Lindsay Tyler: Get some context.

Michelle Wang: What we’re talking about.

Lindsay Tyler: Yes.

So the – I think what you're referring to is investment grade companies doing asset level financing. Usually in conjunction with a private credit firm, and like all financing trends that came before it, all good financing trends, this one also resulted from the serendipitous intersection of supply and demand of capital.

On the supply of capital, the private credit pocket of capital driven by large pockets of insurance capital is now north of $2 trillion and it has increased 10x in scale in the past decade. So, the need to deploy these funds is driving these private credit firms to seek out ways to invest in investment grade companies in a yield enhanced manner.

Lindsay Tyler: Right. And typically, we're saying 150 to 200 basis points greater than what maybe an IG bond would yield.

Michelle Wang: That's exactly right. That's when it starts to get interesting for them, right? And then the demand of capital, the demand for this type of capital, that's always existed in other industries that are more asset-heavy like telcos.

However, the new development of late is the demand for capital from tech due to two megatrends that we're seeing in tech. The first is semiconductors. Building these chip factories is an extremely capital-intensive exercise, so creates a demand for capital. And then the second megatrend is what we've seen with the hyperscalers and GenerativeAI needs. Building data centers and digital infrastructure for GenerativeAI is also extremely expensive, and that creates another pocket of demand for capital that private credit conveniently kinda serves a role in.

Lindsay Tyler: Right.

Michelle Wang: So look, think we've talked about the ways that companies are using these tools. I'm interested to get your view, Lindsay, on the investor perspective.

Lindsay Tyler: Sure.

Michelle Wang: How do investors think about some of these more bespoke solutions?

Lindsay Tyler: I would say that with deals that have this touch of extra complexity, it does feel that investor communication and understanding is all important. And I have found that, some of these points that you're raising – whether it's the spread pickup and the insurance capital at the asset managers and also layering in ratings implications and the deal terms. I think all of that is important for investors to get more comfortable and have a better understanding of these types of deals.

The last topic I do want us to address is the macro environment. This has been another key theme with the conference and with this recent earnings season, so whether it's rate moves this year, the talk of M& A, tariffs – what's your sense on how companies are viewing and assessing macro in their decision making?

Michelle Wang: There are three components to how they're thinking about it.

The first is the rate move. So, the fact that we're 50 to 60 basis points lower in Treasury yields in the past month, that's welcome news for any company looking to issue debt. The second thing I'll say here is about credit spreads. They remain extremely tight. Speaking to the incredible kind of resilience of the investment grade investor base. The last thing I'll talk about is, I think, the uncertainty. [Because] that's what we're hearing a ton about in all the conversations that we've had with companies that have presented here today at the conference.

Lindsay Tyler: Yeah. For my perspective, also the regulatory environment around that M&A, whether or not companies will make the move to maybe be more acquisitive with the current new administration.

Michelle Wang: Right, so until the dust settles on some of these issues, it's really difficult as a corporate decision maker to do things like big transformative M&A, to make a company public when you don't know what could happen both from a the market environment and, as you point out, regulatory standpoint.

The thing that's interesting is that raising debt capital as an investment grade company has some counter cyclical dynamics to it. Because risk-off sentiment usually translates into lower treasury yields and more favorable cost of debt.

And then the second point is when companies are risk averse it drives sometimes cash hoarding behavior, right? So, companies will raise what they call, you know, rainy day liquidity and park it on balance sheet – just to feel a little bit better about where their balance sheets are. To make sure they're in good shape…

Lindsay Tyler: Yeah, deal with the maturities that they have right here in the near term.

Michelle Wang: That's exactly right. So, I think as a consequence of that, you know, we do see some tailwinds for debt issuance volumes in an uncertain environment.

Lindsay Tyler: Got it. Well, appreciate all your insights. This has been great. Thank you for taking the time, Michelle, to talk during such a busy week.

Michelle Wang: It's great speaking with you, Lindsay.

Lindsay Tyler: And thanks to everyone listening in to this special episode recorded at the Morgan Stanley TMT Conference in San Francisco. 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.

While central bank policy will always matter for markets, our Head of Corporate Credit Research Andrew Sheets explains why investors should not be worried about the number of Fed cuts in 2025.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about why the number of Fed rate cuts this year may matter less than you think.

It's Wednesday, March 5th, at 2pm in London.

Financial markets spend a lot of time discussing the Federal Reserve. And for good reason. The central bank of the world’s largest economy plays a central role in fighting inflation and setting interest rates. And what they’ll do this year is topical and shifting. At Morgan Stanley, our economists think that US Tariff and Immigration policy will lead the Fed to keep rates somewhat higher, for somewhat longer, than they did at the start of the year.

Yet we think there may be just a little bit too much focus on just how much the Fed changes policy over the course of the year. Indeed, we’d go as far as to say that given the choice, investors should be rooting for less change, not more.

To start, for all that’s happened in the world since the end of October of 2024, expectations for the Fed’s interest rate path have been remarkably stable. The US 2-year Treasury, which is a decent proxy of where the Fed’s rate will average over the next 24 months, has hovered in a very narrow range. It simply hasn’t been telling us very much; other factors have been moving markets.

There’s also a pretty reasonable rule of thumb from history: stability is good. A stable Fed funds rate, almost by definition, implies a stable equilibrium that doesn’t involve overly high inflation pushing rates further up, or overly weak growth pushing them further down. The best growth in recent history, in the mid-1990s, occurred after the Fed reduced interest rates less than one-percent, and then kept them stable, at a pretty elevated rate for a pretty extended period of time.

Large changes in rates, on the other hand, in either direction are a different story. Some of the markets worst losses have coincided with the largest declines in the Fed’s target rate – because those large rate cuts usually occur only when there is a large, unexpected slowing in the economy; something markets often don’t like.

Meanwhile, we think the Fed also very much wants to avoid a scenario where it has to start raising rates again, given the potential confusion that this could signal after it only recently continued to lower them. And so if over the course of this year, the Fed does need to raise rates, given the very high bar we think they’ve given themselves for action – it probably suggests that something unexpected, and not in a necessarily good way, has occurred.

Central bank policy will always matter for markets. But for investors, the question of whether the Fed will cut once, which is the Morgan Stanley base-case, twice, or not at all in 2025 may not matter all that much, at least for credit. Far more important is the performance of the economy, and whether big changes to tariffs or immigration policy drive big changes to growth and inflation. Those big changes, which could drive big changes in Fed policy responses, are the scenario that worries us.

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

Our U.S. Public Policy and Currency analysts, Ariana Salvatore and Andrew Watrous, discuss why the dollar fell at the beginning of the first Trump administration and whether it could happen again this year. 

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist.

Andrew Watrous: And I'm Andrew Watrous, G10 FX Strategist here at Morgan Stanley.

Ariana Salvatore: Today, we'll focus on the U.S. dollar and how it might fare in global markets during the first year of the new Trump administration.

It's Tuesday, March 4th at 10am in New York.

So, Andrew, a few weeks ago, James Lord came on to talk about the foreign exchange volatility. Since then, tariffs and trade policy have been in the news. Last night at midnight, 25 percent tariffs on Mexico and Canada went into effect, in addition to 10 percent on China. So, let's set the scene for today's conversation. Is the dollar still dominant in global currency markets?

Andrew Watrous: Yes, it is. The U.S. dollar is used in about $7 trillion worth of daily FX transactions. And the dollar's share of all currency transactions has been pretty stable over the last few decades. And something like 80 percent of all trade finance is invoiced in dollars, and that share has been pretty stable too.

A big part of that dollar dominance is because of the depth and safety of the Treasury security market.

Ariana Salvatore: That makes sense. And the dollar fell in 2017, the first year of the Trump administration. Why did that happen?

Andrew Watrous: Yeah, so 2017 gets a lot of client attention because the Fed was hiking, there was a lot of uncertainty about would happen in NAFTA, and the U.S. passed a fiscally expansionary budget bill that year.

So, people have asked us, ‘Why the U.S. dollar went down despite all those factors?’ And I think there are three reasons. One is that even though the possibility that the U.S. could leave NAFTA was all over the headlines that year, U.S. tariffs didn't actually go up. Another factor is that global growth turned out to be really strong in 2017, and that was helped in part by fiscal policy in China and Europe. And finally, there were some political risks in Europe that didn't end up materializing.

So, investors took a sigh of relief about the possibility that I think had been priced in a bit that the Eurozone might break up. And then a lot of those factors went into reverse in 2018 and the U.S. dollar went up.

Ariana Salvatore: So, applying that framework with those factors to today, is it possible that we see a repeat of 2017 in terms of the U.S. dollar decline?

Andrew Watrous: Yeah, I think it's likely that the U.S. dollar continues to go lower for some of the same reasons as we saw in 2017. So, I think that compared to 2017, there's a lot more U.S. dollar positive risk premium around trade policy. So, the bar is higher for the U.S. dollar to go up just from trade headlines alone.

And just like in 2017, European policy developments could be a tailwind to the euro. We've been highlighting the potential for German fiscal expansion as European defense policy comes into focus. And unlike in 2017, when the Fed was raising rates, now the Fed is probably going to cut more this year. So that's a headwind to the dollar that didn't exist back in 2017.

So, on trade, Ariana. What developments do you expect? Do you think that Trump's new policies will make 2025 different in any way from 2017?

Ariana Salvatore: So, taking a step back and looking at this from a very high level, a few things are different in spite of the fact that we're actually talking about a lot of similar policies. Tariffs and tax policy were a big focus in 2017 to 2019, and to be sure, this time around, they are too, but in a slightly different way.

So, for example, on tax cuts, we're not talking about bringing rates lower on the individual and corporate side. We're talking about extending current policy. And on tariffs and trade policy, this round I would characterize as much broader, right? So, Trump has scoped in a broader range of trading partners into the discussion like Mexico and Canada; and is talking about a starting point that level-wise is much higher than what we saw in the whole 2018 2019 trade friction period.

The highest rate back then we ever saw was 25 percent, and that was on the final batch of Chinese goods, that list four. Whereas this time, we're talking about 25 percent as a starting point for Mexico and Canada.

I think sequencing is also a really important distinction. In 2017, we saw the tax cuts through the Tax Cuts and Jobs Act (TCJA) come first, followed by trade tensions in 2018 to 2019. This time around, it's really the inverse. Republicans just passed their budget resolution in the House. That lays the groundwork for the tax cut extensions.

But in the meantime, Trump has been talking about tariff implementation since before he was even elected. And we've already had a number of really key trade related catalysts in the just six weeks or so that he's been in office.

Andrew Watrous: So, you mentioned expectations for fiscal policy. What are recent developments there, and what do you think will happen with U.S. fiscal?

Ariana Salvatore: I mentioned the budget resolution in the house that was passed last week. And you can really think of that as the starting point for the reconciliation process to kick off. And consequently, the extension of the Tax Cuts and Jobs Act.

To be clear, we think that House Republicans will be able to align behind extending most of the expiring Tax Cuts and Jobs Act, but that's still in the books until the end of 2025. So, we see many months needed to kind of build this consensus among cohorts of the Republican caucus in Congress, and we already know there's some key sticking points in the discussion.

What happens with the SALT [State and Local Tax] cap? What sort of clawbacks occur with the Inflation Reduction Act? All these are disagreements that right now are going to need time to work their way through Congress. So not a lot of alignment just yet. We think it's going to take most of the year to get there.

But ultimately, we do see an extension of most of the TCJA, which is like I said, current law until the end of 2025.

But Andrew from what I understand when it comes to fiscal policy, there are really two stages in terms of the market impact that we saw in the last administration. Can you walk us through those?

Andrew Watrous: Yeah, so one lesson from 2016 to 2018 is that there were really two stages of when fiscal developments boosted the dollar. The first was right after the U.S. election in 2016, and the second was much later after the Tax Cuts and Jobs Act passed. So right after the 2016 election, within a couple of weeks, the dollar index rallied from 98 up to 103, and 10-year Treasury yields rose as well.

And then things sort of moved sideways in between these two stages. Ten-year Treasury yield just moved sideways. Fiscal wasn't as supportive to the U.S. dollar. And as we know, the dollar went down. And then we had the second stage more than a year later. So, the TCJA was passed in December 2017. And then the dollar rallied after that along with the rise in Treasury yield.

So, we think that now, what we've seen is actually very similar to what happened in 2017, where the dollar and yields moved a lot after the 2024 election; but now the budget reconciliation process probably won't be a tailwind to the dollar until after a tax cuts extension passes Congress. And as you mentioned, that's not going to be for many, many months. So, in the interim, we think there's a lot of room for the dollar to go down.

Ariana Salvatore: And just to level set our expectations there to your point, it is probably going to be later this year. House Republicans have to align on a number of key sticking points. So, we have passage somewhere on the third or fourth quarter of 2025.

But when we think about the fiscal picture, aside from the deficit and the macro impacts, a really key component is going to be what these tax changes mean for the equity market. The extension of certain tax policies will matter more for certain sectors versus others. For example, we know that extending some of the corporate provisions, aside from the lower rate, will have an impact across domestically oriented industries like industrials, healthcare, and telecom.

But Andrew, to bring it back to this discussion, I want to think a little bit more about how we can loop in our expectations for the equity market and map that to certain dollar outcomes. How do you think that this as a barometer has changed, if at all, from Trump's first term?

Andrew Watrous: Yeah, currency strategists like me love talking about yield differentials. But from 2016 to 2018, the U.S. dollar did not trade in line with yield differentials. Instead, in the initial years of President Trump's first term, equities were a much better barometer than interest rates for where the U.S. dollar would go.

After President Trump was elected in 2016, U.S. stocks really outperformed stocks in the rest of the world, and the U.S. dollar went up. Then in 2017, stocks outside the U.S. caught up to the move in U.S. stocks, and the U.S. dollar fell. Then in 2018, all that went into reverse, and U.S. stocks started outperforming again, and the U.S. dollar went up.

So, what we've been seeing in stocks today really echoes 2017, not 2018. Stocks outside the U.S. have caught up to the post election rise in U.S. stocks. And so, just like it did in 2017, we think that the U.S. dollar will decline to catch up to that move in relative stock indices.

Ariana Salvatore: Finally, Andrew, we already discussed the U.S. dollar negative drivers from 2017. But what happened to these drivers the following year in 2018? And is that any indication for what might happen in 2026?

Andrew Watrous: So 2018, as you mentioned, does offer a blueprint for how the U.S. dollar could go up. So, for example, if trade tensions evolve in a direction where our economists would have to significantly downwardly revise their global growth forecasts, then the U.S. dollar could start to look more attractive as a safe haven. And in 2018, there was a big rise in long-end Treasury yields. That's not what we're calling for; but if that were to happen, then the U.S. dollar could catch a bid.

Ariana Salvatore: Andrew, thanks for taking the time to talk.

Andrew Watrous: Great speaking with you, Ariana.

Ariana Salvatore: 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 Semiconductors and Software analysts Joe Moore and Keith Weiss dive into the biggest market debate around AI and why it’s likely to shape conversations at Morgan Stanley’s Technology, Media and Telecom (TMT) Conference in San Francisco. 

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Joe Moore: Welcome to Thoughts on the Market. I'm Joe Moore, Morgan Stanley's Head of U.S. Semiconductors.

Keith Weiss: And I'm Keith Weiss, Head of U.S. Software.

Joe Moore: Today on the show, one of the biggest market debates in the tech sector has been around AI and the Return On Investment, or ROI. In fact, we think this will be the number one topic of conversation at Morgan Stanley's annual Technology, Media and Telecom (TMT) conference in San Francisco.

And that's precisely where we're bringing you this episode from.

It's Monday, March 3rd, 7am in San Francisco.

So, let's get right into it. ChatGPT was released November 2022. Since then, the biggest tech players have gained more than $9 trillion in combined market capitalization. They're up more than double the amount of the S&P 500 index. And there's a lot of investor expectation for a new technology cycle centered around AI. And that's what's driving a lot of this momentum.

You know, that said, there's also a significant investor concern around this topic of ROI, especially given the unprecedented level of investment that we've seen and sparse data points still on the returns.

So where are we now? Is 2025 going to be a year when the ROI and GenAI finally turns positive?

Keith Weiss: If we take a step back and think about the staging of how innovation cycles tend to play out, I think it's a helpful context.

And it starts with research. I would say the period up until When ChatGPT was released – up until that November 2022 – was a period of where the fundamental research was being done on the transformer models; utilizing, machine learning. And what fundamental research is, is trying to figure out if these fundamental capabilities are realistic. If we can do this in software, if you will.

And with the release of ChatGPT, it was a very strong, uh, stamp of approval of ‘Yes, like these transformer models can work.’

Then you start stage two. And I think that's basically November 22 through where are today of, where you have two tracks going on. One is development. So these large language models, they can do natural language processing well.

They can contextually understand unstructured and semi structured data. They can generate content. They could create text; they could create images and videos.

So, there's these fundamental capabilities. But you have to develop a product to get work done. How are we going to utilize those capabilities? So, we've been working on development of product over the past two years. And at the same time, we've been scaling out the infrastructure for that product development.

And now, heading into 2025, I think we're ready to go into the next stage of the innovation cycle, which will be market uptake.

And that's when revenue starts to flow to the software companies that are trying to automate business processes. We definitely think that monetization starts to ramp in 2025, which should prove out a better ROI or start to prove out the ROI of all this investment that we've been making.

Joe Moore: Morgan Stanley Research projects that GenAI can potentially drive a $1.1 trillion dollar revenue opportunity in 2028, up from $45 billion in 2024. Can you break this down for our listeners?

Keith Weiss: We recently put out a report where we tried to size kind of what the revenue generation capability is from GenerativeAI, because that's an important part of this ROI equation. You have the return on the top of where you could actually monetize this. On the bottom, obviously, investment. And we took a look at all the investment needed to serve this type of functionality.

The [$]1.1 trillion, if you will, it breaks down into two big components. Um, One side of the equation is in my backyard, and that's the enterprise software side of the equation. It's about a third of that number. And what we see occurring is the automation of more and more of the work being done by information workers; for people in overall.

And what we see is about 25 percent, of overall labor being impacted today. And we see that growing to over 45 percent over the next three years.

So, what that's going to look like from a software perspective is a[n] opportunity ramping up to about, just about $400 billion of software opportunity by 2028. At that point, GenerativeAI will represent about 22 percent of overall software spending. At that point, the overall software market we expect to be about a $1.8 trillion market.

The other side of the equation, the bigger side of the equation, is actually the consumer platforms. And that kind of makes sense if you think about the broader economy, it's basically one-third B2B, two-thirds B2C. The automation is relatively equivalent on both sides of the equation.

Joe Moore: So, let's drill further into your outlook for software. What are the biggest catalysts you expect to see this year, and then over the coming three years?

Keith Weiss: The key catalyst for this year is proving out the efficacy of these solutions, right?

Proving out that they're going to drive productivity gains and yield real hard dollar ROI for the end customer. And I think where we'll see that is from labor savings.

Once that occurs, and I think it's going to be over the next 12 to 18 months, then we go into the period of mainstream adoption. You need to start utilizing these technologies to drive the efficiencies within your businesses to be able to keep up with your competitors. So, that's the main thing that we're looking for in the near term.

Over the next three years, what you're looking for is the breakthrough technologies. Where can we find opportunities not just to create efficiencies within existing processes, but to completely rewrite the business process.

That's where you see new big companies emerge within the software opportunity – is the people that really fundamentally change the equation around some of these processes.

So, Joe, turning it over to you, hardware remains a bottleneck for AI innovation. Why is that the case? And what are the biggest hurdles in the semiconductor space right now?

Joe Moore: Well, this has proven to be an extremely computationally intensive application, and I think it started with training – where you started seeing tens of thousands of GPUs or XPUS clustered together to train these big models, these Large Language Models. And you started hearing comments two years ago around the development of ChatGPT that, you know, the scaling laws are tricky.

You might need five times as much hardware to make a model that's 10 percent smarter. But the challenge of making a model that's 10 percent smarter, the table stakes of that are very significant. And so, you see, you know, those investments continuing to scale up. And that's been a big debate for the market.

But we've heard from most of the big spenders in the market that we are continuing to scale up training. And then after that happened, we started seeing inference suddenly as a big user of advanced processors, GPUs, in a way that they hadn't before. And that was sort of simple conversational types of AI.

Now as you start migrating into more of a reasoning AI, a multi pass approach, you're looking at a really dramatic scaling in the amount of hardware, that's required from both GPUs and XPUs.

And at the same time the hardware companies are focused a lot on how do we deliver that – so that it doesn't become prohibitively expensive; which it is very expensive. But there's a lot of improvement. And that's where you're sort of seeing this tug of war in the stocks; that when you see something that's deflationary, uh, it becomes a big negative. But the reality is the hardware is designed to be deflationary because the workloads themselves  are inflationary.

And so I think there's a lot of growth still ahead of us. A lot of investment, and a lot of rich debate in the market about this.

Keith Weiss: Let's pull on that thread a little bit. You talked initially about the scaling of the GPU clusters to support training. Over the past year, we've gotten a little bit more pushback on the ideas or the efficacy of those scaling laws.

They've come more under question. And at the same time, we've seen the availability of some lower cost, but still very high-performance models. Is this going to reshape the investments from the large semiconductor players in terms of how they're looking to address the market?

Joe Moore: I think we have to assess that over time. Right now, there are very clear comments from everybody who's in charge of scaling large models that they intend to continue to scale.

I think there is a benefit to doing so from the standpoint of creating a richer model, but is the ROI there? You know, and that's where I think, you know, your numbers do a very good job of justifying our model for our core companies – where we can say, okay, this is not a bubble. This is investment that's driven by these areas of economic benefit that our software and internet teams are seeing.

And I think there is a bit of an arms race at the high end of the market where people just want to have the biggest cluster. And that's, we think that's about 30 percent of the revenue right now in hardware – is supporting those really big models. But we're also seeing, to your point, a very rich hardware configuration on the inference side post training model customization. Nvidia said on their on their earnings call recently that they see several orders of magnitude more compute required for those applications than for that pre-training. So, I think over time that's where the growth is going to come from.

But you know, right now we're seeing growth really from all aspects of the market.

Keith Weiss: Got it. So, a lot of really big opportunities out there utilizing these GPUs and ASICs, but also a lot of unknowns and potential risks. So, what are the key catalysts that you're looking for in the semiconductor space over the course of this year and maybe over the next three years?

Joe Moore: Well, 2025 is, is a year that is really mostly about supply.

You know, we're ramping up, new hardware But also, several companies doing custom silicon. We have to ramp all that hardware up and it's very complicated.

It uses every kind of trick and technique that semiconductors use to do advanced packaging and things like that. And so, it's a very challenging supply chain and it has been for two years. And fortunately, it's happened in a time when there's plenty of semiconductor capacity out there.

But I think, you know, we're ramping very quickly. And I think what you're seeing is the things that matter this year are gonna be more about how quickly we can get that supply, what are the gross margins on hardware, things like that.

I think beyond that, we have to really get a sense of, you know, these ROI questions are really important beyond 2025. Because again, this is not a bubble. But hardware is cyclical and there; it doesn't slow gracefully. So, there will be periods where investment may fall off and it'll be a difficult time to own the stocks. And that's, you know, we do think that over time, the value sort of transitions from hardware to software.

But we model for 2026 to be a year where it starts to slow down a little bit. We start to see some consolidation in these investments.

Now, 12 months ago, I thought that about 2025. So, the timeframe keeps getting pushed out. It remains very robust. But I think at some point it will plateau a little bit and we'll start to see some fragmentation; and we'll start to see markets like, you know, reasoning models, inference models becoming more and more critical. But that's where when I hear you and Brian Nowak talking about sort of the early stage that we are of actually implementing this stuff, that inference has a long way to go in terms of growth.

So, we're optimistic around the whole AI space for semiconductors. Obviously, the market is as well. So, there's expectations, challenges there. But there's still a lot of growth ahead of us.

So Keith, looking towards the future, as AI expands the functionality of software, how will that transform the business models of your companies?

Keith Weiss: We're also fundamentally optimistic about software and what GenerativeAI means for the overall software industry.

If we look at software companies today, particularly application companies, a lot of what you're trying to do is make information workers more productive. So, it made a lot of sense to price based upon the number of people who are using your software. Or you've got a lot of seat-based models.

Now we're talking about completely automating some of those processes, taking people out of the loop altogether. You have to price differently. You have to price based upon the number of transactions you're running, or some type of consumptive element of the amount of work that you're getting done. I think the other thing that we're going to see is the market opportunity expanding well beyond information workers.

So, the way that we count the value, the way that we accrue the value might change a little bit. But the underlying value proposition remains the same. It's about automating, creating productivity in those business processes, and then the software companies pricing for their fair share of that productivity.

Joe Moore: Great. Well, let me just say this has been a really useful process for me. The collaboration between our teams is really helpful because as a semiconductor analyst, you can see the data points, you can see the hardware being built. And I know the enthusiasm that people have on a tactical level. But understanding where the returns are going to come from and what milestones we need to watch to see any potential course correction is very valuable.

So on that note, it's time for us to get to the exciting panels at the Morgan Stanley TMT conference. Uh, And we'll have more from the conference on the show later this week. Keith, thanks for taking the time to talk.

Keith Weiss: Great speaking with you, Joe.

Joe Moore: 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 Research and Public Policy Strategy explains why conflicting news on tariffs and government spending may point to a case for bonds.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today we’ll be discussing recent U.S. public policy headline noise and the signal within that for investors.

It’s Friday, February 28th, at 12:30 pm in New York.

For investors paying attention to events in Washington, D.C., the past few weeks have been disorienting. Tariff announcements have continued, but with shifting details on timing and magnitude. And Congress passed a bill to enable substantial spending cuts, but subsequent media reports made clear the votes to actually enact these cuts later this year may not be there.  

Our recent client conversations have revealed that investors’ confusion has reached new heights, and there’s little consensus, or conviction, about whether U.S. policy choices are set to help or hurt the economy and markets. 

Net-net, it's a lot of policy noise, and very little signal. That said, here’s what we think investors can anchor to. 

For all the headlines on potential new tariffs for China, Mexico, Canada and on products like copper, actual tariff actions have followed a graduated pace, in line with our base case of ‘fast announcement, slow implementation’ – where tariffs on China start and continue to climb, but tariffs on the rest of world move slowly and are more subject to negotiation. Tariffs on Mexico and Canada appear, in our view, likely to be pushed out once again given progress in negotiation on harmonizing trade policy and progress in reduced border crossings.  

On the other hand, tariffs on China, already raised an incremental 10 percent a few weeks back, seem likely to step up again as there are much bigger disagreements that the two nations don’t appear close to resolving. 

But even if tariffs move according to the pace that we expect, that doesn’t mean they come without cost. The U.S.’s goal is to bring more investment onshore, with an aim toward increasing goods production, thereby reducing trade deficits, securing important supply chains, and growing industrial jobs. The theory is that higher tariff barriers might incentivize more direct investment into the U.S., as companies build supply chains in the U.S. to avoid the higher tariff costs.  

But even if that theory plays out, there’s a cost to that transition. In a recent blue paper, my colleague Rajeev Sibal led a team through an analysis demonstrating that the next phase of supply chain realignment would be considerably costlier to companies, given the complexity of production that must be shifted. So either way, companies take on new costs – tariffs, CapEx, or both. That challenges corporate margins, and economic growth, at least for a time. And there’s plenty of execution risk along the way. 

So what’s an investor to do? Our cross asset and interest rate strategy teams think it's time to lean more heavily into bonds. Equity markets may do just fine here, with investors looking through these near term costs, but the risk of something going wrong with, for example, tariffs escalation or broader geopolitical conflict, may keep a ceiling on investors’ risk appetite. 

Conversely, a growth slowdown presents a clearer case for owning bonds, particularly since it wasn’t that long ago that better economic data helped the Treasury market price out most of the expected monetary policy cuts for 2025. 

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.

Two recent surveys indicate that U.S. consumer confidence has shown a notable decline amid talks about inflation and potential tariff. Our Head of Corporate Credit Research Andrew Sheets discusses the market implications.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about the consumer side of the confidence debate. 

It’s Thursday, February 27th at 2pm in London. 

Two weeks ago on this program I discussed signs that uncertainty in U.S. government policy might be hitting corporate confidence, as evidenced by an unusually slow start to the year for dealmaking. That development is a mixed bag. Less confidence and more conservatism in companies holds back investment and reduces the odds of the type of animal spirits that can drive large gains. But it can be a good thing for lenders, who generally prefer companies to be more cautious and more risk-averse. 

But this question of confidence is also relevant for consumers. And today, I want to discuss what some of the early surveys suggest and how it can impact our view.

To start with something that may sound obvious but is nonetheless important, Confidence is an extremely powerful psychological force in the economy and financial markets. If you feel good enough about the future, you’ll buy a stock or a car with little regard to the price or how the economy might feel at the moment. And if you’re worried, you won’t buy those same things, even if your current conditions are still ok, or if the prices are even cheaper. Confidence, you could say, can trump almost everything else. 

And so this might help explain the market’s intense focus on two key surveys over the last week that suggested that US consumer confidence has been deteriorating sharply.

First, a monthly survey by the University of Michigan showed a drop in consumer confidence and a rise in expected inflation. And then a few days later, on Tuesday, a similar survey from the Conference Board showed a similar pattern, with consumers significantly more worried about the future, even if they felt the current conditions hadn't much changed. 

While different factors could be at play, there is at least circumstantial evidence that the flurry of recent U.S. policy actions may be playing a role. This drop in confidence, for example, was new, and has only really showed up in the last month or two. And the University of Michigan survey actually asks its respondents how news of Government Economic policy is impacting their level of confidence. And that response, over the last month, showed a precipitous decline. 

These confidence surveys are often called ‘soft’ data, as opposed to the hard economic numbers like the actual sales of cars or heavy equipment. But the reason they matter, and the reason investors listened to them this week, is that they potentially do something that other data cannot. One of the biggest challenges that investors face when looking at economic data is that financial markets often anticipate, and move ahead of turns in the underlying hard economic numbers. And so if expectations are predictive of the future, they may provide that important, more leading signal. 

One weak set of consumer confidence isn’t enough to change the overall picture, but it certainly has our attention. Our U.S. economists generally agree with these respondents in expecting somewhat slower growth and stickier inflation over the next 18 months; and Morgan Stanley continues to forecast lower bond yields across the U.S. and Europe on the expectation that uncertainties around growth will persist. 

For credit investors, less confidence remains a double-edged sword, and credit markets have been somewhat more stable than other assets. But we would view further deterioration in confidence as a negative – given the implications for growth, even if it meant a somewhat easier policy path. 

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

Our Chief U.S. Economist Michael Gapen discusses the possible economic implications of restrictive immigration policies in the U.S., highlighting their potential effect on growth, inflation and labor markets.

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Welcome to Thoughts on the Market. I’m Michael Gapen, Morgan Stanley’s Chief U.S. Economist. Today I’ll talk about the way restrictive immigration policies could potentially slow U.S. economic growth, push up inflation, and impact labor markets.

It’s Wednesday, February 26th, at 2pm in New York.

Lately, investors have been focused on the twists and turns of Trump’s tariffs. Several of my colleagues have discussed the issue of tariffs from various angles on this show. But we think the new administration’s immigration policy deserves more attention. 

Immigration is more than just the entry of foreign citizens into the U.S. for residency. It's a complex process with significant implications for our economy. According to the Bureau of Labor Statistics, as of June 2024, 19 per cent of the US workforce was made up of immigrants – which is over 32 million people. This is a significant increase from 1994, when only about 10 per cent of the workforce was foreign-born. Immigrants tend to be employed in sectors like agriculture, construction and manufacturing, but also in face-to-face services sectors like retail, restaurants, hotels and healthcare. 

Immigration surged to about 3 million per year after the pandemic. In fact, immigration rates in 2022 to 2024 were more than twice the historical run rate. This surge helped the US economy to "soft land" following a period of high inflation. It boosted both the supply side and the demand side of the U.S. economy. Labor force growth outpaced employment, which helped to moderate wage and price pressures. 

However, Trump’s policymakers are changing the rules rapidly and reversing the immigration narrative. Already by the second half of 2024, border flows were slowing significantly based on the lagged effects of steps previously taken by the Biden administration. Under the new administration, news reports suggest immigration has slowed to near zero in recent weeks.

In our 2025 year-ahead outlook, we noted that restrictive immigration policies were a key factor in our prediction for slower growth and firmer inflation. We estimate that immigration will slow from 2.7 million last year to about 1 million this year and 500,000 next year. The recent data suggests immigration may slow every more forcefully than we expect.

If immigration slows broadly in line as we predict, the result will be that population growth in 2025 will be about 4/10ths of 1 per cent. That’s less than half of what the U.S. economy saw in 2024. The impact of slower immigration on labor force measures should be visible over time. For the moment though, there is enough noise in monthly payrolls and the unemployment rate to mask some of the labor force effects. But over three or six months, the impact of slower immigration should become clearer.

In terms of economic growth, if immigration falls back to 1 million this year and 500,000 next year, this could reduce the rate of GDP growth by about a-half a percentage point this year and maybe even more next year, and put upward pressure on inflation, particularly in services, and to some extent overall wages. Slower immigration could pull short-run potential GDP growth down from the 2.5-3.0 per cent that we saw in recent years to 2 per cent this year, and 1-1.5 per cent next year. 

On the other hand, the unemployment rate might fall modestly as immigration controls reduce the number of households with high participation rates and low spending capacity. This could lead to tighter labor markets, moderately faster wage growth, and upward pressure on inflation. So we think we are looking at a two-speed labor market. Slower employment growth will feel soft and sluggish. But a low unemployment rate suggests the labour market itself is still tight. 

Given all of this, we think more restrictive immigration policies could lead to tighter monetary policy and keep the Fed on its currently restrictive stance for longer. All of this supports our expectation of just one cut this year and further rate cuts only next year after growth slows.

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.

A shift to private destinations for cruise lines could affect both operators and guests by 2030. Our Europe Leisure & Travel analyst Jamie Rollo explains.

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Welcome to Thoughts on the Market. I’m Jamie Rollo, Morgan Stanley’s Europe Leisure & Travel Analyst. And today I’ll talk about an intriguing trend – the cruise lines’ accelerating expansion into private islands. 

It’s Tuesday, February the 25th, at 2 PM in London.

Now the lure of a private island cruise is simple. You get almost exclusive access to a tropical retreat. You can lounge or snorkel on a pristine beach, you can enjoy a meal in a private cabana, you can even book a massage or a yoga class. The only other people around are fellow passengers on your vacation. So this isn't just the stuff of popular TV shows. It’s potentially the future of cruising. 

Cruise lines have actually been offering private islands for more than a decade. So it’s hardly a new phenomenon. In fact, in 2019, we estimate the majority of Caribbean cruise passengers visited a private island. 

As it happens, the Caribbean is the world's largest cruise destination. About saw 36 million cruise calls were there last year; that’s about 40 percent of global passenger capacity. And that’s surpassing the second largest region, the Mediterranean, at about 17 percent. Of course, the Caribbean’s proximity to North America and its year-round tropical climate make it a prime location for cruising. But despite these advantages, historically the Caribbean’s been seen as more of a lower-yielding market compared to regions like Europe or Alaska, which arguably have even more amazing scenery or historic sites. 

Interestingly, recent trends suggest that reputation might be changing. And new private islands over the last few years have reinvigorated the Caribbean cruise market. 

So what’s a private destinations or islands offer? For your guests, they get a seamless integration with the cruise experience. There’s no transfer required to a destination. There’s no external visitors coming into the resort. No-hassle, no-traffic, and very low crime. 

And for the cruise lines, well, they get greater control over the customer experience. They create superior customer satisfaction, which generates more repeat business. In addition, they can get that on-island spend that the guest would have spent with external vendors. And they can charge premium rates for exclusive areas. 

On top of that, many of these islands are quote close to the U.S. mainland, so you’re saving on fuel because the ship doesn’t have to steam so far; and on port fees. And then finally, proximity to the U.S. also can increase the short cruise duration market, which widens the addressable market for new-to-cruise passengers. And also can limit anti-tourism or anti-cruise sentiment because it moves guests out of congested areas and prevents unwanted visitors. 

All in all, the private island model offers a very high return on invested capital and may well be the future of the cruise line industry. In fact, if we add up the expansion plans of the biggest listed cruise lines, we think their private island guest count will double over the next few years. And that could add over 10 per cent to top line sales and 30 per cent earnings-per-share for the fastest growing cruise lines. 

So very considerable financials, but also it’s a private paradise within reach … and an idea we can all set sail to. 

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 CIO and Chief U.S. Equity Strategist Mike Wilson explains the challenges to growth for U.S. stocks and why some investors are looking to China and Europe.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing new headwinds for growth and what that means for equities. 

It's Monday, Feb 24th at 11:30am in New York. 

So let’s get after it.  

Until this past Friday’s sharp sell off in stocks, the correlation between bond yields and stocks had been in negative territory since December. This inverse correlation strengthened further into year-end as the 10-year U.S. Treasury yield definitively breached 4.5 per cent on the upside for the first time since April of 2024. In November, we had identified this as an important yield threshold for stock valuations. This view was based on prior rate sensitivity equities showed in April of 2024 and the fall of 2023 as the 10-year yield pushed above this same level. In our view, the equity market has been signaling that yields above this point have a higher likelihood of weighing on growth. Supporting our view, interest rate sensitive companies like homebuilders have underperformed materially. This is why we have consistently recommended the quality factor and industries that are less vulnerable to these headwinds.

In our year ahead outlook, we suggested the first half of 2025 would be choppier for stocks than what we experienced last fall. We cited several reasons including the upside in yields and a stronger U.S. dollar. Since rates broke above 4.5 per cent in mid-December, the S&P 500 has made no progress. Specifically, the 6,100 resistance level that we identified in the fall has proven to be formidable for the time being. In addition to higher rates, softer growth prospects alongside a less dovish Fed are also holding back many stocks. As we have also discussed, falling rates won’t help if it’s accompanied by falling growth expectations as Friday’s sharp selloff in the face of lower rates illustrated. 

Beyond rates and a stronger US dollar, there are several other reasons why growth expectations are coming down. First, the immediate policy changes from the new administration, led by immigration enforcement and tariffs, are likely to weigh on growth while providing little relief on inflation in the short term. Second, the Dept of Govt Efficiency, or DOGE, is off to an aggressive start and this is another headwind to growth, initially.

Third, there appears to have been a modest pull-forward of goods demand at the end of last year ahead of the tariffs, and that impulse may now be fading. Fourth, consumers are still feeling the affordability pinch of higher rates and elevated price levels which weighed on last month's retail sales data. Finally, difficult comparisons, broader awareness of Deep Seek, and the debate around AI [CapEx] deceleration are weighing on the earnings revisions of some of the largest companies in the major indices.

All of these items are causing some investors to consider cheaper foreign stocks for the first time in quite a while – with China and Europe doing the best. In the case of China, it’s mostly related to the news around DeepSeek and perhaps stimulus for the consumer finally arriving this year. The European rally is predicated on hopes for peace in Ukraine and the German election results that may lead to the loosening of fiscal constraints. Of the two, China appears to have more legs to the story, in my opinion. 

Our Equity Strategy in the U.S. remains the same. We see limited upside at the index level in the first half of the year but plenty of opportunity at the stock, sector and factor levels. We continue to favor Financials, Software over Semiconductors, Media/Entertainment and Consumer Services over Goods. We also maintain an overriding penchant for quality across all size cohorts.

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

Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explores how a potential peace deal in Ukraine could reshape the global airline industry.

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Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Today’s topic is how a potential peace deal in Ukraine could affect global airlines. 

It’s Friday, February 21st, at 2pm in Hong Kong. 

The situation remains fluid, but we believe a potential peace deal in Ukraine could have broad implications for the global airline industry. From the reopening of Russian airspace to potential changes in fuel prices and flight routes, there are many variables at play. 

Russian airspace is currently off-limits due to the conflict, but a peace agreement could change that. The reopening of Russian airspace would be a significant catalyst for global airlines, reducing travel times and fuel consumption on routes between Europe, North America, and Asia. 

Fuel prices account for 20-40 per cent of airlines' costs, so any changes can have a significant impact on their bottom line. We believe a peace deal could lead to a moderate fall in fuel prices, benefiting all airlines, but particularly those with high-cost exposure and low margins. 

There could also be specific regional implications. The European air travel market could benefit significantly from an end to the Ukraine conflict. The reopening of Russian airspace would improve European airlines’ competitiveness on Asian routes, while a fall in fuel prices would reduce their operating costs. There would also be lower congestion in the intra-European market. 

Asian airlines, particularly Chinese ones, could experience a mixed impact. On the one hand, they could see an increase in wide-body utilization and passenger numbers if more direct flights to the U.S. are introduced. On the other hand, losing their advantage over European airlines of flying through Russian airspace would be negative. But, at the same time, Chinese airlines should remain competitive on pricing given meaningfully lower labor costs. 

U.S. airlines could also benefit in two significant ways. They could see a boost in revenues from adding back profitable routes such as U.S. to India or U.S. to South Korea that may have been suspended. Being able to fly directly over Russia would mean shorter, more direct flight paths resulting in less fuel burn and lower costs. U.S. airlines could also see a cost decrease from a moderate fall in jet fuel prices. 

Finally, Latin American carriers could also benefit from a peace deal. If global carriers reallocate capacity to China, it could tighten the market even further, creating an attractive capacity environment for the LatAm region. 

We’ll continue to bring you relevant updates on this evolving situation. 

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 Chief Economist Seth Carpenter explains the potential domino effect that President Trump’s reciprocal tariffs could have on the U.S. and global economies.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'm going to talk about downside risks to the U.S. economy, especially from tariffs.

It's Thursday, February 20th at 10am in New York.

Once again, tariffs are dominating headlines. The prospect of reciprocal tariffs is yet one more risk to our baseline forecast for the year. We have consistently said that the inflationary risk of tariffs gets its due attention in markets but the adverse growth implications that's an underappreciated risk.

But we, like many other forecasters, were surprised to the upside in 2023 and 2024. So maybe we should ask, are there some upside risks that we're missing?

The obvious upside risk to growth is a gain in productivity, and frequent readers of Morgan Stanley Research will know that we are bullish on AI. Indeed, the level of productivity is higher now than it was pre-COVID, and there is some tentative estimate that could point to faster growth for productivity as well.

Of course, a cyclically tight labor market probably contributes and there could be some measurement error. But gains from AI do appear to be happening faster than in prior tech cycles. So, we can't rule very much out. In our year ahead outlook, we penciled in about a-tenth percentage point of extra productivity growth this year from AI. And there is also a bit of a boost to GDP from AI CapEx spending.

Other upside risks, though, they're less clear. We don't have any boost in our GDP forecast from deregulation. And that view, I will say, is contrary to a lot of views in the market. Deregulation will likely boost profits for some sectors but probably will do very little to boost overall growth. Put differently, it helps the bottom line far more than it helps the top line. A notable exception here is probably the energy sector, especially natural gas.

Our baseline view on tariffs has been that tariffs on China will ramp up substantially over the year, while other tariffs will either not happen or be fleeting, being part of, say, broader negotiations. The news flow so far this year can't reject that baseline, but recently the discussion of broad reciprocal tariffs means that the risk is clearly rising.

But even in our baseline, we think the growth effects are underestimated. Somewhere in the neighborhood of two-thirds of imports from China are capital goods or inputs into U.S. manufacturing. The tariffs imposed before on China led to a sharp deterioration in industrial production. That slump went through the second half of 2018 and into and all the way through 2019 as a drag on the broader economy. Just as important, there was not a subsequent resurgence in industrial output.

Part of the undergraduate textbook argument for tariffs is to have more produced at home. That channel works in a two-economy model. But it doesn't work in the real world.

Now, the prospect of reciprocal tariffs broadens this downside risk. Free trade has divided production functions around the world, but it's also driven large trade imbalances, and it is precisely these imbalances that are at the center of the new administration's focus on tariffs. China, Canada, Mexico – they do stand out because of their imbalances in terms of trade with the U.S., but the underlying driving force is quite varied. More importantly, those imbalances were built over decades, so undoing them quickly is going to be disruptive, at least in the short run.

The prospect of reciprocity globally forces us as well to widen the lens. The risks aren't just for the U.S., but around the world. For Latin America and Asia in particular, key economies have higher tariff supply to U.S. goods than vice versa.

So, we can't ignore the potential global effects of a reciprocal tariff.

Ultimately, though, we are retaining our baseline view that only tariffs on China will prove to be durable and that the delayed implementation we've seen so far is consistent with that view. Nevertheless, the broad risks are clear.

Thanks for listening. And 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 co-heads of Securitized Products Research, James Egan and Jay Bacow, explain how the increase in home prices, a tight market supply and steady mortgage rates are affecting home sales.

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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 at Morgan Stanley.

Today, a look at the latest trends in the mortgage and housing market.

It's Wednesday, February 19th, at 11am in New York.

Now, Jim, there's been a lot of headlines to kick off the year. How is the housing market looking here? Mortgage rates are about 80 basis points higher than the local lows in September. That can't be helping affordability very much.

James Egan: No, it is not helping affordability. But let's zoom out a little bit here when talking about affordability. The monthly payment on the medium-priced home had fallen about $225 from the fourth quarter of 2023 to local troughs in September. About a 10 percent decrease. Since that low, the payment has increased about $150; so, it's given back most of its gains.

Importantly, affordability is a three-pronged equation. It's not just that payment. Home prices, mortgage rates, and incomes. And incomes are up about 5 percent over the past year. So, affordability has improved more than those numbers would suggest, but those improvements have certainly been muted as a result of this recent rate move. 

Jay Bacow: Alright. Affordability is up, then it’s down. It’s wrong, then it’s right. It sounds like a Katy Perry song. So, how have home sales evolved through this rollercoaster?

James Egan: Well, you and I came on this podcast several times last year to talk about the fact that home sales volumes weren't really increasing despite the improvement in affordability. One point that we made over and over again was that it normally takes 9 to 12 months for sales volumes to increase when you get this kind of affordability improvement. And that would make the fourth quarter of 2024 the potential inflection point that we were looking for. And despite this move in mortgage rates, that does appear to have been the case. Existing home sales had a very strong finish to last year. And in the fourth quarter, they were up 8 percent versus the fourth quarter of 2023. That's the first year-over-year increase since the second quarter of 2021.

Jay Bacow: All right. So that's pretty meaningful. And if looking backward, home sales seem to be inflecting, what does that mean for 2025?

James Egan: So, there's a number of different considerations there. For one thing, supply – the number of homes that are actually for sale – is still very tight, but it is increasing. It may sound a little too simplistic, but there do need to be homes for sale for homes to sell, and listings have reacted faster than sales. That strong fourth quarter in existing home sales that I just mentioned, that brought total sales volumes for the year to 1 percent above their 2023 levels. For sale inventory finished the year up 14 percent.

Jay Bacow: Alright, that makes sense. So, more people are willing to sell their home, which means there's a little bit more transaction volume. But is that good for home prices?

James Egan: Not exactly. And it is those higher listings and our expectation that listings are going to continue to climb that's been the main factor behind our call for home price growth to continue to slow. Ultimately, we think that you see home sales up in the context of about 5 percent in 2025 versus 2024.

Our leading indicators of demand have softened, a little, in December and January, which may be a result of this sharp increase in rates. But ultimately, when we look at turnover in the housing market, and we're talking about existing sales as a share of the outstanding homes in the U.S. housing market, we think that we're kind of at the basement right now. If we're wrong in our sales volume call, I would think it's more likely that there are more sales than we think. Not less.

Jay Bacow: Let me ask you another easy question. How far would rates have to fall to really incentivize more supply and/or demand in the housing market?

James Egan: That's the $45 trillion question. We think the current housing market presents a fascinating case study in behavioral economics. Even if mortgage rates were to decline to 4.5 percent, only 35 percent of people would be in the money. And that's still over 200 basis points from where we are today.

That being said, we think it's unlikely that mortgage rates need to fall all the way to that level to unlock the housing market. While the lack of any historical precedent makes it difficult for us to identify a specific threshold at which activity could increase meaningfully, we recently turned to Morgan Stanley's AlphaWise to conduct a consumer pulse survey to get a better sense of how people were feeling about their housing options.

Jay Bacow: I like data. How are those people feeling?

James Egan: All right, so 31 percent of people anticipate buying a home over the next two years, and almost half are considering buying over the next five. Interestingly, only 21 percent are considering selling their home over the next two years. In other words, perceived demand is about 50 percent greater than marginal supply, at least in the immediate future, which we think could be a representation of that lock-in effect.

Current homeowners’ expectations of near-term listings are depressed because of how low their mortgage rate is. But we did ask: What if mortgage rates were to fall from 6.8 percent today to 5. 5 percent? In that world, 85 to 90 percent of the people planning to buy a home in the next two years stated that they would be more likely to execute on that purchase.

So, we think it's safe to say that a decline in mortgage rates could accelerate purchase decisions. But Jay, are we going to see that decline?

Jay Bacow: Well, our interest rate strategists do think that rates are going to rally from here. They've updated their 10-year forecast to expect the tenure note ends 2025 at 4 percent. If the tenure note's at 4 percent, mortgage rate should come down from here, but not to that 4.5 percent, or probably even that 5.5 percent level that you quoted. You know, honestly, you don't really want to stay, you don't really want to go. We're probably talking about like a 6 percent mortgage rate. Not quite that level.

But Jim, this is a national level, a national mortgage rate, and housing markets about location and location and location. Are there geographical nuances to your forecast?

James Egan: People all over the country are asking, should they stay or should they go now, and that answer is different depending on where you live, right? If you look at the top 100 MSAs in the country, 8 of the top 11 markets showing the largest increases in inventory over the past year can be found in Florida.

So, we would expect Florida to be a little bit softer than our national numbers. On the other hand, inventory growth has been most subdued in the Northeast and the Midwest, with several markets continuing to see inventory declines.

Jay Bacow: All right, well selfishly, as somebody that lives in the Northeast, I am a little bit happy to hear that. But otherwise, Jim, it's always a pleasure listening to you.

James Egan: Pleasure talking to you too, Jay. Thanks for listening, and if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

DISCLAIMER

Jay Bacow: So, Jim, the lock-in effect is: You don’t really want to stay. No. But you don’t really want to go.

James Egan: That is exactly; that is perfect! Wow. That is the whole issue with the housing market.

Our CIO and Chief U.S. Equity Strategy Mike Wilson suggests that stock, factor and sector selection remain key to portfolio performance.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing equities in the context of higher rates and weaker earnings revisions. 

It's Tuesday, Feb 18th at 11:30am in New York. 

So let’s get after it.

Since early December, the S&P 500 has made little headway. The almost unimpeded run from the summer was halted by a few things but none as important as the rise in 10-year Treasury yields, in my view. In December, we cited 4 to 4.5 percent as the sweet spot for equity multiples assuming growth and earnings remained on track. We viewed 4.5 percent as a key level for equity valuations. And sure enough, when the Fed leaned less dovish at its December meeting, yields crossed that 4.5 percent threshold; and correlations between stocks and yields settled firmly in negative territory, where they remain. In other words, yields are no longer supportive of higher valuations—a key driver of returns the past few years. 

Instead, earnings are now the primary driver of returns and that is likely to remain the case for the foreseeable future. While the Fed was already increasingly less dovish, the uncertainty on tariffs and last week’s inflation data could further that shift with the bond market moving to just one cut for the rest of the year. Our official call is in line with that view with our economists now just looking for just one cut–in June. It depends on how the inflation and growth data roll in. 

Our strategy has shifted, too. With the S&P 500 reaching our tactical target of 6100 in December and earnings revision breadth now rolling over for the index, we have been more focused on sectors and factors. In particular, we’ve favored areas of the market showing strong earnings revisions on an absolute or relative basis.

Financials, Media and Entertainment, Software over Semiconductors and Consumer Services over Goods continue to fit that bill. Within Defensives, we have favored Utilities over Staples, REITs and Healthcare. While we’ve seen outperformance in all these trades, we are sticking with them, for now. We maintain an overriding preference for Large-cap quality unless 10-year Treasury yields fall sustainably below 4.5 percent without a meaningful degradation in growth. The key component of 10-year yields to watch for equity valuations remains the term premium – which has come down, but is still elevated compared to the past few years. 

Other macro developments driving stock prices include the very active policy announcements from the White House including tariffs, immigration enforcement, and cost cutting efforts by the Department of Government Efficiency, also known as DOGE. For tariffs, we believe they will be more of an idiosyncratic event for equity markets. However, if tariffs were to be imposed and maintained on China, Mexico and Canada through 2026, the impact to earnings-per-share would be roughly 5-7 percent for the S&P 500. That’s not an insignificant reduction and likely one of the reasons why guidance this past quarter was more muted than fourth quarter results. 

Industries facing greater headwinds from China tariffs include consumer discretionary goods and electronics. Lower immigration flow and stock is more likely to affect aggregate demand than to be a wage cost headwind, at least for public companies. Finally, skepticism remains high as it relates to DOGE’s ability to cut Federal spending meaningfully. I remain more optimistic on that front, but realize greater success also presents a headwind to growth before it provides a tailwind via lower fiscal deficits and less crowding out of the private economy—things that could lead to more Fed cuts and lower long-term interest rates as term premium falls. 

Bottom line, higher backend rates and growth headwinds from the stronger dollar and the initial policy changes suggest equity multiples are capped for now. That means stock, factor and sector selection remains key to performance rather than simply adding beta to one’s portfolio. On that score, we continue to favor earnings revision breadth, quality, and size factors alongside financials, software, media/entertainment and consumer services at the industry level.  

Thanks for listening. If you enjoy the podcast, 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 Public Policy Research, Michael Zezas, joins our Chief U.S. Economist, Michael Gapen, to discuss the possible outcomes for President Trump’s immigration policies and their effect on the U.S. economy.

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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 Public Policy Research.

Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist for Morgan Stanley.

Michael Zezas: Our topic today: President Trump's immigration policy and its economic ramifications.

It's Friday, February 14th at 10am in New York.

Michael, migration has always been considered an important feature of the global economy. In fact, you believe that strong immigration flows were an important element in the supply side rebound that set the stage for a U.S. soft landing. If we think back to the time before President Trump took office almost a month ago, how would you categorize immigration trends then?

Michael Gapen: So, we saw a very sharp increase in immigration coming out of the pandemic. I would say, if you look at longer term averages, say the 20 years leading up to the pandemic, normally we'd get about a million and a half immigrants, per year into the United States. A lot of variation around that number, but that was the long-term average.

In 2022 through 2024, we saw immigration surge to about 3 million per year. So about twice as fast as we saw normally. And that happened at a very important time. It allowed for very significant and rapid growth in the labor force, just at a time when the economy was emerging from the pandemic and demand for labor was quite high.

So, it filled that labor demand. It allowed the economy to grow rapidly, while at the same time helping to keep wages lower and inflation starting to come down. So, I do think it was a major underpinning force in the ability of the U.S. economy to soft land after several years of above target inflation.

Michael Zezas: Got it. And so now, with a second President Trump term, are we set up for a reversal of this immigration driven boost to the economy?

Michael Gapen: Yeah, I think that's the key question for the outlook, and our answer is yes. That if we are going to significantly restrict immigration flows, the risk here is that we reverse the trends that we've just seen in the previous year.

So, I certainly believe one of the main goals of the Trump administration is to harden the border and initiate greater deportations. And these steps in my mind come on the back of steps that the Biden administration already took around the middle of last year that began to slow immigration flows.

So yes, I do think we should look for a reversal of the immigration driven boost to the economy. But Mike, I would actually throw this question back to you and say on the first day of his presidency, Trump issued a series of executive orders pertaining to immigration. Where are we now in that process after these initial announcements? And what do you expect in terms of policy implementation?

Michael Zezas: Well, I think you hit on it. There's two levers here. There's stepped up deportations and removals and there's working with Mexico on border enforcement. Things like the remain in Mexico policy where Mexico agrees to keep those seeking asylum on their side of the border; and to facilitate that, they've stepped up their military presence to do that.

Those are really kind of the two levers that the U.S. is pushing on to try and reduce the flow of migrants coming into the U.S. Still to be determined how much these actually have an impact, but I think that's the direction of policy travel.

Michael Gapen: And are there any catalysts specifically that you're watching for? I mean, recently the administration proposed tariffs on Mexico and Canada around border control, but those have been delayed. Is there anything on the horizon we should look for this time around?

Michael Zezas: Yeah. So obviously the president tied the potential for tariffs on Mexico and Canada to the idea that there should be some improvement on border enforcement. It's going to be difficult for investors, I think, to assess in real time how much progress has been made there. Mostly it's a data challenge here. There are official government statistics which have a good amount of detail about removals and folks stopped at the border and demographics in terms of age and, and whether or not they were working. That might really kind of help us piece together the story in terms of whether or not there's going to be future tariffs – and Michael, probably for you, to what extent there's an impact on the economy if folks are already in the labor force.

But that data is on a lag, it'll be really difficult to tell what's happening now for at least several months. Maybe we're going to get some hints about what's going on for comments coming in earnings calls, for example, from companies that deal in construction and food service and hospitality. But I don't know that those anecdotes would be sufficient to really draw substantial conclusions. So, I think we're a bit in a fog for the next couple months on exactly what's happening.

But based on all this, Michael, what's your outlook for immigration this year and beyond?

Michael Gapen: Yeah, so we, as I mentioned, we were getting about 3 million immigrants per year between 2022 and 2024; long run averages before the pandemic were more like a million and a half a year. Our outlook is that immigration flows should slow below pre- COVID averages to about 1 million this year and about 500,000 in 2026. And again, that would be the well below the long run average of about a million and a half per year.

Now, as you mentioned, understanding these flows in real time is hard and there's a lot of uncertainty around this and how effective policies may be. So, I think people should consider ranges around this baseline, if you will. On one hand, we could see a reduction in unauthorized immigration replaced by more authorized immigration. So maybe there's a benign scenario where immigration slows back to its one and a half million per year. But it's more through legal and formal channels than unauthorized channels.

Alternatively, it could be the case that some of the policies, you mentioned in terms of, say, stepped up deportations or other measures, and maybe there's a chilling effect. That there's just like an externality on immigration behavior. And in fact, we slow maybe to about 500,000 this year and see a decline in about 250,000 next year.

So, I think there's a lot of uncertainty about it. We think immigration slows below its longer run averages, which would represent a major shift from what we've seen over the last three years.

Michael Zezas: Got it. So, lots of crosscurrents here, about how the actual labour supply is impacted. But bottom line, if we do arrive at a point where there’s a significant reduction in immigration, what’s the expectation about what that means for the U.S. economy?

Michael Gapen: Yeah, so a lot of cross currents here. Number one, I think with a high degree of confidence, we can say reduced immigration should lead to slower potential growth, right? So, a slower growth in the labor force should mean slower growth in trend hours, right? Potential GDP is really only the sum of growth in trend hours and trend productivity.

So, the surge in immigration we saw really boosted potential growth up to 2.5 per cent to 3 per cent in recent years. So, if we reduce immigration, potential growth should slow. I think back towards, say, 2 per cent this year, maybe even 1 to 1.5 per cent next year. So, you slow down growth in the labor force, potential should moderate.

Second, and I think the more difficult question is, well, okay, if you also reduce growth in the labor force, you're going to get less employment, and that's a demand side effect. So, which dominates here, the supply side or the demand side? And here, I think to go back to your first question – yeah, I do think we're going to get a reversal of the outcome that we just saw.

So, I think it'll moderate both potential and actual growth. So, I think actual growth slows. The amount of employment we see should decline and soften. We're not saying the level of employment will decline, but the growth rate of employment should slow. But it should coincide with a low unemployment rate, so it's going to be a very different labor market. A lot less employment growth, but still a tight labor market in terms of low unemployment.

That should keep wages firm, particularly in the service sector where a lot of immigrants work, and we think it'll also help keep inflation firm. So, it could keep the Fed on the sideline for a significant period of time, for example.

And I'd just like to close, Mike, by saying I think this is an underappreciated risk for financial markets. I think investors have digested trade policy uncertainty, but I'm not convinced that risks around immigration and their effect on the economy are well understood.

Michael Zezas: Got it. Well Michael, thanks for taking the time to talk.

Michael Gapen: Thank you.

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

Our Head of Foreign Exchange & Emerging Markets Strategy James Lord discusses how much tariff-driven volatility investors can expect in currency markets this year.

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Welcome to Thoughts on the Market. I’m James Lord, Morgan Stanley’s Head of Foreign Exchange & Emerging Markets Strategy. 

Today – the implications of tariffs for volatility on foreign exchange markets. 

It’s Thursday, February 13th, at 3pm in London. 

Foreign exchange markets are following President Trump’s tariff proposals with bated breath. A little over a week ago investors faced significant uncertainty over proposed tariffs on Mexico, Canada, and China. In the end, the U.S. reached a deal with Canada and Mexico, but a 10 per cent tariff on Chinese imports went into effect. Currencies experienced heightened volatility during the negotiations, but the net impacts at the end of the negotiations were small. Announced tariffs on steel and aluminum have had a muted impact too, but the prospect of reciprocal tariffs are keeping investors on edge. 

We believe there are three key lessons investors can take away from this recent period of tariff tension. First of all, we need to distinguish between two different types of tariffs. The first type is proposed with the intention to negotiate; to reach a deal with affected countries on key issues. The second type of tariff serves a broader purpose. Imposing them might reduce the U.S. trade deficit or protect key domestic industries.

There may also be examples where these two distinct approaches to tariffs meld, such as the reciprocal tariffs that President Trump has also discussed. 

The market impacts of these different tariffs vary significantly. In cases where the ultimate objective is to make a deal on a separate issue, any currency volatility experienced during the tariff negotiations will very likely reverse – if a deal is made. However, if the tariffs are part of a broader economic strategy, then investors should consider more seriously whether currency impacts are going to be more long-lasting. For instance, we believe that tariffs on imports from China should be considered in this context. As a result, we do see sustained dollar/renminbi upside, with that currency pair likely to hit 7.6 in the second half of 2025. 

A second key issue for investors is going to be the timing of tariffs. April 1st is very likely going to be a key date for Foreign Exchange markets as more details around the America First Trade Policy are likely revealed. We could see the U.S. dollar strengthen in the days leading up to this date, and investors are likely to consider where subsequently there will be a more significant push to enact tariffs. 

A final question for investors to ponder is going to be whether foreign exchange volatility would move to a structurally higher plane, or simply rise episodically. Many investors currently assume that FX volatility will be higher this year, thanks to the uncertainty created by trade policy. However, so far, the evidence doesn’t really support this conclusion. Indicators that track the level of uncertainty around global trade policy did rise during President Trump's first term, specifically around the period of escalating tariffs on China. And while this was associated with a stronger [U.S.] dollar, it did not lead to rising levels of FX volatility. 

We can see again, at the start of Trump's second term, that rising uncertainty over trade policy has been consistent with a stronger U.S. dollar. And while FX volatility has increased a bit, so far the impact has been relatively muted – and implied volatility is still well below the highs that we’ve seen in the past ten years. FX volatility is likely to rise around key dates and periods of escalation; and while structurally higher levels of FX volatility could still occur, the odds of that happening would increase if tariffs resulted in more substantial macro economic consequences for the U.S. economy.

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

The down-to-the-deadline nature of Trump’s trade policy has created market uncertainty. Our Head of Corporate Credit Research Andrew Sheets points out a silver lining. 

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about a potential silver lining to the significant uptick in uncertainty around U.S. trade policy. 

It's Wednesday, February 12th at 2pm in London. 

One of the nuances of our market view is that we think credit spreads remain tight despite rising levels of corporate confidence and activity. We think these things can co-exist, at least temporarily, because the level of corporate activity is still so low, and so it could rise quite a bit and still only be in-line with the long-term trend. And so while more corporate activity and aggression is usually a negative for lenders and drives credit spreads wider, we don’t think it’s quite one yet. 

But maybe there is even less tension in these views than we initially thought. 

The first four weeks of the new U.S. Administration have seen a flurry of policy announcements on tariffs. This has meant a lot for investors to digest and discuss, but it’s meant a lot less to actual market prices. Since the inauguration, U.S. stocks and yields are roughly unchanged. 

That muted reaction may be because investors assume that, in many cases, these policies will be delayed, reversed or modified. For example, announced tariffs on Mexico and Canada have been delayed. A key provision concerning smaller shipments from China has been paused. So far, this pattern actually looks very consistent with the framework laid out by my colleagues Michael Zezas and Ariana Salvatore from the Morgan Stanley Public Policy team: fast announcements of action, but then much slower ultimate implementation. 

Yet while markets may be dismissing these headlines for now, there are signs that businesses are taking them more seriously. Per news reports, U.S. Merger and Acquisition activity in January just suffered its lowest level of activity since 2015. Many factors could be at play. But it seems at least plausible that the “will they, won’t they” down-to-the-deadline nature of trade policy has increased uncertainty, something businesses generally don’t like when they’re contemplating big transformative action. 

And for lenders maybe that’s the silver lining. We’ve been thinking that credit in 2025 would be a story of timing this steadily rising wave of corporate aggression. But if that wave is delayed, debt levels could end up being lower, bond issuance could be lower, and spread levels – all else equal – could be a bit tighter. 

Corporate caution isn’t everywhere. In sectors that are seen as multi-year secular trends, such as AI data centers, investment plans continue to rise rapidly, with our colleagues in Equity Research tracking over $320bn of investment in 2025. But for activity that is more economically sensitive, uncertainty around trade policy may be putting companies on the back foot. That isn’t great for business; but, temporarily, it could mean a better supply/demand balance for those that lend to them. 

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

Our Chief Asia Economist Chetan Ahya discusses the potential impact of reciprocal U.S. tariffs on Asian economies, highlighting the key markets at risk.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Today: the possibilities of reciprocal tariffs between the U.S. and Asian economies. 

It’s Tuesday, February 11, at 2pm in Singapore.

President Trump’s recent tariff actions have already been far more aggressive than in 2018 and 2019. And this time around, multiple trade partners are simultaneously facing broad-based tariffs, and tariffs are coming at a much faster pace. The risk of trade tensions escalating has risen, and the latest developments may have kicked that risk up another notch. 

The U.S. president is pushing a sweeping tariff of 25 per cent on all foreign steel and aluminum products. Trump has also indicated that he would propose reciprocal tariffs on multiple countries – to match the tariffs levied by each country on U.S. imports. This potential reciprocal tariff proposal suggests that Asia ex China may be more exposed to possible tariff hikes. As of now, Asia’s tariffs on US imports are, for the most part, slightly higher than US tariffs on Asian imports. And based on [the] latest available data, six economies in Asia do impose [a] higher weighted average tariff on the U.S. than the U.S. does on individual Asia economies. 

The tariff differentials are most pronounced for India, Thailand, and Korea. These three economies may face a risk of a hike in tariffs by 4 to 6 percentage points on a weighted average basis, if the U.S. imposes reciprocal tariffs. Individual products may yet face higher tariffs rates but we think [the] overall impact from steel, aluminum and reciprocal tariffs will be manageable. 

But look, trade tensions may still rise further given that 7 out of 10 economies with the largest trade surplus with the U.S. are in Asia. Against this backdrop, policy makers may have to look for ways to address the demands from the U.S. administration. 

For instance, Japan’s Prime Minister Ishiba has committed to increasing investment in the U.S. and is looking to raise energy imports from the U.S. This is seen as a positive step to reduce the U.S. trade deficit with Japan. Meanwhile, ahead of the meeting between President Trump and India’s Prime Minister Modi later this week, India has already taken steps to lower tariffs on the U.S., and may propose [an] increase in imports of oil and gas, defense equipments and aircrafts to narrow its trade surplus with the U.S. 

However, as regards China is concerned, the wide scope of issues in the bilateral relationship suggests that [the] U.S. administration would cite a variety of reasons for expanding tariffs. As things stand, China has been the only economy so far where tariff hikes have stayed in place. Indeed, the recent 10 percent increase in tariffs has already matched the increase in the weighted average tariffs that transpired in 2018 and 2019. And we still expect that tariffs on imports from China will continue to rise over the course of 2025. 

To sum it up, there has been a constant stream of tariff threats from the U.S. administration. While the direct effects of [the] tariffs appear manageable, the bigger concern for us has been that this policy uncertainty will potentially weigh on corporate sector confidence, CapEx and growth cycle.

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.

Global Head of Fixed Income and Public Policy Research Michael Zezas and Head of Global Evaluation, Accounting and Tax Todd Castagno discuss the market and economic implications of proposed tax extensions and tax cuts.

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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 and Public Policy Strategy.

Todd Castagno: And I'm Todd Castagno, Head of Global Evaluation, Accounting and Tax.

Michael Zezas: Today, we'll focus on taxes under the new Trump administration.

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

Recently, at the annual meeting of the World Economic Forum in Davos, President Trump stated his administration will pass the largest tax cut in American history, including substantial tax cuts for workers and families. He was short on the details, but tax policies were a significant focus of his election campaign.

Todd, can you give us a better sense of the tax cuts that Trump's been vocal about so far?

Todd Castagno: Well, there's tax cuts and tax extensions. So, I think that's an important place to set the baseline. The Tax Cuts and Jobs Act (TCJA), under his first administration, starts to expire in 2025. And so, what we view is, the most likelihood is, an extension of those policies going forward. However, there's some new ideas, some new contours as well. So, for instance, a lower corporate rate that gets you in the 15 per cent ballpark can be through domestic tax credits, new incentives.

I think there's other items on the individual side of the code that could be explored as well. But we also have to kind of step back and creating new policy is very challenging. So again, that baseline is an extension of kind of the tax world we live in today.

So, Michael, looking at the broader macro picture and from conversations with our economist, how would these tax cuts impact GDP and macro in general?

Michael Zezas: Well, if you're talking about extension of current policy, which is most of our expectation about what happens with taxes at the end of the year, the way our economists have been looking at this is to say that there's no net new impulse for households or companies to behave differently.

That might be true on a sector-by-sector basis, but in the aggregate for the economy, there's no reason to look at this policy and think that it is going to provide a definitive uplift to the growth forecast that they have for 2026. Now, there may be some other provisions that could add in there that are incremental that we'd have to consider.

But still, they would probably take time to play out or their measurable impact would be very hard to define. Things like raising the cap on the state and local tax deduction, that tends to impact higher income households who already aren't constrained from a spending perspective. And things like a domestic manufacturing tax credit for companies, that could take several years to play out before it actually manifests into spending.

Todd Castagno: And you’re kind of seeing that with the prior administration's tax law, the Inflation Reduction Act. A lot of this takes years in order to actually play through the economy. So that's something that investors should consider.

Michael Zezas: Yeah, these things certainly take time; and you know back in 2018 it had been a long ambition, particularly of Republican lawmakers, to reduce the corporate tax rate. They succeeded in doing that, getting it down to 21 per cent in Trump's first term. Now, Trump's talked about getting corporate tax rates lower again here. If he's able to do that, how do you think he would do that? And would that affect how you're thinking about investment and hiring?

Todd Castagno: So, there's the corporate rate itself, and it's at 21 per cent currently. There is a view to change that rate, lower it. However, there's other ways you can reduce that effective tax burden through what we've just discussed. So enhanced corporate deductions, timing differences, companies can benefit from a tax system that ultimately gets them a lower effective rate, even if the corporate rate doesn't move much.

Michael Zezas: And so, what sorts of companies and what sorts of sectors of the market would benefit the most from that type of reduction in the corporate tax burden?

Todd Castagno: So, if you think they're mosaic of all these items, it's going to accrue to domestic companies. That might sound kind of obvious, but if you look at our economy, we have large multinationals and we have domestic companies and we have small businesses. The policies that are being articulated, I think, mostly orient towards domestic companies, industrials, for instance, R&D incentives, again powering our AI plants, energy, et cetera.

Michael Zezas: Got it. And is there any read through on if a company does better under this policy – if they're big relative to being small?

Todd Castagno: There are a lot of small business elements as well. So, I mentioned that timing difference, being able to deduct a piece of machinery day one versus over seven years. So, there's a lot of benefits that are not in the rate itself that can accrue through smaller businesses.

Michael Zezas: YAnd what about for individual taxpayers, particularly the middle class? What particular tax cuts are on the table there?

Todd Castagno: So, first and foremost is the child tax care credit. So, it’s current policy, but after COVID, it was enhanced. A higher dollar amount, different mechanism for receiving funds. And so, there is bipartisan support and President Trump as well, bringing back a version of an enhanced credit. Now, the policy is a little bit tricky, but I would say there's very good odds that that comes back. You know, you mentioned the state and local tax deduction, right? The politics are also tricky, but there could be a rate of change where that reverts back to pre-TCJA.

But one of the things, Michael, is all these policies are very expensive. So, I'm just curious, in your mind, how do we balance the price tag versus the outcome?

Michael Zezas: Well, I think the main constraint here to consider is that Republicans have a very slim majority in the House of Representatives and the Senate, and they're unlikely to get Democratic representatives crossing the aisle to vote with them on a tax package this large. So, they'll really need complete consensus on whatever tax items they extend and the deficit impact that it causes this is the type of thing that ultimately will constrain the package to be smaller than perhaps some of the president's stated ambitions.

So, for example, items like making the interest payments on auto loans tax deductible, we think there might not be sufficient support for that and the budget costs that it would create. So ultimately, we think you get back to a package that's mostly about extending current cuts, adding in a couple more items like that domestic manufacturing tax credit, which is also very closely tied to Republicans larger trade ambition. And you might also see Republicans do some things to reduce the price tag, like, for example, only extend the tax cuts for a few years, as opposed to five or 10 years.

Todd Castagno: Right.

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

Todd Castagno: Great speaking with you, Mike.

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

Our Chief Fixed Income Strategist Vishy Tirupattur thinks that efficiency gains from Chinese AI startup DeepSeek may drive incremental demand for AI.

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Welcome to Thoughts on the Market. I’m Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Today I’ll be talking about the macro implications of the DeepSeek development.

It's Friday February 7th at 9 am, and I’m on the road in Riyadh, Saudi Arabia.

Recently we learned that DeepSeek, a Chinese AI startup, has developed two open-source large language models – LLMs – that can perform at levels comparable to models from American counterparts at a substantially lower cost. This news set off shockwaves in the equity markets that wiped out nearly a trillion dollars in the market cap of listed US technology companies on January 27. While the market has recouped some of these losses, their magnitude raises questions for investors about AI. My equity research colleagues have addressed a range of stock-specific issues in their work. Today we step back and consider the broader implications for the economy in terms of productivity growth and investment spending on AI infrastructure.

First thing. While this is an important milestone and a significant development in the evolution of LLMs, it doesn’t come entirely as a shock. The history of computing is replete with examples of dramatic efficiency gains. The DeepSeek development is precisely that – a dramatic efficiency improvement which, in our view, drives incremental demand for AI. Rapid declines in the cost of computing during the 1990s provide a useful parallel to what we are seeing now. As Michael Gapen, our US chief economist, has noted, the investment boom during the 1990s was really driven by the pace at which firms replaced depreciated capital and a sharp and persistent decline in the price of computing capital relative to the price of output. If efficiency gains from DeepSeek reflect a similar phenomenon, we may be seeing early signs [that] the cost of AI capital is coming down – and coming down rapidly. In turn, that should support the outlook for business spending pertaining to AI.

In the last few weeks, we have heard a lot of reference to the Jevons paradox – which really dates from 1865 – and it states that as technological advancements reduce the cost of using a resource, the overall demand for the resource increases, causing the total resource consumption to rise. In other words, cheaper and more ubiquitous technology will increase its consumption. This enables AI to transition from innovators to more generalized adoption and opens the door for faster LLM-enabled product innovation. That means wider and faster consumer and enterprise adoption. Over time, this should result in greater increases in productivity and faster realization of AI’s transformational promise.

From a micro perspective, our equity research colleagues, who are experts in covering stocks in these sectors, come to a very similar conclusion. They think it’s unlikely that the DeepSeek development will meaningfully reduce CapEx related to AI infrastructure. From a macroeconomic perspective, there is a good case to be made for higher business spending related to AI, as well as productivity growth from AI.

Obviously, it is still early days, and we will see leaders and laggards at the stock level. But the economy as a whole we think will emerge as a winner. DeepSeek illustrates the potential for efficiency gains, which in turn foster greater competition and drive wider adoption of AI. With that premise, we remain constructive on AI’s transformational promise.

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

DISCLAIMER

In the last few weeks… (Laughs) It’s almost like the birds are waiting for me to start speaking.

Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explains why a resurgence in air travel is leading China’s emergence from deflation.

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Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Chinese airlines are at a once-in-a-decade inflection point, and today I’ll break down the elements of this turnaround story.

It’s Thursday, Feb 6th at 10am in Hong Kong.

Last week, hundreds of millions of people across Asia gathered to celebrate the lunar new year with their families. I was one of them and took a flight back to my hometown Nanjing. Airports were jam-packed for days, with air travel expected to exceed 90 million trips.

It’s all indicative of Chinese airlines making a comeback after a seven-year run of underperformance. In fact, we believe Airlines will be one of the first industries to emerge from China's deflationary pressures this year. And this has implications for the country's broader economy.

Although COVID impacted Airlines globally, other regions have since recovered. In China, the earnings recovery is just beginning. Since 2018, Chinese Airlines have experienced demand hits from the trade tension, currency depreciation, COVID-19, and post-COVID macro headwinds.

It’s been two years since Chinese borders lifted restrictions and air travelers are returning in force. Excess capacity has now been digested. Slower deliveries of aircrafts continue to limit supply, and it is more difficult for airlines to get new aircraft and increase their available seats. Passenger load factors will continue to strengthen this year, which means the airlines are running close to full capacity. This will increase Airlines' pricing power within the next 6 to 12 months, feeding through to earnings.

If we put that in a global context, China’s airlines industry handled around 700 million passengers in 2024, 8 per cent of global air passengers; but that 700 million passengers only account for half of China’s population. In the US, air passenger numbers can be three times its population.

Chinese airlines have just reached break-even in the past year, while many of their global peers have already generated robust profits. Chinese Airlines’ earnings and valuations have lagged global peers in both absolute and relative terms. But now, with a turnaround coming into view, Chinese Airlines have a longer runway for stronger earnings growth and share price performance than global peers.

What’s more, the August 2024 turnaround in US airlines offers several key takeaways for China. US Airlines’ share prices recovered last year, following a long period of underperformance post COVID. The wait before the inflection was long, but share prices moved up quickly once the turning point was reached, and valuation expanded ahead of earnings recovery. Big US airlines outperformed smaller players during the most recent rally. We think all these are relevant to the Chinese Airlines story.

If we look at earnings – Chinese Big Three airlines reached breakeven in 2024, making a small profit in 2025, and that profit will double in 2026. But that’s not yet the peak of the cycle; peak cycle earnings could again double the 2026 level, probably in 2027 to 2028. That’s the reason why we think Chinese airlines are on the path to doubling share prices.

To sum up, Chinese Airlines represent a once-in-a-decade opportunity for investors. With strengthened passenger load factors and a positive demand outlook, coupled with significant potential for earnings growth, this industry looks ready for takeoff.

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. For those who celebrate – 新春快乐，恭喜发财！

Our Global Head of Fixed Income Research & Public Policy Strategy Michael Zezas discusses the potential economic outcomes of a shifting North American trade policy.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today – the latest on tariffs and potential outcomes of a shifting North American trade policy. 

It’s Wednesday, February 5, at 10am in New York. 

In a series of last-minute phone calls on Monday, President Trump reached a deal with Mexican President Claudia Sheinbaum and Canadian Prime Minister Justin Trudeau. President Trump agreed to delay the announced 25 percent tariffs on Mexico and Canada for a month – citing their intention to do more on their borders against migration and drug trafficking. But President Trump’s 10 percent tariffs on all Chinese products went into effect yesterday morning. China responded promptly with its own countermeasures, which are not expected to take effect until Monday, February 10, leaving room for potential negotiations. 

These developments don’t come as a surprise. We had been assuming – one – that Canada and Mexico could avoid tariffs by making border concessions, which they did. And – two – that the US would craft a tariff policy related to China independent from its considerations around Mexico and Canada. If the underlying goal is to transform its trade relationship with China, then the US has an interest in preserving an alignment with Canada and Mexico. 

Given all of that, our base case of “fast announcements, slow implementation” looks intact. We expect tariffs on China and some products from Europe to ramp up through the end of the year, putting downward pressure on economic growth into 2026. 

If tariffs on Mexico and Canada are avoided or delayed further, there would be no change to our broader economic outlook. The U.S. dollar could weaken as it prices out some tariff risk. Within U.S. equities, consumer discretionary as well as broader cyclical stocks could lead. 

If, however, we're wrong and tariffs do go up on Mexico and Canada after this one-month pause, then we expect some rise in inflation, growth to slow, and the U.S. dollar and Treasuries to outperform equities; at least for a time as the U.S. gets to work rewiring its global trade relationships. 

Tariffs are likely to dominate news headlines in the days and months to come. We'll keep tracking the topic and bring you updates. 

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 analysts Ariana Salvatore, Stephen Byrd and Devin McDermott discuss President Trump’s four executive orders around energy policy and how they could reshape the sector.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist.

Stephen Byrd: And I'm Stephen Byrd, Morgan Stanley's Head of Research Product for the Americas and Global Head of Sustainability Research.

Devin McDermott: And I'm Devin McDermott, Head of North American Energy Research.

Ariana Salvatore: Our topic today looms large in investors minds. We'll be digging into how the new policies proposed under President Trump's administration will fundamentally reshape energy markets.

It's Tuesday, February 4th at 10am in New York.

On his first day in office, President Trump declared a national energy emergency. He issued four key executive orders, setting out a sweeping plan to maximize oil and gas production. All of this on top of stepping back in tangible ways from the Biden administration's clean energy plans. We think these orders can have a significant impact on the future of energy, one of Morgan Stanley's four key themes for 2025.

So, Stephen, let's start there. One of the biggest questions is which segments of the power and AI theme stand to benefit the most, and which ones will be the most challenged?

Stephen Byrd: Yeah, Ariana, I'd say the two biggest beneficiaries will be natural gas and nuclear, probably in that order. And in terms of challenges, I do think, wind, especially offshore wind, will be quite challenged. So, when I think about natural gas, it's very clear that we have an administration that's very pro natural gas.

And natural gas is also going to need to be part of the power mix for data centers. It's flexible. It could be built relatively quickly. There are a lot of locational options that are perfect here. So, I do think natural gas is a winner.

On nuclear, we do think Republicans broadly, and also many Democrats, firmly support nuclear power. Nuclear is quite helpful, especially for larger data centers or supercomputers. They're large, there's a lot of land at these nuclear plants. And so, I would expect to see some very large data centers built at operational nuclear plants. And we do think the Trump administration will work hard to make that – from a regulatory point of view – make that happen.

I also think we'll see a lot of support at the federal level for new nuclear power plant construction, as well as bringing the U.S. nuclear fuel cycle back to the U.S. So those are a few of the areas that I would expect to do well.

Ariana Salvatore: Devin, same question for you on the energy sector. How are you thinking about the impacts?

Devin McDermott: Yeah, it's a good question, and there's a lot in these executive orders. I mean, some of the key things that we're focused on as impacting the sector include encouraging federal lands development and leasing for oil and gas activity, with a specific focus on Alaska. Resuming LNG permit authorizations, which lifts the ban that's been in place for the last year. Eliminating EV targets, including pausing some IRA funds tied to EVs. Broad support for infrastructure permitting, including pipelines. And then a broader review of environmental regulations, including some recent headlines that point to rolling back fuel efficiency and emission standards for cars and trucks – something that the prior Trump administration did as well.

The near-term financial impact to the industry of all this is fairly limited. But there are two key longer-term considerations. First, on the oil side, rolling back fuel efficiency standards and other environmental regulations doesn't stop the transition to lower carbon alternatives, but it does slow it. And in particular, it moderates the longer-term erosion of gasoline and diesel demand; and creates a backdrop where incumbent energy players have a longer runway to harvest cash from these legacy businesses and time to scale up profitable low carbon growth, which is still progressing, despite the policy changes.

And then second, gas is the biggest winner, building on some of Stephen's comments. The policy initiatives that we're seeing here are likely to support more LNG exports and more gas power generation relative to the status quo.

Ariana Salvatore: So, Devin, one of the things you mentioned there is regulation, and we think that's specifically reflected in this theme of unleashing American energy that Trump likes to talk about. It seems that this would set the stage for looser regulation and more supportive policy for oil and gas development.

Do you expect any meaningful changes in near-term investment levels or production growth across the industry?

Devin McDermott: It's an easy one, Ariana. No. The reality is the majority of U.S. oil and gas investment activity occurs on state or privately held lands. It's regulated at the state level. And the amount of investment that occurs across presidential election cycles really doesn't change all that much. And, in fact, some of the highest growth years ever for the U.S. oil and gas sector occurred under the Obama administration and also the most recent Biden term where production of both commodities actually hit all time highs.

So, when your baseline is things really aren't that bad, it's tough to do much that really accelerates the throttle and causes companies to add more activity or add more oil or gas drilling rigs. And the last thing I just say on this point is the sector is not funding constrained. There's adequate free cash flow; there's adequate investment capacity. And that also is another limiting factor on doing anything that positively influences willingness to spend capital.

In the end, it's really more about price – and where oil prices specifically goes as it relates to oil and gas investment – rather than policy.

Stephen Byrd: So, Ariana, let me move from Devin's thoughts on price back to policy – and if you take a step back, a key question that we often get asked is: Will the President's executive orders be fully implemented? What do you think?

Ariana Salvatore: Well, it's always necessary to frame these policy proposals in terms of their feasibility, right? So, we're still parsing through all of the details of these executive orders. But we already feel higher conviction in some areas over others, where we think the president has clear and present authority to make policy changes.

For example, President Trump can pretty easily unilaterally decide to move away from Biden's clean energy targets, but he's going to have a much harder time rescinding money that has already been appropriated, dispersed, or obligated towards these ends. For example, through the Inflation Reduction Act. We think that process is going to be much longer and likely result in a very targeted repeal as opposed to a broad-based claw back of funds.

Stephen Byrd: Just thinking about sequencing, can you talk more about, sort of, the potential specific sequencing of these policies?

Ariana Salvatore: There are a few different balls in the air right now, so to speak, as we noted in the run up to the inauguration. We expected President Trump to focus first on the areas that are more within his unilateral control as president. So, that really comes down to tariffs and trade policy more broadly, as well as immigration.

I would also put deregulation in that bucket, but more on a sector specific basis. So, as we've talked about, we think there's clear deregulatory tailwinds for the energy sector. It's also clear in financials. But across the board, these are going to have more limited success in the energy complex.

But Stephen, back to you, given everything that we've been talking about, how do you see the future of clean energy, renewables, EVs – all these elements that make up the Inflation Reduction Act and the broader energy transition?

Stephen Byrd: Yeah, as I think about the areas that are most at risk, I think it's very clearly electric vehicles as well as wind power. Both have been, the subject of direct criticism and we would expect a high risk of elimination or reduction of support there. So that will cause some issues. I would say especially offshore wind faces multiple issues and we think the growth outlook is now very challenged.

Now that said, onshore wind is often, for example, done on private land rather than public land, and the economics in many locations for both wind and solar remain quite favorable. And I think a big area of underappreciated upside would be AI itself – in the sense that the hyperscalers have very significant zero carbon emissions goals. So, what we see happening is we think these hyperscalers over time as they build out more and more data centers, which do have very high carbon footprints, we do think these hyperscalers are going to engage in power contracts with new renewable projects. So that is a boost to demand that I think the market is really not well appreciating.

Ariana Salvatore: And finally, let's consider the issue of powering data centers. Devin, you've spoken about your positive outlook for natural gas. Do you think natural gas is going to play a bigger role in powering large U.S. data centers?

Devin McDermott: Yeah, we do, and there's been an uptick in natural gas related announcements as it relates to data center growth in the U.S. over the last few months. And more recently, we've actually seen some very large deals; plus carbon capture which addresses some of the emissions concerns that Stephen was mentioning before – that the hyperscalers have longer term.

It's important to contextualize this, though, with the broader growth backdrop for natural gas. The market here domestically is on the cusp of what we see as a structural growth cycle driven really by two key pillars. The first of which is that rise in LNG exports that I was alluding to before, where we're on track to roughly double U.S. export capacity over the next five years. And the second pillar is power. And power has a lot of different subsets to it. It's onshore manufacturing, it's this broader trend of electrification, like more electric appliances, a little bit from EVs. Some underlying industrial activity growth and then data centers in AI.

So that is meaningful. That's a lot of gas, but there's also a lot more in all the other buckets I talked about.

Ariana Salvatore: Stephen, pivoting back to you, beyond natural gas, how do you see this theme of powering AI developing more broadly under the new Trump energy policies?

Stephen Byrd: Yeah, you know, I think broadly what we see is that a number of debottlenecking technologies are going to become very important. We cannot get enough power for data centers that we need really over the next several years. So, we're going to need to be very creative.

One option will be to build data centers at large nuclear power plants. I think we'll definitely see that. We will also, I think, see converting bitcoin sites into data centers. That's going to be quite popular. And then lastly, I do think electric transmission will see excellent growth. That is certainly one way to try to debottleneck the grid – is to increase the grid itself.

That takes many years, but I do think there will be more and more willpower. Both at the federal and state level to provide incentives for electric transmission. So that's an asset class that's definitely a winner.

Ariana Salvatore: Last question for both of you, Stephen. I know we're going to hear from you in an upcoming episode about the implications of DeepSeek, but just to get a little bit of a sneak peek here. I'd love a quick take on how you're thinking about DeepSeek.

Stephen Byrd: It's really quite jarring in a week to go from a $500 billion U.S. AI plan to a LLM with a reported price tag of just $6 million. I come away bullish on power demand, and let me walk through why that is. You know, I think that as the cost of inference drops, and we're seeing many signs of that – not just DeepSeek, but many other developments. As that happens, the absolute demand for inference compute goes up, and that compute requires a lot of electricity, so I'm quite bullish there.

Also on AI training, I think the market has gotten too negative. I think that what we'll see is continued LLM R&D to go to the next level of capability. And there are at least five U.S. companies who are going to spend in the tens of billions, possibly into the hundreds of billions of dollars each on training the next generation of Large Language Models, which could be much, much more capable than the current generation. So, I'm actually quite bullish on the outlook for power demand from AI.

Ariana Salvatore: Devin?

Devin McDermott: The news drove a big dislocation across the gas value chain and pullback in many exposed stocks. And we think those types of dips are a buying opportunity because the gas setup is constructive or compelling for many reasons. Power is one of them, but you're not paying for power in the stock prices today.

Ariana Salvatore: Stephen, Devin, thanks for taking the time to talk. And to our listeners, thanks for tuning in. 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 CIO and Chief U.S. Equity Strategist Mike Wilson explains why U.S. stocks took a hit that is likely to sustain through the first half of 2025.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing tariffs, recent developments in AI and what it means for stocks.

It's Monday, Feb 3rd at 11:30am in New York.

So, let’s get after it.

While 2024 was a strong year for many stocks, it was mostly a second half story. With recession fears peaking last summer and a Fed that remained on hold due to still elevated inflation, markets were essentially flat year-to-date in early August.

But then everything changed. The Fed surprised markets with a 50 basis points cut to show its commitment to keeping the economy out of recession. This was followed by better labor data and two more 25 basis points cuts from the Fed. Investors took this as a green light to add more equity to portfolios—the riskier the better. 

It also became clear to markets and many observers that President Trump was likely going to win the election, with a rising chance of a Republican sweep in Congress. Given the more pro-growth agenda proposed by candidate Trump and his track record during his first term as President, he made investors even more bullish. Finally, given all the concern about a hung election, the fact that we got such definitive results on election night only added fuel to the equation. Hedges were swiftly removed and even reversed to long positions as both asset managers and retail investors chased performance for fear of falling behind, or missing out. 

In October, I suggested the S&P 500 would likely trade to 6100 on a clean election outcome. After promptly hitting that level in early December, stocks had a very weak month to finish the year with deteriorating breadth. The S&P 500 started the year soft before rallying sharply into inauguration day, essentially re-testing that 6100 level once again. The difference this time is that the re-test occurred on much lower breadth with high quality resuming its leadership role. Tariffs were always on the agenda, as was immigration enforcement, both of which are growth negative in the short-term.

In my view, investors simply got complacent about these risks and are now dealing with them in real time. This also fits with our view that the first half of the year was likely to be tougher for stocks as equity negative policies would be implemented immediately before the equity positive policies like de-regulation, tax extensions and reduced government spending had time to play out in the form of less crowding out and lower interest rates.

At the Index level, I expect the S&P 500 to trade in a range between 5500 to 6100 for the next 3 to 6 months, with our fourth quarter price target at 6500 remaining intact. Since we have been expecting tariffs to be implemented, this realization only furthers our preference for consumer services over goods. It also supports our preference for financials and other domestically geared businesses that have limited currency or trade exposures. 

In addition to rising political uncertainty, we also saw the release of DeepSeek’s latest AI chat bot last week. This added another level of uncertainty for investors that could have lasting implications at both the stock and index level given the importance of this investment theme. On one hand it could also accelerate the adoption of AI technologies if it truly lowers the cost – but many portfolios will need to adjust for this shift if that’s the case. We think it further supports our ongoing preference for software and media over semiconductors. 

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

Morgan Stanley Research analysts Michelle Weaver, Chris Snyder and Nik Lippmann discuss U.S.-Mexico trade and the future of reshoring and near-shoring under the Trump administration.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity Strategist at Morgan Stanley.

Christopher Snyder: I’m Chris Snyder, US Multi-Industry Analyst.

Nikolaj Lippmann: And I'm Nik Lippmann, Chief Latin America Equity Strategist.

Michelle Weaver: On this episode of our special mini-series covering Big Debates, we'll talk about the U.S.-Mexico trade relationship and the key issues around reshoring and nearshoring.

It's Friday, January 31st at 10am in New York.

The imposition of tariffs back in 2018 under the first Trump administration and the COVID pandemic put a severe strain on global supply chains and catalyzed reshoring and nearshoring in North America. But with inflation and supply chain concerns no longer front and center, investors are questioning whether the U.S. reshoring momentum can continue.

Chris, what's your view here?

Christopher Snyder: I think it's in the very early innings. You know, if you look at the history of U.S. manufacturing, the country really started ceding share in about 2000 when China joined the World Trade Organization. So, it's been going on for 25 years; we've been giving share back to the world. I think the process of taking share back is probably slower and ultimately is a multi-decade opportunity.

But you're absolutely right. The supply chain concerns are no longer like they were three to four years ago. But what I think has persevered since the pandemic is this heightened focus on operational durability and resiliency; and really shortening supply chains and getting closer to the end user, which I'm sure we'll hear more from Nick about, on the Mexico side.

But, you know, if you kind of look back at global supply chains and manufacturing, it's really been a chase to find low-cost labor for the last 45 years. And while that's always important, we think going forward, capital and proximity to end users will increasingly dictate that regional allocation of CapEx. I mean, those parameters are very supportive for the U. S.

You know, one thing I would like to kind of, you know, make sure is known on our U.S. reshoring view is that, you know, oftentimes it's thought of that we're shutting down a factory in China and reopening the same factory in the United States, and that's really a very rare example.

Our view is that the world, and very specific industries need to add capacity. And we just simply think that the U.S. is better positioned to get that incremental factory relative to any point in the last 45 years, due to the combination of structural tech diffusion, but also this focus on resiliency. And one thing that I really do think is underappreciated is that global manufacturing grows 4 to 5 per cent a year. In the U.S. it's been more in the 1 to 2 percent range because we're constantly ceding share. But even if the U.S. just stops giving back share, you could see the growth profile of U.S. industrials double.

Michelle Weaver: How would you size the reshoring opportunity? Do you have a dollar amount on what that could be worth?

Christopher Snyder: Yeah, we’ve sized it at $10 trillion. You know, and it's been a combination of the CapEx, the fixed asset investment that's needed to build these factories, then ultimately the production, you know, opportunity that will come to those factories thereafter.

Michelle Weaver: And you've argued that the U.S. reshoring flame was really lit in 2018 with the first wave of the Trump tariffs. It seems clear that trade policies by the new administration will continue to support reshoring. What's your outlook there?

Christopher Snyder: Yeah, you're absolutely right. Prior to 2018, there wasn't really a thought process. If you need an incremental factory, you most likely just put it in China. And I think the tariffs, back in 2018 or [20]19 really started, or kickstarted boardroom conversations around global supply chains. So, I think a Trump presidency absolutely adds duration to this theme via protectionism or tariffs that the administration will implement.

If you go back to the Trump 1.0 tariffs, supply chains reacted to the change in cost structures very quickly. We didn't see a huge wave of investment back into the United States. We just saw production exit China and move to broader Asia, because the focus was tariff avoidance.

Now, we think the focus is around building operational, resiliency and durability which better positions the U.S. to get that incremental factory. And one thing that I think is underappreciated here is just how much leverage U.S. politicians have. The U.S. is the best demand region in the world. The U.S. accounts for about 30 per cent of global goods consumption. That's equal to the E.U. and China combined. It's also the best margin region in the world, not only for U.S. companies; but most international companies do their best margins in the United States. So, you can raise the cost to serve the U.S. market, and no one is turning away from the region that has the best demand and the best margins.

Michelle Weaver: So, of course, tariffs in the pandemic have been major catalysts for U.S. reshoring. Have there been any other drivers like tech diffusion?

Christopher Snyder: Yeah. I view the pandemic as the catalyst, and I view tech diffusion as the structural tailwind for U.S. manufacturing. Over time, we will continue to figure out ways to squeeze labor out of the manufacturing cost profile. It's hard to kind of pinpoint it, but I think if we look out over any 5- or 10-year window, we will see that. That's a structural talent for the United States, given the high labor costs. And really what it will help do is just narrow the cost delta, between low cost producing regions. I also think as we kind of extend this tech diffusion into GenAI; I also think what's going on is, will fuel another round of protectionism. So, you know, kind of further keeping that cycle going.

Michelle Weaver: Nick, of course the big question investors are asking is how will the Trump trade agenda impact Mexico? Contrary to the prevailing market view, you've argued that Mexico can actually win big with Trump. How's this possible?

Nikolaj Lippmann: That's right, Michelle. Look, we recently upgraded Mexico to equal weight, from underweight. And while some of the news we see around the administration seems a bit like a sequel, there are other things that are just very different.

We're not talking about ripping apart the USMCA but actually bringing forward renegotiations from [20]26 to [20]25. It's a much more constructive message. It's a very young deal, and yet I think the world we live in today is quite different from the world of 2018. When we look at what are some of the things where Mexico could actually end up winning big, we look at the regionalism that appears to be a number one agenda.

We look at the – how difficult it would be for the United States to de-risk from China. And from Mexico simultaneously. And also, fundamentally at that integration across the border, the industrial integration. It's clear that there's a need for calibration. There's a need for calibration in terms of a lot of the trade policy. There's been talks about maybe a customs union and I think that's far out in the future. But there's a need to try to figure out how to calibrate trade. And also, you know, there are things that Mexican policy makers can do to deal with the non-trade related issues, such as immigration or the cartels. And I think frankly, it's in Mexico's interest to deal with some of these issues.

Michelle Weaver: Where are we in the whole Mexico as a China bridge versus China buffer debate?

Nikolaj Lippmann: Right. That's another good question, Michelle. And one thing that we've been writing a lot about. The key difference from where we were, in Trump 1.0 and now is just how different the relationship with China really is. And I think one area where we've been scratching our head a little bit with regards to the – how Mexican policymakers have reacted after signing the USMCA deal is really just around that. That relationship with China. Well, I think that might have – they might have misread or underestimated just how much times have changed.

We've seen a big increase in import from China. There have been very specific manufacturing ecosystems. And we've also seen increased investments by China and Mexico. Now, this has caused Mexico's trade deficit with China to go up a lot – almost double. And we've also seen an increase in the trade deficit between Mexico and the United States, in Mexico's favor.

Now, that could imply that it's all the China bridge, I think that's far from the truth. But, you know, Mexico is probably two-third or a little more above. It's really that integration that I think policy makers in Mexico need to understand. And then you need to manage that these emerging elements of being a bridge. This is not in Mexico's interest; it's not in the U.S. interest to simply just be a bridge.

We have done a lot of surveys with corporates around the world; and the way the European, and American companies in particular view Mexico is completely different from the way Asian and in particular Chinese companies view Mexico. The Chinese companies view Mexico much more as a place of assembly – whereas Americans think of Mexico as an integrated part of the manufacturing value chain.

Michelle Weaver: Finally, how will the Mexico nearshoring theme develop from here?

Nikolaj Lippmann: This is a great debate, I think. And one that's going to be – I think we're going to be writing a lot with Chris about, and with you guys around, about. Also, with the U.S. policy team. We laid out in 2022 this hypothesis that onshoring, nearshoring was about to happen. In terms of Mexico, it would imply $150 billion over five years. And very importantly, it was going to be – it could happen so fast because it was brownfield.

It was more to the same. Where you already had manufacturing ecosystems, you could add to that. We saw very little evidence that you could do greenfield. But now that the world has evolved, we're looking at some of these greenfield manufacturing ecosystems that are really not present in North America, not in the United States, not in Canada, not in Mexico, such as EV batteries or IT hardware, some of the things that are starting to emerge around the big chip investments.

And we're wondering what are going to be the policy objectives pertaining to these very specific manufacturing ecosystems that in many cases are quite important for national security. If that is to happen, I think it's going to happen slower, much like what Chris laid out, but it's going to be much more impactful. So, I'm sure we're going to be working closely on these debates.

Michelle Weaver: Nick, Chris, thank you for taking the time to talk. And to our listeners, 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 Global Head of Fixed Income and Public Policy Research, Michael Zezas, and Global Head of Macro Strategy, Matt Hornbach, discuss how the Trump administration’s fiscal policies could impact Treasuries markets.

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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 Public Policy Research.

Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy.

Michael Zezas: Today, we'll talk about U.S. fiscal policy expectations under the new Trump administration and the path for U.S. Treasury yields.

It's Thursday, January 30th at 10am in New York.

Fiscal policy is one of the four key channels that have a major impact on markets. And I want to get into the outlook for the broader path for fiscal policy under the new administration. But Matt, let's start with your initial take on this week's FOMC meeting.

Matthew Hornbach: So, investors came into the FOMC meeting this week with a view that they were going to hear a message from Chair Powell that sounded very similar to the message they heard from him in December. And I think that was largely the outcome. In other words, investors got what they expected out of this FOMC meeting. What did it say about the chance the Fed would lower interest rates again as soon as the March FOMC meeting? I think in that respect investors walked away with the message that the Fed’s baseline view for the path of monetary policy probably did not include a reduction of the policy rate at the March FOMC meeting. But that there was a lot of data to take on board between now and that meeting. And, of course, the Fed as ever remains data dependent.

All of that said, the year ahead for markets will rely on more than just Fed policy. Fiscal policy may feature just as prominently. But during the first week of Trump's presidency, we didn't get much signaling around the president's fiscal policy intentions. There are plenty of key issues to discuss as we anticipate more details from the new administration.

So, Mike, to set the scene here. What is the government's budget baseline at the start of Trump's second term? And what are the president's priorities in terms of fiscal policies?

Michael Zezas: You know, I think the real big variable here is the set of tax cuts that expire at the end of 2025. These were tax cuts originally passed in President Trump's first term. And if they're allowed to expire, then the budget baseline would show that the deficit would be about $100 billion smaller next year.

If instead the tax cuts are extended and then President Trump were able to get a couple more items on top of that – say, for example, lifting the cap on state and local tax deduction and creating a domestic manufacturing tax credit; two things that we think are well within the consensus of Republicans, even with their slim majority – then the deficit impact swings from a contraction to something like a couple hundred billion dollars of deficit expansion next year. So, there's meaningful variance there.

And Matt, we've got 10-year Treasury yields hovering near highs that we haven't seen since before the global financial crisis around 10 years ago. And yields are up around a full percentage point since September. So, what's going on here and to what extent is the debate on the deficit influential?

Matthew Hornbach: Well, I think we have to consider a couple of factors. The deficit certainly being one of them, but people have been discussing deficits for a long time now. It's certainly news to no one that the deficit has grown quite substantially over the past several years. And most investors expect that the deficit will continue to grow. So, concerns around the deficit are definitely a factor and in particular how those deficits create more government bonds supply. The U.S. Treasury, of course, is in charge of determining exactly how much government bond supply ends up hitting the marketplace.

But it's important to note that the incoming U.S. Treasury secretary has been on the record as suggesting that lower deficits relative to the size of the economy are desired. Taking the deficit to GDP ratio from its current 7 per cent to 3 per cent over the next four years is desirable, according to the incoming Treasury secretary. So, I think it is far from conclusive that deficits are only heading in one direction. They may very well stabilize, and investors will eventually need to come to terms with that possibility.

The other factor I think that's going on in the Treasury market today relates to the calendar. Effectively we have just gone through the end of the year. It's typically a time when investors pull back from active investment, but not every investor pulls back from actively investing in the market. And in particular, there is a consortium of investors that trade with more of a momentum bias that saw yields moving higher and invested in that direction; that, of course, exacerbated the move.

And of course, this was all occurring ahead of a very important event, which was the inauguration of President Trump. There was a lot of concern amongst investors about exactly what the executive orders would entail for key issues like trade policy. And so there was, I think, a buyer's strike in the government bond market really until we got past the inauguration.

So, Mike, with that background, can you help investors understand the process by which legislation and its deficit impact will be decided? Are there signposts to pay attention to? Perhaps people and processes to watch?

Michael Zezas: Yeah, so the starting point here is Republicans have very slim majorities in the House of Representatives and the Senate. And extending these tax cuts in the way Republicans want to do it probably means they won't get enough Democratic votes to cross the aisle in the Senate to avoid a filibuster.

So, you have to use this process called budget reconciliation to pass things with a simple majority. That's important because the first step here is determining how much of an expected deficit expansion that Republicans are willing to accept. So, procedurally then, what you can expect from here, is the House of Representatives take the first step – probably by the end of May. And then the Senate will decide what level of deficit expansion they're comfortable with – which then means really in the fall we'll find out what tax provisions are in, which ones are out, and then ultimately what the budget impact would be in 2026.

But because of that, it means that between here and the fall, many different fiscal outcomes will seem very likely, even if ultimately our base case, which is an extension of the TCJA with a couple of extra provisions, is what actually comes true.

And given that, Matt, would you say that this type of confusion in the near term might also translate into some variance in Treasury yields along the way to ultimately what you think the end point for the year is, which is lower yields from here?

Matthew Hornbach: Absolutely. There's such a focus amongst investors on the fiscal policy outlook that any volatility in the negotiation process will almost certainly show up in Treasury yields over time.

Michael Zezas: Got it.

Matthew Hornbach: On that note, Mike, one more question, if I may. Could you walk me through the important upcoming dates for Congress that could shed light on the willingness or ability to expand the deficit further?

Michael Zezas: Yeah, so I'd pay attention to this March 14th deadline for extending stopgap appropriations because there will likely be a lot of chatter amongst Congressional Republicans about fiscal expectations. And it's the type of thing that could feed into some of the volatility and perception that you talked about, which might move markets in the meantime.

I still think most of the signal we have to wait for here is around the reconciliation process, around what the Senate might say over the summer. And then probably most importantly, the negotiation in the fall about ultimately what taxes will be passed, what that deficit impact will be. And then there's this other variable around tariffs, which can also create an offsetting impact on any deficit expansion.

So still a lot to play for despite that near term deadline, which might give us a little bit of information and might influence markets on a near term basis.

Matthew Hornbach: Great. Well Mike, thanks for taking the time to talk.

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

Our Head of Corporate Credit Research and Head of Retail Consumer Credit discuss what choppy demand and tariff risk could mean for sectors that depend on consumer spending.

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

Jenna Gianelli: I’m Jenna Gianelli, Head of Retail Consumer Credit, here at Morgan Stanley.

Andrew Sheets: And today on this episode, we're going to discuss the outlook for the retail and consumer sectors.

It’s Wednesday, Jan 29th at 9 am in New York.

So, Jenna, it's great to talk with you, and it's really great to talk about the retail and consumer sectors heading into 2025, because it's such an important part of the investor debate. On the one hand, a lot of economic data in the U.S. seems strong, including a very low unemployment rate. And yet, we’re also hearing a lot about cost-of-living pressures on consumers, lower consumer confidence, and investor concern that the consumer is just not going to be able to hold up in this higher rate environment. And then you can layer on uncertainty from the new administration. Will we see tariffs? How large will they be? And how will retailers, which often import a lot of their goods, handle those changes?

So, maybe just kind of starting off at a 40, 000-foot view, how are you thinking about consumer dynamics going into 2025?

Jenna Gianelli: Of course. So, I think that that choppy consumer demand environment is actually one of the strongest pillars of our more cautious view, going into next year. How the sector, performed last year was not in tandem with kind of what the macro headlines suggested. The macro headlines were quite positive, and the consumer was, you know, seemingly strong. But there was a lot going on under the hood when you looked at different dichotomies, right? So, if you looked at the high-end versus the low-end, if you looked at goods versus services. And then within, you know, certain categories, there were categories that were, you know, really quite strong based on what the consumer was prioritizing – goods, essentials, personal care, beauty, right? And then there were others that they really shied away from.

So, I think what we're going to see in 2025 is quite a bit more of that. When we think that the high-end will continue to be resilient, that pressure on the low-income consumer will continue. But actually moderate potentially as into [20]25, as we think about lower interest rates, potentially, you know, lesser immigration and so less competition for jobs at the lower income level. So maybe even some tailwinds, but it's really an alleviation of pressure and easier compares. But we do expect overall some deceleration, right? Because we had a lot of pent-up demand, especially on the high-end.

So, we are expecting services, demand to slow, in 2025 and goods actually to hold up relatively well. So, we really are focused on what's going on at the individual category level and the different types of consumers that we're looking at.

Andrew Sheets: And as you think about some of those, you know, subcategories that you, you cover, maybe just a minute on a couple that you think will perform the best over this year and some that you think might face the biggest challenges.

Jenna Gianelli: There are some that have been under relative pressure, in [20]23 and [20]24 where we might actually see some, you know, relief. Now, depending on the direction of rates in the housing market, we could see and expect to see an uptick in bigger ticket spending, durables, home related, that have been under, you know, some pressure.

And also, you know, categories where, you know, the consumer, they're arguably discretionary. But maybe they pulled back because there was a big surge in demand just post-COVID. Pet in our universe is actually one example of those, where it's been a bit depressed and we actually expect to see, you know, some recovery into next year; also tied to housing right as new house formation starts.

So, but again, a lot of that is predicated on the, you know, housing direction of rates and some of these other macro factors. I'd say, irrespective of the more macro influences, we do still expect that essentials – grocery, and certain categories like a beauty, pockets of apparel and brands, right? It really comes down to the brands, the brand heat, the brand relevance. If it's relevant to the consumer, they're going to spend on it. And so, that's where we really focus on the micro level; our picks of which brands are resonating, which categories are resonating. Which is, those are some of the, you know, the few that we're expecting, either a recovery in or still, you know, relative, outperformance.

I'd say on the laggard side, which is probably the next piece of that question. I mean, look, there's still a lot of secular headwinds at play. And so, you know, from a department store perspective outside of event risk or idiosyncratic risk, we're still generally expecting department stores and kind of traditional specialty apparel, mall-based, with not a lot of channel diversification to still generally underperform and see similar trends they've seen the last few years.

Andrew Sheets: So, Jenna, your sector is sitting at the center of this kind of very interesting economic debate over how healthy the consumer really is. And, you know, it's also sitting at the center of the policy debate because tariffs are a dynamic that could dramatically affect retailers depending on how large they are and how they're implemented.

So how do you think about tariff risk? And can you give some sense of how you think about exposure of your sector to those dynamics?

Jenna Gianelli: So, tariffs and policy risk and the uncertainty, is one of the big reasons. And when we think about, you know, retail – and particularly discretionary retail – why we're more cautious on the space into [20]25. Tariffs is the biggest piece of that. The degrees of exposure across our universe, varying degrees to a very wide range, right? So, we have some that are minimal, you know, let's say 5 per cent out of, you know, China sourcing some up to 70 per cent out of China sourcing. And then you layer in, well, what about goods from Canada and Mexico and what if there's a universal tariff?

And so, the range of outcomes, is, you know, so significant. And so, what we are advocating to investors is that we go in with the expectation that tariffs are a – an uncertain, but certain threat, right? And not completely minimizing them within a portfolio but reducing the ones that do tend to have those higher, you know, exposures.

I'd say the range from when we stress tested the earnings headwinds potential. I mean, it was anything from call it down 10 per cent EBITDA to down 60-70 per cent EBITDA in the most draconian scenarios. And so, I think taking a very prudent approach, assuming that there will be some level of tariffs phased in, you know; if we look back to the 2018 timeframe – different sets of goods, different times, different rates and go from there.

Andrew Sheets: So, Jenna, we've talked about the economy. We've talked about some of the policy and tariff risk potentially impacting consumer and retail. You know, a third really key strategic theme for us is more corporate activity, more M&A. And again, I think this is where your sector is so interesting because you were already kind of in the center of some of these debates, last year with corporate activity.

So, can you talk a little bit about how you see that? And again, you also have this interesting dynamic that some of the targets of M&A activity in your sector were some of the businesses that were kind of struggling, that were kind of seen as some of these laggards. And so how does that just represent different investor views of their prospects? How do you think people should think about that going forward?

Jenna Gianelli: So, look, I think M&A could have positive risk for 2025 and also negative risk for some of our companies. And it really depends, at least from a credit perspective, how we think about some of their indentures and bond language and likelihood of pro forma capital structures.

But I think without getting, you know, too deep into that, our expectation is that M&A will increase. We know that there is private equity capital on the sidelines to the extent that rates, even if we're in a little bit of a higher for longer, if the expectation is that we do on the year [20]25 in a slightly lower regime, at least we have some stability or visibility on the rate front. Which should, you know, spur more corporate activity.

And then also, I think, look, just equity valuations, right? I mean, our universe, particularly when you think about – the size of the equity check that you need to come in at and the valuations are a bit cheaper because across our universe, we did see some underperformance last year.

So, I think those are the kind of main drivers of why we'll see the activity pick up on the underperforming pieces of the space. There are still pockets of value that I think private equity sponsors are seeing. The ones that have come up most notably are real estate, right? And, you know, we saw…

Andrew Sheets: Because these retailers often own a large…

Jenna Gianelli: Many of the department stores own a significant amount of their real estate. 20, 20, 40, 50 per cent depending on your, you know, assumptions and how you value this real estate. But even with conservative LTV assumptions, there is lending capability here. And I think so that's, you know, one piece of it, those that have multi-banner assets that appeal to different consumer cohorts, that have maybe a solid private label portfolio.

When you think about intellectual property, there are real assets, for certain retailers. And so, I think that's what, you know, private equity historically has seen as the play. Now, how that manifests throughout the space? You know, from an LBO perspective; I do still think that getting a really large LBO for a traditional, you know, mature type of retailer could be challenging, but there are creative ways to get these deals done.

And again, I think because of what we have is some legacy indentures, traditional, more investment grade style capital structures, there might be flexibility to approach, you know, LBOs in a more creative way – without having to access the capital markets in such a big way as maybe you would traditionally think.

Andrew Sheets: And so, this would be examples of private equity firms coming in, doing an LBO or a leveraged buyout where you can actually almost take advantage of the borrowing that company has already done in the market…

Jenna Gianelli: Yes. Keep the debt outstanding.

Andrew Sheets: ... at attractive levels.

Jenna Gianelli: Exactly. Exactly.

Andrew Sheets: So, Jenna, it's so great to talk to you. Well, it's always great to talk to you, but it's so great to talk to you now because I do think, you know, as we, we look into 2025, I think there's always a lot of focus on, you know, the direction of markets, you know. Will rates go up or down? Will equities go up or down? But I think what's so clear talking to you about your sector is that there are all these themes that are really about dispersion. That we see, you know, really different trends by the type of consumer segment and sub segment; that we see very different trends by how exposed companies are to tariffs, right? You mentioned anything from, your earnings could be down 10 per cent to 60 per cent. And, you know, very different dynamics, you know, winners and losers from M&A.

And so, I do think it just highlights that this is a year where, from the strategy side, we think spreads are kind of more range bound. But there does seem to be a lot of dispersion within the sector. And there seems like, well, there's going to be plenty that's going to keep you busy.

Jenna Gianelli: I hope so.

Andrew Sheets: Great. Jenna, thanks for taking the time to talk.

Jena Gianelli: Thank you, Andrew.

Andrew Sheets: Great. And thanks for listening. If you enjoyed the show, 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 Public Policy Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss the potential impact of U.S. tariffs in China and beyond.

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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 Public Policy Research.

Chetan Ahya: And I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Michael Zezas: Today, we'll talk about what U.S. tariffs would mean for Asia's economy.

It's Tuesday, January 28th at 8am in New York.

Chetan Ahya: And 9pm in Hong Kong.

Michael Zezas: Chetan, a week into the new Trump administration, I'm eager to talk tariffs with you. You and I came on the show before the U.S. election to discuss the potential impact of new tariff policies on China's economy in particular. And now that President Trump has taken office, he's been vocal about levying tariffs in a lot of places, including on China. The policy underpinning all of that appears to be a tariff review under the America First Trade Policy. That suggests to us that he's developing options to impose tariffs with China as a focus, but there's still time before implementation -- as these legal options are developed. That's in line with our base case; but investors have been talking a lot about the idea that maybe these tariffs never go on.

What's your view here? And why do you think ultimately we are headed to a place where tariffs go higher?

Chetan Ahya: Well, I think if you just look at the press comments that the president has made at the same time, if you read through this America First document, we sort of think that there are five avenues under which tariffs can go up on China.

Number one is the recommendation from the America First policy document that the agencies in the U.S. will have to study how the large trade partners, which are running trade surpluses with the U.S. are managing their trade practices. Number two, a para in the America First document, which is suggesting that the trade agreements that US and China signed in 2018-19, how is China dealing with the commitments under that agreement?

And number three is the clause which is currently exempting imports into the U.S. under [the] de minimis rule of imports under U.S. $800 per bill being allowed to import without any tariffs being imposed. And what the document is suggesting is to assess what is the potential revenue loss occurring to the government, and how can they plug that. Number four is a potential tariff action with the sale of a social media company. And number five, a potential tariff action which is linked to the fentanyl issue.

So, as you can see, there are a number of avenues under which tariffs can go up on China and therefore we kind of keep that in our base case that tariffs will go up on China.

And Mike, some investors are also optimistic and thinking that there is a possibility of a new trade deal being taken up by U.S. and China. What do you think are the chances of that?

Michael Zezas: I think they're quite low. So, you mentioned five areas of potential dispute that the U.S. might want to use tariffs as a way of dealing with -- and I think that speaks to the idea that the bar is pretty high for China to avoid tariffs relative to some of the other negotiations the U.S. wants to engage in with other trade partners. Or maybe said differently, if the America First Trade Policy is pointing the U.S. at closing goods, trades, deficits, and improving security and making sure that it's not engaged with trade with other countries that are harming national security -- it seems that there are more of those activities going on between the U.S. and China than with other trade partners. Closing, for example, a $300 billion goods trades deficit would seem to be just really, really difficult within the structures of the economy.

So, if we're right, and the chance of tariff de escalation with China appears to be slim, do you think Beijing, for example, might use renminbi depreciation to mitigate some of those economic risks?

Chetan Ahya: Well, yes, we do think that China’s policymakers will allow depreciation in [renminbi] when tariffs are being imposed. However, we also think that the depreciation this time that they will allow will be less than what they did in 2018-19. And China has already been facing some capital outflows; and allowing a large depreciation could bring self fulfilling situation of more capital outflows and even sharper currency depreciation pressures.

Michael Zezas: Beijing also started introducing stimulus measures last fall to boost the Chinese economy. Would tariffs disrupt this policy?

Chetan Ahya: Certainly in our base case, despite the policy stimulus measures that China is taking, we think that overall growth in China will be lower in 2025 meaningfully. And more importantly in our view, China’s biggest challenge is deflation and tariffs will only exacerbate deflationary pressures.

Michael Zezas: And so, we're talking a lot about China here, but obviously there's a risk of tariffs being applied to a broader set of U.S. trading partners in Asia. Now that's not our base case. We think ultimately the focus will be on China because a lot of those trading partners will be able to come to agreements with the U.S. to limit potential future tariffs; but of course, there's a considerable risk that we're wrong. As we mentioned this America First Trade Policy is developing a wide range of options to levy tariffs across multiple geographies and multiple products. So, if that were to come to pass, Chetan, what is it that other Asian governments might be able to do to mitigate the impact from higher tariffs?

Chetan Ahya: First of all, this will be significantly negative for region's growth outlook. And there are two ways in which [the] region will get impacted. Firstly, because of the fact that China will be facing tariffs and China's growth will slow down, it will also have spillover effects for the rest of the region. At the same time, as you mentioned, there is a possibility that there are bilateral disputes opened up with other economies in the region. And so that will also add to the downside pressure for [the] region's growth.

In terms of what they can do to offset this downside; we think that region's central bank will take up monetary easing and at the same time the governments will expand their fiscal deficit. But both of those measures will not be enough to fully offset the downside from tariff increase.

Michael Zezas: Makes sense. Chetan, thanks for taking the time to talk.

Chetan Ahya: 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 and share Thoughts on the Market with a friend or colleague today.

Morgan Stanley Research looks at how the European defense industry might respond to military spending pressure from the Trump administration.

----- Transcript -----

Paul Walsh: Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's Head of Europe Product.

Ross Law: And I'm Ross Law, Head of the European Aerospace and Defense Team.

Paul Walsh: Today, we're discussing the outlook for European defense amid renewed pressure for more military spending from the Trump administration.

It's Monday, the 27th of January, at 9.30am in London.

Now Ross, the new Trump administration is now in place, and shifting NATO's defense burden to Europe is a top priority for President Trump. In fact, President Trump has made several comments throughout his campaign and after taking office. He has suggested that Europe should increase defense spending to 5 per cent of GDP. And just for reference, right now, many European countries are at or above NATO's target of spending 2 per cent of GDP on defense.

What's your reaction? Are President Trump's demands of 5 percent realistic?

Ross Law: In short, we don't think so. In a perfect world, yes, 5 per cent is exactly where Europe should be, to make up for the huge underspend that we've seen over the past three decades since the end of the Cold War, which we've calculated at around the $2 trillion mark. There's also a desire in Europe to reduce its reliance on the US, particularly under a Trump presidency. But we see the 5 per cent spending level as unrealistic on multiple fronts.

Firstly, from an economic perspective, given the lack of fiscal headroom in Europe; and for reference, 5 per cent would require an additional $600 billion of spend annually. Secondly, from a political perspective, given multiple pockets of uncertainty, and the fact that a rise in defense spending may mean a cut to spending elsewhere. And lastly, from an industry perspective, given the multi-decade underspend I mentioned, we don't think the industry could absorb anywhere close to such a strong increase in demand, at least near-term.

So, while we do see upside pressure to European defense spending, our base case is that 3 per cent could be a more reasonable target. Not only would this be a compromise between the current 2 per cent target and Trump's 5 per cent demands; it would also allow Europe to match the spending levels of the US, which is expected at around 3.1 per cent in 2024. Even still, this would represent a 50 per cent increase or around $200 billion per year in additional European spent. This would, of course, further improve industry fundamentals and why we remain very positive on the sector.

Paul Walsh: And as of now, Europe is heavily dependent on the U.S. for its defense. According to various data sources, more than 50 per cent of European arms imports came from the U.S. in 2019 through 2023, and that's up from 35 per cent in 2014. Given this, what steps would Europe need to take to reduce its dependence on the U.S.?

Ross Law: The first step is to invest in the defense industrial base. Europe buys equipment from the U.S. for several reasons. Firstly, because the U.S. develops some of the most advanced technologies in the world because it has consistently invested in its defense industry. Secondly, because the U.S. equipment is often cheaper due to the benefits of scale. And thirdly, because it supports the very unique relationship between Europe and the U.S., which has essentially provided a security umbrella for the past three decades.

So, Europe needs to invest, both to develop capabilities and technologies to rival U.S. peers, and also to expand capacity so that we can meet our own equipment needs. This, of course, all requires investment and also time. So, Europe will remain reliant on the U.S. for many years to come. But if Europe is serious about wanting to be more sovereign, we need a more capable defense industry.

Paul Walsh: So, you talked there, Ross, about investment and time. So now the big question, how would Europe fund this upward pressure on defense budgets?

Ross Law: Well, this is the million-dollar question, or the 200-billion-dollar question, you might say. Unfortunately, this is part of the equation that is, so far, most unclear – and the basis for an ongoing series of reports we've entitled the “European Defense Dilemma” – essentially the very clear need to spend more on defense, but no clear way to fund it. So far, we've seen some creative ways to fund near-term spending plans, from off balance sheet special funds like in Germany, to using the interest received on frozen Russian assets.

But these, in our view, all seem fairly temporary in nature. What we really need is structural change, and that requires political commitment. Clearly, there is a lot of political change happening right now in Europe. Germany is holding an election in a few weeks time. France doesn't yet have a budget. There's also fiscal issues here in the UK. But we're hoping that 2025 is the year in which we may get clearer political commitments to longer-term structural improvements in defense spending. The German election is a clear near-term catalyst for us, where the raising of the debt break may in part be used to fund higher defense spending. But we're also looking to the upcoming NATO summit in June as an opportunity to officially increase the NATO spending target, we think potentially to 3 per cent, to support a more structural increase in European defense spending.

Paul Walsh: In light of all of this, what's your outlook for the European defense industry?

Ross Law: We remain bullish. In fact, we turned even more bullish as part of our 2025 outlook published earlier this month. The pressure to raise spending even to 3 per cent of GDP should progressively benefit industry fundamentals.

So, we see upside to both forecasts. Given these are currently premised on a 2 per cent of GDP assumption, as well as devaluation multiples, which we view today as very attractive, with the sector trading in line with this long-term average – despite the improving fundamentals I've just described.

Paul Walsh: And finally, Ross, what developments if any might change your outlook?

Ross Law: The key for us this year is seeing clear political commitments from governments on more structural increases in spending. So, we're going to be watching the German election and the outcome of the French budgetary process very carefully. It's unlikely to be plain sailing. There was a media article published just this morning suggesting the UK government may be unwilling to raise spending beyond the current 2.3 per cent level. But we are hoping that as a whole 2025 sees Europe make a stronger commitment to defending itself.

Paul Walsh: Ross, fascinating as always. Thanks for taking the time to talk.

Ross Law: Great speaking with you Paul.

Paul Walsh: 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 Head of Corporate Credit Research Andrew Sheets argues that while investor hopes are running high, corporate confidence isn’t.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about optimism, how we measure it, whether it’s overly excessive and what lies ahead. 

It's Friday January 24th at 2pm in London. 

A central tenet of investing, including credit investing, is to be on the lookout for excessive optimism. By definition, the highest prices in a market cycle will happen when people are the most convinced that only great things lie ahead. The lowest prices, when you’d love to buy, happen when investors have given up all hope. 

But identifying peak optimism, in real time, is tricky. It’s tricky because there is no generally agreed definition; and it's tricky because, sometimes, things just are good. Investors have been excited about the US Technology sector for more than a decade now. And yet this sector has managed to deliver extraordinary profit growth over this time – and extraordinarily good returns. 

Yet this debate does feel relevant. The US equity market has soared over 50 per cent in the last two years. Equity valuations are historically high, both outright and relative to bonds. Credit risk premiums are near 20-year lows. Speculative investor activity is increasing. And so, have we finally hit peak optimism, a level from which we can go no further? 

Our answer, for better or worse, is no. While we think investor optimism is elevated, corporate optimism is not. And corporations are really important in this debate, enjoying enormous financial resources that can invest in the economy or other companies. While we do think corporate confidence will pick up, it is going to take some time. 

One of our favorite measures of corporate confidence is merger and acquisition activity. Buying another company is one of the riskiest things management can do, making it a great proxy for underlying corporate confidence. Volumes of this type of activity rose about 25 per cent last year, but they are still well below historical averages. And it would be really unusual for a major market cycle to end without this sort of activity being above-trend. 

Another metric is the riskiness of new borrowing. Taking on new debt is another measure of corporate confidence, as you generally do something like this when you feel good about the future, and your ability to pay that debt off. But for the last three years the volume of low-rated debt in the US market has actually been shrinking, while the issuance of the riskiest grades of corporate borrowing is also down significantly from the 2017-2022 average. Again, these are not the types of trends you’d expect with excessive corporate optimism. 

Uncertainties around tariffs, or the policies from the new US administration could still hold corporate confidence back. But the low starting point for corporate confidence, combined with what we expect to be a deregulatory push, mean we think it is more likely that corporate activity and aggressiveness have room to rise – and that this continues throughout 2025. Such an increase usually does present greater risk down the line; but for now, we think it is too early to position for those more negative consequences of increasing corporate aggression.  

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

Morgan Stanley Research analysts Michelle Weaver, Michael Cyprys and Ryan Kenny discuss the resurgence in capital markets activity and how sponsors might deploy the $4 trillion that has been sitting on the sidelines. 

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity strategist at Morgan Stanley.

Michael Cyprys: I'm Mike Cyprys, Head of U.S. Brokers, Asset Managers and Exchanges Research.

Ryan Kenny: And I'm Ryan Kenney, U.S. Mid-Cap Advisors Analyst at Morgan Stanley.

Michelle Weaver: In this episode of our special miniseries covering Big Debates, we'll focus on the improving M&A and IPO landscape and whether retail investing can sustain in 2025.

It's Thursday, January 23rd at 10am in New York.

2023 saw the lowest level of global M&A activity in at least 30 years. But we've started to see activity pick up in 2024. Mike, what have been the key drivers behind this resurgence, and where are we now?

Michael Cyprys: Look, I think it's been a combination of factors in the context of a lot of pent-up activity and a growing urge to transact after a very subdued period of, you know, call it four- to six quarters of quite limited activity. Key drivers as we see it ranging from equity markets that have expanded across much of the world, low levels of equity volatility. broad financing, availability with meaningful issuance as you look across investment grade and high yield bond markets, tight credit spreads, interest rates stabilizing in [20]24, and then the Fed began to cut.

So, liquidity pretty robust, all of that helping reduce bid-ask spreads. In terms of where we are now, post election, think there's just a lot of excitement here around a new administration; where we could see some changes around the antitrust environment that can be helpful, as we think about unlocking greater M&A activity across sponsors as well as strategics, and helping improve corporate confidence.

But look, the recent rout of market could delay some of the transactional activity uplift. But we view that as more of a timing impact, and we are quite positive here in [20]25 as we think about scope for continued surge of activity.

Michelle Weaver: We've seen rates rising pretty substantially since December. Does that throw a wrench into this at all, or do you think we see more stabilization there?

Michael Cyprys: I think it could be a little bit of a slowdown, right? That would be the risk here, but as we think about the path for moving forward, I do think that there are a lot of factors that can be very helpful in terms of driving a continued pickup in activity, which we're going to talk about -- and why that will be the case.

Michelle Weaver: Great. And you mentioned financial sponsors earlier, I want to drill down there a little more. What do you think would get sponsor activity to pick up more meaningfully?

Michael Cyprys: Well, as I think about it, activity is already starting to pick up clearly across strategics as well as sponsors. On the sponsor side, it's been lagging a bit relative to strategics. We think both of which will build, and Ryan will get to that on the strategic side. As we think about the sponsors -- they're sitting with $4 trillion of capital to put to work that's been sitting on the sidelines where you just haven't seen as much activity over the past couple of years.

Overall activity in [20]24 was probably call it maybe around 20 per cent below peak levels, and this is burning a hole in the pockets of both sponsors as well as their clients. And so, we see a growing urge to transact here, which gets to some of your earlier questions there too.

So why is that? Well, the return clock is ticking; the lack of deployment is hurting returns within funds. Some of this dry powder also expires by the end of [20]25; and so if it's not yet deployed, then sponsors won't get some of the performance fee economics that come through to them on that capital. So that's all, all on the deployment side.

As we think about the realization or exit side, we think that's probably going to lag, but we'd still expect, a steady build through this year. Today sponsors are sitting on call it around $10 trillion of portfolio of investments that are in the ground, and they haven't really provided much in the way of liquidity back to their customers, the LPs and the funds. And so, this is putting a little bit of a strain not only on the client relationships that want more money back from their private investments that haven't received it, but it's also one of the causes of what has been a little bit of a challenging fundraising backdrop across private equity funds.

Hence if sponsors can return more capital to their clients, that can be helpful in terms of healing the overall fundraising backdrop. So, look, putting all that together, we expect an expanding pace of transactional deal activity across the sponsors from both the buy side as well as the sell side in terms of our activity.

Michelle Weaver: And Ryan, how about IPOs? Have they been part of a similar trend?

Ryan Kenny: Yes, definitely. So, with IPOs, we're also expecting a significant resurgence off of a low base. So just to put some numbers on it. In 2024, announced M&A volumes relative to nominal GDP, we're around 40 per cent below three-decade averages; equity capital markets [ECM] or ECM was even more muted, 50 per cent below three decade averages. And the leading indicators for ECM are very similar to the leading indicators for M&A. You want a strong equity market, relatively low volatility so that companies have the confidence to go public and so that deals can price well. And those conditions are really starting to materialize already in 2024; and we saw a few big IPOs price well last year, and launch well. The fourth quarter also looks strong. We saw a significant acceleration in industry ECM activity in October, November, December. 4Q volumes tracking up over 50 per cent year-over-year.

Michelle Weaver: Let's dig a little deeper into potential policies from the incoming Trump administration. What are your expectations around antitrust regulation and its impact on M&A?

Ryan Kenny: So, Trump has announced his appointments to the FTC and to the DOJ antitrust division. And our expectation is a return to normal. And that's coming off of what was a more onerous and not-clear environment under Biden. The Biden administration's approach was to disincentivize M&A; and they did that by defining M&A market concentration in novel ways -- looking at things like labor markets, and looking at how competitiveness is defined in new ways. And these new ways of defining concentration decrease the clarity of whether a specific deal would be challenged.

So, from a CEO and board perspective, you don't want to waste the time of your management team and your board going through a deal that might not go through; in addition to the risk of prolonging the deal, and the risk of higher legal expenses during the process. So now that we're returning more towards normal, that's our expectation. We expect there will still be some deals like a challenge, but it will operate under more historical norms and so that really checks the box of getting CEO confidence up to transact more.

Michelle Weaver: And I know that dynamic you’re talking about with market concentration created quite a big drag on large M&A deals and large-cap M& A. Do you think we could start to see that come back as well?

Ryan Kenny: Yeah, expect large-cap deals to rebound even more than small-cap deals. When we started to see the activity pick up in 2024, it was led by more mid-cap corporates. And now we expect to see large deals return in force at a time when financial sponsors, like what Mike was just talking about, coming back in force at the same time -- which drives up the animal spirits when all parts of the M&A market are returning at the same time.

Michelle Weaver: And what are some other catalysts beyond the political side that investors should watch in 2025 around capital markets developments?

Ryan Kenny: So, I categorize it as macro catalysts and structural catalysts The macro catalysts are clarity on tariff and immigration policies, how that will impact GDP. Clarity on the interest rate path. And look you don't need more rate cuts to get this market moving; you can still have a significant increase, even if there are no more rate cuts this year.

But narrowing the range of outcomes is important. And I think we're already there, where maybe we get no cuts this year. Maybe we get two cuts. It's a much tighter environment than where we were over the last few years. And so that helps narrow the bid-ask spread between buyers and sellers.

Structural catalysts that are really critical this cycle are the need for AI capabilities. Innovation in tech, innovation in biotech healthcare, the energy transition, reshoring and exploring your geographic footprint in a multipolar world -- are all really critical when you evaluate the types of companies that a board would want to acquire.

Michelle Weaver: What’s your outlook for 2025? And then even beyond that when it comes to both M&A and IPO activity?

Ryan Kenny: So, in 2025, we see a strong rebound in both ECM and M&A. ECM volumes in our base case, we expect to roughly double off of a low base. M&A announcements, we expect up over 50 per cent year-over-year in 2025. And importantly, that's our base case. Even in our bear case, we model an increase in both ECM and M& A volumes, given we're coming off of such low levels.

We've had three years of light activity and pent-up demand, and pipelines have already begun to build. When we look forward beyond 2025, we think this is the beginning of a multi-year capital markets growth cycle -- with bigger deal sizes and more deal count than average, driven by three years of pent-up demand and an economy that's a third larger than 2021, which was the last time we had a capital markets cycle.

Michelle Weaver: And then Mike, what does this rebound in capital markets activity, including M&A and IPOs means specifically for retail investing?

Michael Cyprys: Overall, a supportive macro backdrop with a rebound in capital markets activity, we think should be helpful in terms of bringing more investors into the markets, including retail investors. Whether it's from corporate actions and IPOs, it helps in terms of more stocks to trade; also helps in terms of revising animal spirits.

I think that's all helpful in terms of supporting engagement across both single stock volumes and equity markets as well as options. So, all of that together, we were expecting greater investor engagement here in [20]25. And confidence as well can help boost not just trading volumes but also margin lending and securities lending. And so, all of that can be helpful as we think about our forecast for our retail brokerage coverage group.

Michelle Weaver: Mike, Ryan, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoyed the podcast, please share it with a friend or colleague today.

On his first day in office, President Trump issued a series of executive orders, signaling his intent to deliver on campaign promises. Our Global Head of Fixed Income and Public Strategy Michael Zezas takes a closer look at economic impacts of Trump’s proposed policy path.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head of Fixed Income and Public Policy Strategy. On this episode of the podcast, we’ll discuss how trade policy uncertainty is creating volatility in markets.

It’s Wednesday, January 22nd, at 10am in New York.

Earlier this week, Donald Trump was again inaugurated as President of the United States. In the days that have followed, we’ve fielded tons of questions from investors, who are trying to parse the meaning of myriad executive orders and answers to press questions – looking through that noise for signals about the if, when, and how of policy changes around tariffs, taxes, and more. This effort is understandable because – as we’ve discussed here many times – the US public policy path will have substantial effects on the outlook for the global economy and markets. 

And while we’ve spent some time here explaining our assumptions for the US policy path, it's important for investors to understand this. Even if you correctly forecast the timing and severity of changes to trade, tax, immigration, and other policies, you shouldn’t expect markets to consistently track this path along the way. That’s because there’s bound to be a fair amount of confusion among investors, as President Trump and his political allies publicly speculate on their policy tactics and make a wide variety of outcomes seem plausible. 

Take tariff policy for example. On Monday, the President announced an America First Trade Policy, where the whole of government was instructed to come up with policy solutions to reduce goods trade deficits and related economic and national security concerns. Tariffs were cited as a tool to be used in furtherance of these goals, and instructions were given to develop authorities on a range of regional and product-specific tariff options. Said more simply, while new tariffs were not immediately implemented, the President appears to be maximizing his optionality to levy tariffs when and how he wants. That will mean that all public comments about tariffs and deadlines, including Trump’s comments to reporters on tariffs for Mexico, Canada, and China, must be taken seriously – even if they don’t ultimately come to fruition, which currently we don’t think they will for Mexico and Canada. 

For markets, that max optionality can drive all sorts of short term outcomes. In the US Treasury market, for example, our economists believe these tariffs and a variety of other factors ultimately make for slower economic growth in 2026; and so we expect Treasury yields will ultimately end the year lower. But along the way they could certainly move higher first. As my colleague Matt Hornbach points out, tariff threats can drive investor concerns about temporary inflation leading markets to price in a slower pace of Fed interest rate cuts, which helps push short maturity yields higher. 

So bottom line: investors should be carefully considering US public policy choices when thinking about the medium term direction of markets. But they should also expect considerable volatility along the way, because the short term path can look a lot different from the ultimate destination. 

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 Chief Asia Economist Chetan Ahya discusses how tariffs, the power of the U.S. dollar, and the strength of domestic demand will determine Asia’s economic growth in 2025.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Today on the podcast: three critical themes that will shape Asia’s economy in 2025. 

It’s Tuesday, January 21, at 2 PM in Hong Kong. 

Let's start with the big picture: We foresee Asia's growth decelerating from 4.5 per cent last year to 4.1 per cent in 2025. The whole region faces a number of challenges and opportunities that could sway these numbers significantly. We highlight [the] following three key factors. 

First up, tariffs. They are our single biggest concern this year. The pace, scale and affected geographies will determine the magnitude of the growth drag. In our base case, within Asia, we expect tariffs to be imposed on China in a phased manner from the first half of 2025. As Mike Zezas, our Head of US Public Policy states, this will be about fast announcements and slow implementation. 

Given tariffs and trade tensions are not new, we think this means corporate confidence may not be as badly affected as it was in 2018-19. But the key risk is if trade tensions escalate. For instance, into more aggressive bilateral disputes outside of US-China or if [the] US imposes universal tariffs on all imports. Asia will be most affected, considering that seven out of [the] top ten economies that run large trade surpluses with the US are in Asia. If either of these risk scenarios materialize, it could bring a repeat of [the] 2018-19 growth shock. 

Next, let's consider the Fed and the US dollar. Asian central banks find themselves in a bind with the US Federal Reserve's hawkish shift – which we think will result in only two rate cuts in 2025. The Fed is taking a cautious approach, driven by worries over inflation concerns, which could be exacerbated by changes in trade and fiscal policy. This has led to strength in the US dollar and on the flipside, weakness in Asian currencies. This constrains Asian central banks from making aggressive rate reductions -- even though Asia’s inflation is in a range that central banks are comfortable with. 

Finally, with [the] external environment not likely to be supportive, domestic demand within key Asian economies will be an important anchor to [the[ region's growth outlook. We are constructive on the outlook for India and Japan but cautious on China. 

China has a deflation challenge, driven by excessive investment and excess capacity. Solving it requires policy makers to rely more on consumption as a means to meet its 5 per cent growth target. While some measures have been implemented and we think more are coming, we remain skeptical that these measures will be enough for China to lift consumption growth meaningfully. We see investment remaining the key growth driver and the implementation of tariffs will only exacerbate the ongoing deflationary pressures. 

In India and Japan, we think domestic demand tailwinds will be able to offset external headwinds. We expect a robust recovery in India fueled by government capital expenditure, monetary easing and acceleration in services exports. This should put GDP growth back on a 6.5 per cent trajectory. In Japan we expect real wage and consumption growth reacceleration, which will lead [the] Bank of Japan to be confident in the inflation outlook such that it hikes policy rates twice in 2025. 

This week marks the start of the new Trump administration. And together with my colleagues, we are watching closely and will continue to bring you updates on the impact of new policies on Asia.

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.

Government bond yields in the U.S. and Europe have risen sharply. Our Head of Corporate Credit Research Andrew Sheets explains why this surprising trend is not yet cause for concern.

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

With bond yields rising substantially over the last month, I’m going to discuss why we’ve been somewhat more relaxed about this development and what could change our mind. 

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

We thought credit would have a good first half of this year as growth held up, inflation came down, and the Federal Reserve, the European Central Bank and the Bank of England all cut rates. That mix looked appealing, even if corporate activity increased and the range of longer-term economic outcomes widened with a new U.S. administration. We forecast spreads across regions to stay near cycle tights through the first half of this year, before a modest softening in the second half. 

Since publishing that outlook in November of last year, some of it still feels very much intact. Growth – especially in the U.S. – has been good. Core inflation in the U.S. and in Europe has continued to moderate. And the Federal Reserve and the European Central Bank did lower interest rates back in December. 

But the move in government bond yields in the U.S. and Europe has been a surprise. They've risen sharply, meaning higher borrowing cost for governments, mortgages and companies. How much does our story change if yields are going to be higher for longer, and if the Fed is going to reduce interest rates less? 

One way to address this debate, which we’re mindful is currently dominating financial market headlines, is what world do these new bond yields describe? Focusing on the U.S., we see the following pattern. 

There’s been strong U.S. data, with Morgan Stanley tracking the U.S. economy to have grown to about 2.5 per cent in the fourth quarter of last year. Rates are rising, and they are rising faster than the expected inflation – a development that usually suggests more optimism on growth. We’re seeing a larger rise in long-term interest rates relative to shorter-term interest rates, which often suggests more confidence that the economy will stay stronger for longer. And we’ve seen expectations of fewer cuts from the Federal Reserve; but, and importantly, still expectations that they are more likely to cut rather than hike rates over the next 12 months. 

Putting all of that together, we think it’s a pattern consistent with a bond market that thinks the U.S. economy is strong and will remain somewhat stronger for longer, with that strength justifying less Fed help. That interpretation could be wrong, of course; but if it's right, it seems – in our view – fine for credit. 

What about the affordability of borrowing for companies at higher yields? Again, we’re somewhat more sanguine. While yields have risen a lot recently, they are still similar to their 24 month average, which has given corporate bond issuers a lot of time to adjust. And U.S. and European companies are also carrying historically high amounts of cash on their balance sheet, improving their resilience. 

Finally, we think that higher yields could actually improve the supply-demand balance in corporate bond markets, as the roughly 5.5 per cent yield today on U.S. Investment Grade credit attracts buyers, while simultaneously making bond issuers a little bit more hesitant to borrow any more than they have to. We now prefer the longer-term part of the Investment Grade market, which we think could benefit most from these dynamics. 

If interest rates are going to stay higher for longer, it isn’t a great story for everyone. We think some of the lowest-rated parts of the credit market, for example, CCC-rated issuers, are more vulnerable; and my colleagues in the U.S. continue to hold a cautious view on that segment from their year-ahead outlook. But overall, for corporate credit, we think that higher yields are manageable; and some relief this week on the back of better U.S. inflation data is a further support. 

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

The Federal Reserve’s shrinking balance sheet could have far-reaching implications for the banking sector, money markets and monetary policy. Global Head of Macro Strategy Matthew Hornbach and Martin Tobias from the U.S. Interest Rate Strategy Team discuss. 

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Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy.

Martin Tobias: And I'm Martin Tobias from the U.S. Interest Rate Strategy Team.

Matthew Hornbach: Today, we're going to talk about the widespread concerns around the dip in reserve levels at the Fed and what it means for banking, money markets, and beyond.

It's Thursday, January 16th at 10am in New York.

The Fed has been shrinking its balance sheet since June 2022, when it embarked on quantitative tightening in order to combat inflation. Reserves held at the Fed recently dipped below [$]3 trillion at year end, their lowest level since 2020. This has raised a lot of questions among investors, and we want to address some of them.

Marty, you've been following these developments closely, so let's start with the basics. What are Fed reserves and why are they important?

Martin Tobias: Reserves are one of the key line items on the liability side of the Fed balance sheet. Like any balance sheet, even your household budget, you have liabilities, which are debts and financial obligations, and you have assets. For the Fed, its assets primarily consist of U.S. Treasury notes and bonds, and then you have liabilities like U.S. currency in circulation and bank reserves held at the Fed.

These reserves consist of electronic deposits that commercial banks, savings and loan institutions, and credit unions hold at Federal Reserve banks. And these depository institutions earn interest from the Fed on these reserve balances.

There are other Fed balance sheet liabilities like the Treasury General Account and the Overnight Reversed Repo Facility. But, to save us from some complexity, I won't go into those right now. Bottom line, these three liabilities are inversely linked to one another, and thus cannot be viewed in isolation.

Having said that, the reason this is important is because central bank reserves are the most liquid and ultimate form of money. They underpin nearly all other forms of money, such as the deposits individuals or businesses hold at commercial banks. In simplest terms, those reserves are a sort of security blanket.

Matthew Hornbach: Okay, so what led to this most recent dip in reserves?

Martin Tobias: Well, that's the good news. We think the recent dip in reserves below [$] 3 trillion was simply related to temporary dynamics in funding markets at the end of the year, as opposed to a permanent drain of cash from the banking system.

Matthew Hornbach: This kind of reduction in reserves has far reaching implications on several different levels. The banking sector, money markets, and monetary policy. So, let's take them one at a time. How does it affect the banking sector?

Martin Tobias: So individual banks maintain different levels of reserves to fit their specific business models; while differences in reserve management also appear across large compared to small banks. As macro strategists, we monitor reserve balances in the aggregate and have identified a few different regimes based on the supply of liquidity.

While reserves did fall below [$]3 trillion at the end of the year, we note the Fed Standing Repo Facility, which is an instrument that offers on demand access to liquidity for banks at a fixed cost, did not receive any usage. We interpret this to mean, even though reserves temporarily dipped below [$]3 trillion, it is a level that is still above scarcity in the aggregate.

Matthew Hornbach: How about potential stability and liquidity of money markets?

Martin Tobias: Occasional signs of volatility in money market rates over the past year have been clear signs that liquidity is transitioning from a super abundancy closer to an ample amount. The fact that there has become more volatility in money market rates – but being limited to identifiable dates – is really indicative of normal market functioning where liquidity is being redistributed from those who have it in excess to those in need of it.

Year- end was just the latest example of there being some more volatility in money market rates. But as has been the case over the past year, these temporary upward pressures quickly normalized as liquidity in funding markets still remains abundant. In fact, reserves rose by [$] 440 billion to [$] 3.3 trillion in the week ended January 8th.

Matthew Hornbach: Would this reduction in reserves that occurred over the end of the year influence the Fed's future monetary policy decisions?

Martin Tobias: Right. As you alluded to earlier, the Fed has been passively reducing the size of its balance sheet to complement its actions with its primary monetary policy tool, the Fed Funds Rate. And I think our listeners are all familiar with the Fed Funds Rate because in simplest terms it's the rate that banks charge each other when lending money overnight, and that in turn influences the interest you pay on your loans and credit cards. Now the goal of the Fed's quantitative tightening program is to bring the balance sheet to the smallest size consistent with efficient money market functioning.

So, we think the Fed is closely watching when declines in reserves occur and the sensitivity of changes in money market rates to those declines. Our house baseline view remains at quantitative tightening ends late in the first quarter of 2025.

Matthew Hornbach: So, bottom line, for people who invest in money market funds, what's the takeaway?

Martin Tobias: The bottom line is money markets continue to operate normally, and even though the Fed has lowered its policy rates, the yields on money markets do remain attractive for many types of retail and institutional investors.

Matthew Hornbach: Well, Marty, thanks for taking the time to talk.

Martin Tobias: Great speaking with you, Matt.

Matthew Hornbach: And thanks for listening. If you enjoy Thoughts on the Market, [00:06:00] please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Our Global Head of Fixed Income & Public Policy Research Michael Zezas discusses how Morgan Stanley’s key themes – deglobalization, longevity, the future of energy, and artificial intelligence – will evolve in 2025 and beyond.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Public Policy Research. Today I’ll discuss the key investment megatrends Morgan Stanley Research will be following closely in 2025. 

It’s Wednesday, January 15th, at 10am in New York. 

Short-term trends can offer investors valuable insights into immediate market dynamics. But it’s the long-term trends that truly shape the investment landscape. That’s why each year, Morgan Stanley Research identifies a short list of megatrends that we believe will provide long-term investment opportunities in an ever-changing world. 

Three of Morgan Stanley’s megatrends—artificial intelligence, longevity, and the future of energy—carry over from last year. A fourth—the rewiring of the global economy—returns to our list after a hiatus in 2024. While none of these megatrends is new, each has evolved in terms of how it applies to investment strategies. 

Let’s start with the rewiring of global commerce for a Multipolar World. As I mentioned, this theme rejoins our list of key megatrends after a year-long break. Why? In short, it’s clear that policymakers globally are poised to implement policies that will speed up the breakdown of the post-Cold War globalization trend. Simply put, policymakers are keen to promote their visions of national and economic security through less open commerce and more local control of supply chains and key technologies. Multinationals and sovereigns may have to accelerate their adaptation to this reality. Some will face tougher choices than others, while there are some who may still benefit from facilitating this transition. Knowing who fits into which category—and how this new reality may play out—will be critical for investors. 

Our next theme—Longevity—remains an essential long-term secular trend, and this year the focus will be on measurable impacts for governments, economies, and corporates. The ripple effects of an aging population, the drive for healthy longevity, and challenging demographics across many geographies continue to impact markets. And in 2025, we see investors focusing on several specific longevity debates: First, innovation across healthcare – especially in an AI world, with obesity medications remaining front and center. Second, impacts on consumer behavior – including the drive for affordable nutrition. Third, the need to reskill aging workforces – especially if retirement ages move higher. And, finally, there’s implications for financial planning and retirement – with a bull market for financial advice just starting. 

Our next theme centers around energy. When we think about the future of energy, our focus for 2025 shifts from decarbonization to the wide range of factors driving the supply, demand, and delivery of energy across geographies. And the common thread here is the potential for rapid evolution. We’ll be tracking four key dynamics: First, an increasing focus on energy security. Second, the massive growth in energy demand driven by trillions of dollars of AI infrastructure spend, to be met both by fossil fuel-powered plants and renewables. Third, innovative energy technologies such as carbon capture, energy storage, nuclear power, and power grid optimization. And fourth, increased electrification across many industries. We continue to believe that carbon emissions will likely exceed the targets in various nations’ climate pledges. So, we expect focus to shift toward climate adaptation and resilience technologies and business models. 

Our last key theme is artificial intelligence and tech diffusion. Although it’s been two years since the launch of ChatGPT, we’re still in the early innings of AI's diffusion across sectors and geographies. However, while 2024 was driven by AI enablers and infrastructure companies, in 2025 we expect the market to focus on early AI downstream use cases that drive efficiency and market share. As you heard yesterday, our Global Head of Thematic Research Ed Stanley, explained that there’s alpha in understanding this rate of change. Agentic AI will be center stage, with robust enterprise adoption, stock outperformance for early adopters, positive surprises in model capabilities, greater breadth of monetization, and thus less attention to return-on-investment debates. 

Before I close, it’s worth mentioning that you will likely see connections between these complex themes. As an example, the complexity of a multipolar world makes energy security all the more vital. The demand for energy connects with the enormous power requirements of AI. And AI is set to drive healthcare innovations which could help us lead longer healthier lives. We see these four themes not as static categories but as an interconnected roadmap for investing over the long-term – and we’ll be sharing more on specific debates throughout the year. 

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 Head of Thematic Research Ed Stanley discusses how artificial intelligence is changing and what could be in store for investors in 2025.

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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Global Head of Thematic Research. Today I'll discuss how understanding AI’s rate of change can generate alpha in the year of AI agents.

It’s Tuesday, the 14th of January, at 2 PM in London.

Even if you haven't been using artificial intelligence in your work or home life yet – you’ll doubtless have heard about its capabilities by now. Tasked, for example, with drafting an elevator pitch for a 100-page report; it's a tedious task at the best of times. But using an AI model not only does it become a breeze, but these models can also generate you a podcast – if you so wish – through which to disseminate it, and almost in any language conceivable. But now imagine the algorithm begins thinking through multi-stage processes itself – planning, executing – to generate that 100-page report itself, in the first place. That … is an example of Agentic AI. 

As the name implies, this next phase of AI development is where software programs gain agency, transitioning from reactive chatbots that we’ve been using into proactive task fulfillment agents. And this transition is happening now. 

Over the past 36 months, we’ve gone from reliable output that can displace or supplement 5-second or 5-minute tasks, such as translation or quick summaries, to models that are providing reliable output for 15-minute tasks, 1-hour tasks – like the ones that I just mentioned. And each time the skeptics have claimed that model improvements are slowing down, and thus call into question the returns on hundreds of billions of dollars that have been spent on AI infrastructure, the AI research labs manage to take another leap forward, surprising even seasoned analysts. 

That’s why we think this is such an important trend for 2025. AI Adopter companies that can leverage these agents will start to pull ahead of their peers. And as a result, tracking AI’s evolution in the materiality of companies’ investment cases, we think, has never been more important. 

Since our first AI Adopter survey in January 2024 to our latest just published in January 2025, we've seen profound shifts in the thousands of stocks that we cover globally. This ongoing transformation not only underscores that AI’s diffusion is advancing rapidly, but that we’re still very much in its early innings.

To understand the breakneck speed of the AI evolution through the lens of its impact on the stock markets, we need to wrap our heads around the concept of “rate of change.” We just published the third iteration of our AI mapping survey of 3,700 global stocks under coverage. And it reveals that 585 of those stocks had their AI exposure or materiality to investment case changed by our analysts – and that is just versus 6 months ago. And it impacts around $14 trillion of global market cap. 

And this rate of change in AI isn't just a buzzword; it's a tangible metric driving outperformance. So, if we look back in the second half of last year, 2024, stocks where our analysts previously increased both AI exposure and materiality in our last survey – went on to outperform broader equity markets by over 20 per cent in the second half of 2024. If we apply the same logic looking forward, where do we think most outperformance is going to come from? It’s in those same stocks where our analysts have just upgraded the exposure and materiality to the investment case. 

Beyond this simple screen for AI outperformers we think there are three other key conclusions from our latest survey. The first is AI Enabler stocks with Rising Materiality, within which we believe that Semiconductors, which have outperformed well, might soon pass the baton to the Software layer in terms of equity market dominance. Second, Adopters with Pricing Power. These are companies that adopt AI early and use it to expand their margins but sustainably, without having to give it back to their customers. And the third is Financial stocks, in particular, where AI Rate of Change has been the fastest of any sector in our global coverage – in terms of the efficiency gains that we think it can manifest for the share prices. 

So all in all, 2025 promises a slew of significant developments in AI, and, of course, we’ll be here to bring you all of the updates. 

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

In the latest edition of our Big Debates miniseries, Morgan Stanley Research analysts discuss the factors that will shape the global energy market in 2025 and beyond, and where to look for investment opportunities.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. thematic and Equity strategist at Morgan Stanley.

Devin McDermott: I'm Devin McDermott, Head of Morgan Stanley's North America Energy Team.

Mike Canfield: And I'm Mike Canfield, Head of the Europe Sustainability Team,

Michelle Weaver: This is the second episode of our special miniseries, Big Debates, where we cover key investment debates for 2025. Today, we'll look at where we are in the energy transition and some key investment opportunities.

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

Mike Canfield: And 3pm in London.

Michelle Weaver: Since 2005, U.S. carbon emissions have fallen by about 15 percent. Nearly all of this has been tied to the power sector. Natural gas has been displacing coal. Renewable resources have seen higher penetration. When you look outside the power sector, though, progress has been a lot more limited.

Let me come to you first, Devin. What is behind these trends, and where are we right now in terms of the energy transition in the U.S.?

Devin McDermott: Over the last 20 years now, it's actually been a pretty steady trend for overall U.S. emissions. There's been gradual annual declines, ratcheting lower through much of this period. [There’s] really two primary drivers.

The first is, the displacement of coal by natural gas, which is driven about 60 percent of this reduction over the period. And the remainder is higher penetration of renewable resources, which drive the remaining 40 percent. And this ratio between these two drivers -- net gas displacing coal, renewables adding to the power sector -- really hasn't changed all that much. It's been pretty consistent even in this post COVID recovery relative to the 15 years prior.

Outside of power, there's been almost no progress, and it doesn't vary much depending on which end market you're looking at. Industrial missions, manufacturing, PetChem -- all relatively stable. And then the transport sector, which for the U.S. in particular, relative to many other markets and the rest of the world, is a big driver transport, a big driver of emissions. And there it's a mix of different factors. The biggest of which, though, driving the slow uptick in alternatives is the lack of viable economic options to decarbonize outside of fossil fuels. And the fact that in the U.S. specifically, there is a very abundant, low-cost base of natural gas; which is a low carbon, the lowest carbon fossil fuel, but still does have carbon intensity tied to it.

Michelle Weaver: You've also argued that the domestic natural gas market is positioned for growth. What's your outlook for this year and beyond?

Devin McDermott: The natural gas market has been a story of growth for a while now, but these last few years have had a bit of a pause on major expansion.

From 2010 to 2020, that's when you saw the biggest uptick in natural gas penetration as a portion of primary energy in the U.S. The domestic market doubled in size over that 10-year period, and you saw growth in really every major end market power and decarbonization. There was a big piece of it. But the U.S. also transitioned from a major importer of LNG, which stands for liquefied natural gas, to one of the world's largest exporters by the end of last decade. And you had a lot of industrial and petrochemical growth, which uses natural gas as a feedstock.

Over the last several years, globally, gas markets have faced a series of shocks, the biggest of which is the Russia-Ukraine conflict and Europe's loss of a significant portion of their gas supply, which historically had come on pipelines from Russia. To replace that, Europe bought a lot more LNG, drove up global prices, and in response to higher global prices, you saw a wave of new project sanctioning activity around the world. The U.S. is a key driver of that expansion cycle.

The U.S. over the next five years will double; roughly double, I should say, its export capacity. And that is an unprecedented amount of volume growth domestically, as well as globally, and will drive a significant uptick in domestic consumption.

So that the additional exports is pillar number one; and pillar number two, which I'd say is more of an emerging trend, is the rise of incremental power consumption. For the last 15 years, U.S. electricity consumption on a weather adjusted basis has not grown. But if you look out at forecasts from utilities, from various market operators in the country, you're now seeing a trend of growth for the balance of this decade and beyond tied to three key things.

The first is onshore manufacturing. The second is power demand tied to data centers and AI. And the third is this broader trend of electrification. So, a little bit from EV's, more electric appliances, which fit into this decarbonization theme more broadly. We're looking at now an outlet, this is our base case of U.S. electricity demand growing at just shy of 2 percent per year over the next five years. That is a growth rate that we have not seen this century. And natural gas, which generates about 40 percent of U.S. power today, will continue to be a key player in meeting this incremental demand. And that becomes then a second pillar of consumption growth for the domestic market.

Michelle Weaver: And we're coming up on the inauguration here, and I think one really important question for investors is what's going to happen to the energy sector and to renewables when Trump takes office? What are you thinking here?

Devin McDermott: Yes. Well, the policy that supports renewable development in the U.S., wind and solar specifically, has survived many different administrations, both Republican and Democratic. And there's actually several examples over the last 10 to 15 years of Republican controlled Congress extending both the production tax credit and investment tax credit for wind and solar.

So, our base case is no major change on deployments, but also unlikely to see any incremental supportive policy for these technologies. Instead, I think the focus will be on some of the other major themes that we've been talking about here.

One, there's currently a pause on new LNG export permits under the Biden administration that should be lifted shortly post Trump's inauguration. Second, there are greenhouse gas intensity limits on new power plant and existing power plant construction in the U.S. that will likely be lifted, under the incoming Trump administration. So, gas takes a larger share of incremental power needs under Trump than it would have under the prior status quo. And then lastly. Consistently over the last few years, penetration of electric vehicles and low carbon vehicles in general in the United States have fallen short of expectations.

And interestingly, if you look at just the composition of new vehicles sold in the U.S. over the past years, nearly two-thirds were SUVs or heavier light duty vehicles that offset some of the other underlying trends of some uptick in EV penetration.

Under the prior Trump administration, there was a rollback of initiatives to improve the fuel economy of both light duty and heavy-duty transport. I would not be surprised if we see that same thing happen again, which means you have more longevity to gasoline, diesel, other fossil-based transport fuels. Which kind of put this all together -- significant growth for natural gas that could accelerate under Trump, more longevity to legacy businesses like gasoline and diesel for these incumbent energy companies is not a bad backdrop.

Trade's still at double its historical discount versus the broader market. So, not a bad setup when you put it all together.

Michelle Weaver: Great. Thank you, Devin. Mike, new policies under the second Trump administration will likely have an impact far beyond the U.S. And with a potential withdrawal of the U.S. from the Paris Agreement and increased greenhushing, many investors are starting to question whether companies may walk back or delay their sustainability ambitions.

Will decarbonization still be a corporate priority or will the pace of the energy transition in Europe slow in 2025?

Mike Canfield: Yeah, that's the big question. The core issues for EU policymakers at the moment include things like competitiveness, climate change, security, digitalization, migration and the cost of living.

At the same time, Mario Draghi highlighted in his report entitled “The Future of European Competitiveness” that there are three transformations Europe has to contend with: to become more innovative and competitive; to complete its energy transition; and to adapt to a backdrop of less stable geopolitics where dependencies are becoming vulnerabilities, to use his phrase.

We do still expect the EU's direction of travel on things like the Fit for 55 goals, its targets to address critical mineral supplies, and the overall net zero transition to remain consistent. And the UK's Labour Party has advocated for Clean Power 2030 goals of 95 percent clean generation sources.

At the same time, it's fair to say some commentators have pointed to the higher regulatory burden on EU corporates as a potentially damaging factor in competitiveness, suggesting that regulations are costly and can be overcomplicated, particularly for smaller companies. While we've already had a delay in the implementation of the EU's deforestation regulation, some questions do remain over other rules, including things like the corporate sustainability, due diligence directive, and the design of the carbon border adjustment mechanism or CBAM.

We're closely watching corporates themselves to see whether they'll reevaluate their investment plans or targets. One example we've actually already seen is in the metals and mining space where decarbonisation investment plans were adjusted because of inadequate green hydrogen infrastructure and policy concerns, such as the effectiveness of the CBAM.

It does remain committed to its long-term net zero goals. But the company has acknowledged that practical hurdles may delay achievement of its 2030 climate ambitions. We wouldn't be surprised to see other companies take an arguably more pragmatic, in inverted commas, approach to their goals, accepting that technology, infrastructure and policy might not really be ready in time to reach 2030 targets.

Michelle Weaver: Do you believe there are still areas where the end markets will grow significantly and where companies still offer compelling opportunities?

Mike Canfield: Yeah, absolutely. We think sustainable investing continues to evolve and that, as with last year, stock selection will be key to generating alpha from the energy transition. We do see really attractive opportunities in enabling technologies across decarbonisation, whether that's segments like grid transmission and distribution, or in things like Industry 4.0.

We'd recommend focusing on companies with clear competitive moats and avoiding the relatively commoditized areas, as well as looking for strong pricing power, and those entities offering mission critical products or services for the transition. We do anticipate a continued investment focus on data center power dynamics in 2025 with cooling technology increasingly a topic of investor interest.

Beyond the power generation component, the urgent need for investment in everything from electrical equipment to grid technologies, smart grid software and hardware solutions, and even cables is now increasingly apparent. We expect secular growth in these markets to continue apace in 2025.

Within Industry 4.0, we do think adoption of automation, robotics, machine learning, and the industrial Internet of Things is set to grow strongly this year as well. We also see further growth potential in other areas like energetic modernization in buildings, climate resilience, and the circular economy.

Michelle Weaver: And with the current level of policy uncertainty has enthusiasm for green investing or the ‘E’ environmental pillar of ESG declined

Mike Canfield: I think evolved might be a fairer expression to use than declined. Certainly, reasonable to say that performance in some of the segments of the E pillar has been very challenging in the last 12 to 24 months -- with the headwinds from geopolitics, from the higher interest rate backdrop and inflation. At the same time, we have seen a transition towards improver investment strategies, and they're continuing to gain in popularity around the world.

As investors recognize that often the most attractive alpha opportunities are in the momentum, or direction of travel rather than simple, so-called positive screening for existing leaders in various spaces. To this end, the investors that we speak to are often focused on things like Capex trends for businesses as a way to determine how companies might actually be investing to deliver on their sustainability ambitions.

Beyond those traditional E, areas like renewables or electric vehicles, we have therefore seen investors try to diversify exposures. So, broadening out to include things like the transition enablers, the grid technologies, HVAC -- that's heating, ventilation and cooling, products supporting energy efficiency in buildings, green construction and emerging technologies even, like small modular nuclear reactors alongside things like industrial automation.

Michelle Weaver: And, given this evolution of the e pillar, do you think that creates an opportunity for the S or G, the social or governance components of ESG?

Mike Canfield: We do think the backdrop for socially focused investing is very strong. We see compelling opportunities in longevity across a lot of elements, things like advanced diagnostics, healthier foods, as well as digitalization, responsible AI, personal mobility, and even parts of social infrastructure. So things as basic as access to water, sanitation, and hygiene.

One topic we as a team have written extensively on in the last few months It's preventative health care, for example. So, while current health systems are typically built to focus on acute conditions and react to complications with pharmaceuticals or clinical care, a focus on preventative care would, at its most fundamental, address the underlying causes of illnesses to avoid problems from arising in the first place.

We argue that the economic benefits of a more effective health system is self evident, whether that's in terms of reducing the overall burden on the system, boosting the workforce or increasing productivity. Within preventative healthcare, we point to fascinating investment opportunities across innovative biopharma, things like smart chemotherapy, for example, alongside solutions like integrated diagnostics, effective use of AI and sophisticated telemedicine advances -- all of which are emerging to support healthy longevity and a much more personalized targeted health system.

Michelle Weaver: Devin and Mike, thank you for taking the time to talk, and to our listeners, 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.

In the first of a special series, Morgan Stanley’s U.S. Thematic and Equity Strategist Michelle Weaver discusses new frontiers in artificial intelligence with Keith Weiss, Head of U.S. Software Research.

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Michelle: Welcome to Thoughts on the Market I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist.

Keith: And I'm Keith Weiss, Head of U.S. Software Research.

Michelle: This episode is the first episode of a special series we’re calling “Big Debates” – where we dig deeper into some of the many hot topics of conversation going on right now. Ideas that will shape global markets in 2025. First up in the series: Artificial Intelligence.

It's Friday, January 10th at 10am in New York.

When we look back at 2024, there were three major themes that Morgan Stanley Research followed. And AI and tech diffusion were among them. Throughout last year the market was largely focused on AI enablers – we’re talking semiconductors, data centers, and power companies. The companies that are really building out the infrastructure of AI.

Now though, as we’re looking ahead, that story is starting to change.

Keith, you cover enterprise software. Within your space, how will the AI story morph in 2025?

Keith: I do think 2025 is going to be an exciting year for software [be]cause a lot of these fundamental capabilities that have come out from the training of these models, of putting a lot of compute into the Large Language Models, those capabilities are now being built into software functionality. And that software functionality has been in the market long enough that investors can expect to see more of it come into results. That the product is there for people to actually buy on a go forward basis.

One of the avenues of that product that we're most excited about heading into 2025 is what we're calling agentic computing, where we're moving beyond chatbots to a more automated proactive type of interface into that software functionality that can handle more complex problems, handle it more accurately and really make use of that generative AI capability in a corporate or in an enterprise software setting as we head into 2025.

Michelle: Could you give us an example of what agentic AI is and how might an end user interact with it?

Keith: Sure. So, you and I have been interacting with chatbots a lot to gain access to this generative AI functionality. And if you think about the way you interact with that chatbot, right, you have a prompt, you have a question. You have to come up with the question. going to take that question and it's going to, try to contextually understand the nature of that question, and to the best of its ability it's going to give you back an answer.

In agentic computing, what you're looking for is to add more agency into that chatbot; meaning that it can reason more over the overall question. It's not just one model that it's going to be using to compose the answer. And it's not just the composition of an answer where the functionality of that chatbot is going to end. There's actually an ability to execute what that answer is. So, it can handle more complex problems.

And it could actually automate the execution of the answer to those problems.

Michelle: It sounds like this tech is going to have a massive impact on the workplace. Have you estimated what this could do to productivity?

Keith: Yeah, this is -- really aligns to the work that we did actually back in 2023, where we did our AI index, right. We came up with the conclusion that given the current capabilities of Large Language Models, 25 per cent of U.S. occupations are going to be impacted by these technologies. As the capabilities evolve, we think that could go as high as 45 per cent of U.S. labor touched by these productivity enhancing. Or, sort of, being replaced by these technologies. That equates to, at the high end, $4 trillion of labor that's being augmented or replaced on a go forward basis. The productivity gains still yet to be seen; how much of a productivity gain you could see on average. But the numbers are massive, right, in terms of the potential because it touches so much labor.

Michelle: And finally on agentic, is the market missing anything and how does your view differ from the consensus?

Keith: I think part of what the market is missing is that these agentic computing frameworks is not just one model, right? There's typically a reasoning engine of some sort that's organizing multiple models, multiple components of the system that enable you to -- one, handle more complex queries, more complex problems to be solved, lets you actually execute to the answer. So, there's execution capabilities that come along with that. And equally as important, put more error correction into the system as well. So, you could have agents that are actually ensuring you have a higher accuracy of the answer.

It's the sugar that's going to make the medicine go down, if you will. It's going to make a lot easier to adopt in enterprise environments. I think that's why we're a little bit more optimistic about the pace of adoption and the adoption curves we could see with agentic computing despite the fact it's a relatively early-stage technology.

Michelle: You just mentioned Large Language Models, or LLMs; and one barrier there has been training these models. It requires a ton of computing power, among other constraints. How are companies addressing this, and what's in the cards for next year?

Keith: So, if you think about the demand for that compute in our mind comes from two fundamental sources. And as a software analyst, I break this down into research versus development, right? Research is investment that you make to find core fundamental capabilities.

Development is when you take those capabilities and make the investment to create product out of it. Thus far, again, the primary focus has been on the training side of the equation.

I think that part of the equation looks to be asymptotic to a certain extent. The – what people call the scaling laws, the amount of incremental capability that you're getting from putting more compute at the equation is starting to come down.

What people are overlooking is the amount of improvement that you could see from the development side of the equation. So, whereas the demand for GPUs, the demand for data center for that pure training side of the equation might start to slow down a little bit, I think what we're going to see expand greatly is the demand for inference, the demand to utilize these models more fully to solve real business problems.

In terms of where we're going to source this; there are constraints in terms of data center capacity. The companies that we cover, they've been thinking about these problems for the past decade, right? And they have these decade long planning cycles. They have good visibility in terms of being able to meet that demand in the immediate future. But these questions on how we are going to power these data centers is definitely top of mind for our companies, and they're looking for new sources of power and trying to get more creative there.

The pace with which data centers can be built out is a fundamental constraint in terms of how quickly this demand can be realized. So those supply constraints I don't think are going to be a immediate limiter for any of our names when we're thinking about calendar [20]25. But definitely, part of the planning process and part of the longer-term forecasting for all of these companies in terms of where are they going to find all this fundamental resource – because whether it's training or inference, still a lot of GPUs are going to be needed. A lot of compute is going to be needed.

Michelle: Recently we've been hearing about so called artificial general intelligence or AGI. What is it? And do you think we're going to see it in 2025?

Keith: Yeah, so, AGI is the – it's basically the holy grail of all of these development efforts. Can we come up with models that can reason in the human world as well as we can, right? That can understand the inputs that we give it, understand the domains that we're trying to operate in as well or better than we can, so it can solve problems as effectively and as efficiently as we can.

The easiest way to solve that systems integration problem of like, how can we get the software, how could we get the computers to interact with the world in the way that we do? Or get all the impact that we do is for it to replicate all those functionalities. For it to be able to reason over unstructured text the same way we do. To take visual stimuli the same way that we do. And then we don't have to take data and put into a format that's readable by the system anymore.

2025 is probably too early to be thinking about AGI, to be honest. Most technologists think that there's more breakthroughs needed before the algorithms are going to be that good; before the models are going to be that good.

There's very few people who think Large Language Models and the scaling of Large Language Models in themselves are going to get us to that AGI. You're probably talking 10 to 20 years before we truly see AGI emerge. So, 2025 is probably a little bit too early.

Michelle: Well, great, Keith. Thank you for taking the time to talk and helping us kick off big debates. It looks like 2025 we'll see some major developments in AI.

And to our listeners, 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 Corporate Credit Research, Andrew Sheets, offers up bull, bear and base cases for credit markets in the year ahead.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today, I’m going to revisit our story for 2025 – and what could make things better or worse.

It's Thursday, January 9th at 2pm in London. 

Based on the number of out-of-office replies, I have a sneaking suspicion that many investors took advantage [of] the timing of holidays this year for a well deserved break. With this week marking the first full week back, I thought it would be a good opportunity to refresh listeners on what we expect in 2025, and realistic scenarios where things are better or worse.

Our base case is that credit holds up well this year, doing somewhat better in the first half of 2025 than the second. Credit likes moderation, and while we think the shift in U.S. policy leadership generally means less moderation, and a wider range of economic outcomes, this shift doesn’t arrive immediately. On Morgan Stanley’s forecasts, the bulk of the disruptive impact from any changes to tariffs or immigration policy hits in 2026.

Meanwhile, Credit is entering 2025 with some pretty decent tailwinds. The economy is good. The all-in yield – the total yield – on US investment grade corporate bonds, at above 5.4 per cent, is the highest to start any year since January of 2009 – which we think helps demand. And while we think corporate confidence and aggression will rise this year, normally a bad thing for credit; this is going to be coming off of a low, conservative starting point. 

We think that credit spreads will be modestly tighter by mid-year relative to where they finished 2024, and then start to widen modestly in the second half of the year – as the market attempts to price that greater policy uncertainty in 2026. We think that issuers in the Financial and Utilities sectors outperform, and we think bonds between five- and ten-year maturity will do the best.

The bear case is that we exit the current period of moderation more quickly. At one end, a deregulatory push by a new administration could usher in an even faster rise in corporate confidence and aggression, leading to more borrowing and riskier dealmaking. At the other extreme, the strong current state of the economy and jobs market could make further gains harder to come by. If the rise in unemployment that our economists expect in 2026 is larger or arrives earlier, credit could start to weaken well ahead of this.

So, how could things be better – especially given the relatively low, tight starting point for credit spreads? Well, we’d argue that the current mix of data for credit is border-line ideal: reasonable growth, falling inflation, still-low levels of corporate aggressiveness, and still-high yields that are attracting buyers. Recall that the tightest levels of credit in the modern era, which are still tighter than today, occurred during a period with similar characteristics – the mid-1990s.

When thinking about the mid-90s as a bull case, there’s a further detail that’s relevant and topical, especially this week. At that time, interest rates stayed somewhat high and the Fed only lowered short-term rates modestly because the economy held up. In short, in the best environment that we’ve seen for credit, less action by the Federal Reserve was fine – so long as the economic data was good.

This is a bull-case, rather than our base case, because there are also a number of key differences with the mid 1990s, not the least being a much worse trajectory – today – for the US government's budget. But in a scenario where things change less, and the status quo lasts longer, it could come into play.

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

With the inauguration of President-elect Donald Trump approaching, our Global Head of Fixed Income and Public Policy Research weighs the impact for investors of his potential policy measures.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Public Policy Research. Today on the podcast I'll be talking about what investors need to know about recent US policy developments.

It’s Wednesday, Jan 8th, at 2:30pm in New York. 

In less than two weeks, Donald Trump will again become the sitting President of the United States. The economic and market consequences of the policies he might enact, either on his own or in concert with the Congress, continue to be an important debate for investors. Our view has been that the sequencing and severity of policy choices across tariffs, taxes, immigration, and regulation would be very meaningful to the market's outlook. 

So, have we learned anything from news around the policy discussions inside the incoming administration and congressional leaders? Let’s consider it here and level set. 

First, there‘s been news about Republicans debating their approach to legislating some of President Trump’s top policy priorities. That debate centers around whether to create one big bill around taxes, immigration, and a host of other issues or to break it into multiple bills. Leading with immigration reforms, where there may be more consensus within Republicans’ slim Congressional majority; and then following it up with tax cuts and extensions, which may take more time to negotiate given myriad interests. While investors have asked us about this debate quite a bit, the distinction between the approaches may not make much of a difference to investors. 

At the end of the day, what should matter most to markets is the timing and size of the fiscal impact driven by tax changes. Going with one big bill may seem faster, but we’re reminded of the saying ‘Nothing is agreed until everything is agreed.’ In other words, that one big bill would probably only pass as fast as Republicans could agree on its toughest negotiating points – so likely not very soon. 

As for the size of fiscal impact, we continue to see consensus around extending most of the tax cuts that expire at the end of 2025, with some new benefits, like a domestic manufacturing tax credit. So, there should be some fiscal expansion in 2026, a few hundred billion dollars in our view; but this is meaningfully different than the trillions of dollars that the media cites when discussing the whole of the tax policy wish list. 

There’s also been some news on the approach to tariffs, but again it seems more noise than signal. Recent media reports are that Trump might adopt a tariff plan focused on specific products as opposed to a blanket approach on all imports. Trump denied the report via social media. But even if he hadn’t, it's unclear that such a plan could be executed quickly through existing executive powers or through legislation, where it's far from clear that tariffs could be enacted given Democrats' opposition and procedural barriers from budget reconciliation. So, our view remains that new tariffs will likely be enacted but through executive authority – which means a phased-in focus on China and Europe in 2025; and any new authorities developed via existing laws might not be enactable until 2026. So said more simply, the impact of tariffs on the economy may be a late 2025 into 2026 story. 

Putting it together for investors: So far, the news flow hasn’t materially changed our view on the US policy path. Yes, important policy changes are coming, but their implementation may be slow. That should mean that, to start 2025, the healthy fundamentals of the US economy should help drive risk markets, namely U.S. equities and corporate credit, to outperform. If we’re wrong and, for example, tariffs are implemented in larger magnitude at a quicker pace, then it may be a year where less risky assets, like government bonds, outperform. 

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 Seth Carpenter weighs the myriad variables which could impact global markets in 2025, and why this year may be the most uncertain for economies since the start of the pandemic.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'll be talking about 2025 and what we might expect in the global economy.

It's Tuesday, January 7th at 10am in New York.

Normally, our year ahead outlook is a roadmap for markets. But for 2025, it feels a bit more like a choose your own adventure book.

uncertainty is a key theme that we highlighted in our year ahead outlook. The new U.S. administration, in particular, will choose its own adventure with tariffs, immigration, and fiscal policy.

Some of the uncertainty is already visible in markets with the repricing of the Fed at the December meeting and the strengthening of the dollar. Our baseline has disinflation stalling on the back of tariffs and immigration policy, while growth moderates, but only late in the year as the policies are gradually phased in.

But in reality, the sequencing, the magnitude and the timing of these policies remains unknown for now, but they're going to have big implications for the economies and central banks around the world. The U.S. economy comes into the year on solid footing with healthy payrolls and solid consumption spending.

Disinflation is continuing, and the inflation data for November were in line with our forecast, but softer in terms of PCE than what the Fed expected. While the Fed did lower their policy rate 25 basis points at the December meeting, Chair Powell's tone was very cautious, and the Fed's projections had inflation risks skewed to the upside.

The chair noted that the FOMC was only beginning to build in assumptions about policy changes from the new administration. Now, we have conviction that tariffs and immigration restriction will both slow the economy and boost inflation -- but we've assumed that these policies are phased in gradually over the entirety of the year. And consequently -- that materially Stagflationary impetus? Well, it's reserved for 2026, not this year.

Similarly, we've assumed that effectively the entire year is consumed by the process of tax cut extensions. And so, we've penciled in no meaningful fiscal impetus for this year. And in fact, with the bulk of the process simply extending current tax policy, we have very little net fiscal impact, even in 2026.

Now, in China, the deflationary pressure is set to continue with any policy reaction further complicated by U.S. policy uncertainty. The policymaker meeting in late December that they held provided only a modest upside surprise in terms of fiscal stimulus, so we're going to have to wait for any further details on that spending until March with the National People's Congress.

Meanwhile, during our holiday break, the renminbi broke above 7.3, and that level matches roughly the peaks that we saw in 2022 and 2023. The strong dollar is clearly weighing on the fixing. The framework for policy will have to account for a potentially trade relationship with the U.S. So, again, in China, there's a great deal of uncertainty, a lot of it driven by policy.

The euro area is arguably less exposed to U.S. trade risks than China. A weaker euro may help stabilize inflation that's trending lower there, but our growth forecasts suggest a tepid outlook. Private consumption spending should moderate, and maybe firm a bit, as inflation continues to fall, and continued policy easing from the ECB should support CapEx spending.

Fiscal consolidation, though, is a key risk to growth, especially in France and Italy, and any postponement in investment from potential trade tensions could further weaken growth.

Now, in Japan, the key debate is whether the Bank of Japan will raise rates in January or March. After the last Bank of Japan meeting, Governor Ueda indicated a desire for greater confidence on the inflation outlook.

Nonetheless, we've retained our call that the hike will be in January because we believe the Bank of Japan's regional Branch manager meeting will give sufficient insight about a strong wage trend. And in combination with the currency weakness that we've been watching, we think that's gonna be enough for the BOJ to hike this month. Alternatively, the BOJ might wait until the Rengo negotiation results come out in March to decide if a hike is appropriate. So far, the data remains supportive and Japanese style core CPI inflation has gone to 2.7 per cent in November. The market's going to focus on Deputy Governor Himino's speech on January 14th for clues on the timing – January or March.

Finally, as the Central Bank of Mexico highlighted in their most recent rate cut decision, caution is the word as we enter the new year. As economists, we could not agree more. The year ahead is the most uncertain since the start of the pandemic. Politics and policy are inherently difficult to forecast. We fully expect to revise our forecasts more -- and more often than usual.

Thanks for listening, and 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 CIO and Chief U.S. Equity Strategist Mike Wilson considers the year-end slump in U.S. stocks, and whether more market-friendly policies can change the narrative.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing the weak finish to 2024 and what it means for 2025. 

It's Monday, Jan 6th at 11:30am in New York. 

So let’s get after it.

While 2024 was another solid year for US equity markets, December was not. The weak finish to the year is likely attributable to several factors. First, from September to the end of November, equity markets had one of their better 3-month runs that also capped the historically strong 1- and 2-year advances. This rally was due to a combination of events including a reversal of recession fears this summer, an aggressive 50 basis points start to a new Fed cutting cycle, and an election that resulted in both a Republican sweep and an unchallenged outcome that led to covering of hedges into early December. This also lines up with my view in October that the S&P 500 could run to 6,100 on a decisive election outcome.

Second, long-term interest rates have backed up considerably since the summer when recession fears peaked. Importantly, this 100 basis point back-up in the 10-year US Treasury yield occurred as the Fed cut interest rates by 100 basis points. In my view, the bond market may be calling into question the Fed’s decision to cut rates so aggressively in the context of stabilizing employment data. The fact that the term premium has risen by 77 basis points from the September lows is also significant and may be a by-product of this dynamic and uncertainty around fiscal sustainability. As we suggested two months ago, if the change in the term premium was to materially exceed 50 basis points, the equity market could start to take notice and hurt valuations. Indeed, Equity multiples peaked in early- to mid-December around the time when the term premium crossed this threshold. 

Finally, the rise in rates and the Trump election win has ushered in a stronger dollar which is now reaching a level that could also weigh on equities with significant international exposure. More specifically, the US dollar is quickly approaching the 10 per cent year-over-year rate of change threshold that has historically pressured S&P 500 earnings growth and guidance. 

All of these factors have combined to weigh on market breadth, something that still looks like a warning. The divergence between the S&P 500 Index as a ratio of its 200-day moving average and the percent of stocks trading above their 200-day moving average has rarely been wider. This divergence can close in two ways—either breadth improves or the S&P 500 trades closer to its own 200-day moving average, which is 10 per cent below current prices. The first scenario likely relies on a combination of lower rates, a weaker dollar, clarity on tariff policy and stronger earnings revisions. In the absence of those developments, we think 2025 could be a year of two halves with the first half being more challenged before the more market-friendly policy changes can have their desired effects.

It's also worth pointing out that this gap between index pricing and breadth has been more persistent in recent years, something that we attribute to the generous liquidity provisions provided by the Treasury and the Fed. It's also been aided by interventions from other central banks. While not a perfect measure, we do find that the year-over-year change in global money supply in US Dollars is a good way to monitor key inflection points, and that measure has recently rolled over again. 

The recent moves in rates and US dollar is just another reason to stick with quality equities. Our quality bias is rooted in the notion that we remain in a later cycle environment which is typical of a backdrop that is consistent with outperformance of this cohort and the fact that the relative earnings revisions for this high quality factor are inflecting higher. As long as these dynamics persist, we think it also makes sense to stay selective within cyclicals and focused on areas of the market that are showing clear relative strength in earnings revisions. These groups include Software, Financials, and Media & Entertainment.

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

With the start of the new year, our Head of Corporate Credit Research Andrew Sheets looks back to look ahead at trends for credit and other markets in 2025.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’ll be discussing the lessons we can learn from 2024 – a remarkable year that also may be easily forgotten. 

It's Friday January 3rd at 2pm in London. 

In 2024 I celebrated my 20th year with Morgan Stanley. Among my regrets over this time was not keeping a better journal. It’s notable how quickly events in the market that seemed large and remarkable at the time can fade in one’s memory as the years merge together. How markets that seem easy or obvious in hindsight were anything but. 

I say this because many years from now, 2024 may end up being one of those relatively forgettable years. Another year where – as usually happens – the stock market went up. Another year where stocks outperformed bonds, the US dollar strengthened, and US stocks beat those abroad. 

Yet what is significant about 2024 is the scale of all these trends. For anyone managing money, the question of “stocks versus bonds”, “US versus rest-of-world”, “large versus small” or “growth versus value” are some of the most fundamental strategic questions one faces. 

These calls don’t always matter. But last year, they did – to a very large degree. Global stocks outperformed bonds by about 20 percent. Growth outperformed Value by practically the same amount. US stocks beat their global peers by 13 per cent. In short, one’s experience in 2024 and relative performance could have varied significantly, based on just a few relatively simple decisions. 

Related to that is the second lesson. 2024 was the reminder that while Valuation is a powerful long-term force, it can be a much more frustrating 12-month guide. All of those relative relationships I just mentioned – stocks versus bonds, growth versus value, US versus International – all worked in favor of the market that was historically richer entering last year. 

For our third lesson from last year, we’ll focus on Credit, where investors earned a premium over safer government bonds by lending to riskier corporate borrowers. Notable for this asset class in 2024 was, for the most part, it did its own thing; showing some encouraging independence from other markets and highlighting the value of digging into a borrower’s details. 

Specifically, I think this independence showed up in a few different ways. Credit showed low correlation to government bonds, for example, delivering good excess returns despite very large swings in yields or central bank expectations. It also, even more impressively, bucked some of 2024’s biggest trends. 

For example, while the outperformance of the US economy and US assets was one of the biggest stories of 2024, that wasn’t the case in Credit – where Europe and Asia credit actually did marginally better. In contrast to the equity market, smaller companies and Credit outperformed, as spreads and higher yielded loans outperformed larger Investment Grade spreads, even after adjusting for risk. 

And this was true even at a more granular level. Rising corporate activity, alongside more aggressive strategies for companies to deal with their own borrowing created very dispersed outcomes driven by bond-level documentation; far removed from the macro machinations of politics and monetary policy. 

This somewhat weaker connection to the broader world is central to how we think about Credit looking ahead. While big economic and political questions certainly loom in 2025, we think that Credit, for now, will be driven more by more micro, company level trends, and show somewhat lower correlation to other assets – at least through the first half of this year. 

From all of us at Thoughts on the Market, we wish you a very Happy New Year, and all the best for 2025. 

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

Our Head of Global Autos & Shared Mobility Adam Jonas discusses why the electric vehicle market may see a small reset in 2025, but ultimately accelerate under a Trump Administration.

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Adam Jonas: Welcome to Thoughts on the Market. I'm Adam Jonas, Morgan Stanley's Head of Global Autos and Shared Mobility. Today, I'll be talking about the outlook for U.S. automakers and electric vehicles.

It's Thursday, January 2nd at 1pm in New York.

With Trump's inauguration just around the corner, we've seen a resurgence in many auto stocks tied to Internal Combustion Engines, also known as ICE. While questions swirl around the outlook for electric vehicles. In the near term we do think it'll be a bumpy ride for the U.S. EV market. But looking toward the second half of this year and beyond, we think there's hidden value in the EV sector for a number of reasons.

First, let's look at the big picture. In our 2025 outlook for U.S. auto sales, we anticipate demand of 16.3 million units, a modest increase from the previous year, underpinned by projected U.S. GDP growth of around 1.9 percent and lower policy interest rates for auto loans. Looking specifically at EVs, we think the trajectory will be first a dip, then a rip scenario. That is, we're lowering our 2025 forecasts for U.S. EV penetration to 8.5 percent, down slightly from 9 percent previously. However, our long-term outlook remains unchanged, and we continue to forecast significant growth for EVs by 2040.

Now for the big question. What does a Trump administration mean for EVs? Following the U.S. election, investors hopped on the ‘ICE is Nice’ trade based on the expectation that a Trump administration will bring more relaxed U.S. emission standards, reduced EV incentives, and finally increased tariffs – which would drive up the costs of key EV components, such as batteries and semiconductors, predominantly manufactured in Asia.

But the real story is more nuanced. You can't talk about EVs without talking about Elon Musk, who will be leading Trump's Department of Government Efficiency. And we struggle with the idea that the incoming Trump administration working in close partnership with Musk would structurally impede U.S. participation in two of the most important industrial transitions in over a century: electrification and embodied AI.

If the U.S. wants to be a leader in autonomy, it must ultimately embrace EVs, which are the sockets of autonomous capability, and expand its EV infrastructure. How long will the U.S. cling to the soothing vibrations of its internal combustion fleet, while its rivals in China solidify their dominance in software defined electric mobility? Not for very long, in our opinion.

While a rolling back of incentives under Trump may make 2025 a reset year for EV adoption, we view this mainly as a temporary action to help support a more capable and sustainable crop of domestic champions.

That takes us to a resurgence in U.S. onshoring. Bringing manufacturing back to American soil has gained significant momentum and is another factor influencing the long-term outlook; not just for EV makers, but the entire supply chain. With the U.S. light vehicle market predominantly ICE-based at 92 percent of total sales, the real issue isn't the presence of gas powered combustion engines, but the glaring lack of advanced onshore EV production capabilities.

Again, this puts the U.S. at a disadvantage compared to its global competitors and raises questions the Trump administration will need to address. Just what type of manufacturing does the U.S. want to prioritize? Are we looking to maintain the status quo with ICE, or are we aiming to be at the forefront of EV technology?

No doubt, the U.S. auto industry stands at a crossroads between maintaining traditional technologies and embracing new, potentially disruptive advancements in EV and AV sectors. The decisions made in the next few years will likely dictate the pace and direction of the U.S.'s role in the global automotive landscape; and for investors, this brings new challenges – as well as opportunities.

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

Original Release Date November 22, 2024: Our US Public Policy Strategist Ariana Salvatore and Chief Latin America Equity Strategist Nikolaj Lippmann discuss what Trump’s victory could mean for new trade relationships.

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Andrew Sheets: 2024 was a year of transition for economies and global markets. Central banks began easing interest rates, U.S. elections signaled significant policy change, and Generative AI made a quantum leap in adoption and development.

Thank you for listening throughout 2024, as we navigated the issues and events that shaped financial markets, and society. We hope you'll join us next year as we continue to bring you the most up to date information on the financial world. This week, please enjoy some encores of episodes over the last few months and we'll be back with all new episodes in January. From all of us on Thoughts on the Market, Happy Holidays, and a very Happy New Year. 

Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US Public Policy Strategist.

Nikolaj Lippmann: And I'm Nik Lippmann, Morgan Stanley's Chief Latin American Equity Strategist.

Ariana Salvatore: Today, we're talking about the impact of the US election on Mexico's economy, financial markets, and its trade relationships with both the US and China.

It's Friday, November 22nd at 10am in New York.

The US election has generated a lot of debate around global trade, and now that Trump has won, all eyes are on tariffs. Nik, how much is this weighing on Mexico investors?

Nikolaj Lippmann: It’s interesting because there's kind of no real consensus here. I'd say international and US investors are generally rather apprehensive about getting in front of the Trump risk in Mexico; while, interestingly enough, most Mexico-based investors and many Latin American investors think Trump is kind of good news for Mexico, and in many cases, even better news than Biden or Harris. Net, net, Mexican peso has sold off. Mexico's now down 25 per cent in dollar terms year to date, while it was flat to up three, four, 5 per cent around May. So, we've already seen a lot being priced then.

Ariana, what are your expectations for Trump's trade policy with regards to Mexico?

Ariana Salvatore: So, Mexico has been a big part of the trade debate, especially as we consider this question of whether or not Mexico represents a bridge or a buffer between the US and China. On the tariff front, we've been clear about our expectations that a wide range of outcomes is possible here, especially because the president can do so much without congressional approval.

Specifically on Mexico, Trump has in the past threatened an increase in exchange for certain policy concessions. For example, back in 2019, he threatened a 5 per cent tariff if the Mexican government didn't send emergency authorities to the southern border. We think given the salience of immigration as a topic this election cycle, we can easily envision a scenario again in which those tariff threats re-emerge.

However, there's really a balance to strike here because the US is Mexico's main trading partner. That means any changes to current policy will have a substantial impact.

So, Nik, how are you thinking about these changes? Are all tariff plans necessarily a negative? Or do you see any potential opportunities for Mexico here?

Nikolaj Lippmann: Look, I think there are clear risks, but here are my thoughts. It would be very hard for the United States to de-risk from China and de-risk from Mexico simultaneously. Here it becomes really important to double-click on the differences in the manufacturing ecosystems in North America versus Southeast Asia and China.

The North American model is really very integrated. US companies are by a mile the biggest investor. In Mexico – and Mexican exports to the US kind of match the Mexican import categories – the products go back and forth. Mexico has evolved from a place of assembly to a manufacturing ecosystem. 25 years ago, it was more about sending products down, paint them blue, put a lid on it. Now there's much more value add.

The link, however, is still alive. It's a play on enhancing US competitiveness. You can kind of, as you did, call it a China buffer; a fender that helps protect US competitiveness. But by the end of the day, I think integration and alignment is going to be the key here.

Ariana Salvatore: But of course, it's not just the direct trade relationship between the US and Mexico. We need to also consider the global geopolitical landscape, and specifically this question of the role of China. What's Mexico's current trade policy like with China?

Nikolaj Lippmann: Another great question, Ariana, and I think this is the key. There is growing evidence that China is trying to use Mexico as a China bridge.

And I think this is an area where we will see the biggest adjustments or need for realignment. This is a debate we've been following. We saw, with interest, that Mexico introduced first a 25 per cent tariff and then a 35 per cent tariff on Chinese imports. And saw this as the initial signs of growing alignment between the two countries.

However, Mexican import from China never really dropped. So, we started looking at like the complicated math saying 35 per cent times $115 billion of import. You know, best case scenario, Mexico should be collecting $40 billion from tariffs; that's huge and almost unrealistic number for Mexico. Even half of that would go a long way to solve fiscal challenges in that country.

However, when we started looking at the actual tax collection from Chinese imports, it was closer to $3 billion, as we highlighted in a note with our Mexico economist just recently. There's just multiple discounts and exemptions to effective tariffs at neither 25 per cent nor 35 per cent, but actually closer to 2.5 [or] 3 per cent. I think there's a problem with Chinese content in Mexican exports, and I think it's likely to be an area that policymakers will examine more closely. Why not drive-up US or North American content?

Ariana Salvatore: So, it sounds like what you're saying is that there is a political, or rhetorical at least, alignment between the US and Mexico when it comes to China. But the reality is that the policy implementation is not yet there.

We know that there's currently nothing in the USMCA treaty that prevents Mexico from importing goods from China. But a lot has changed over the past four years, even since the pandemic. So, looking forward, do you expect Mexico's policy vis-a-vis China to change after Trump takes office?

Nikolaj Lippmann: I think, I certainly think so, and I think this is again; this is going to be the key. As you mentioned, there's nothing in the USMCA treaty that prevents Mexico from buying the stuff from China. And it's not a customs union. Mexican consumers, much like American consumers, like to buy cheap stuff.

However, the geopolitics that you refer to is important. And when I reflect, frankly, on the bilateral relationship between the two countries, I think Mexican policymakers need to perhaps pause and think a little bit about things like the spirit of the treaty and not just the letter of the treaty; and also about how to maintain public opinion support in the United States.

By the end of the day, when we see what has happened with regards to China after the pandemic, it has been a significant change in political consensus and public opinion. When I think Americans are not necessarily interested in just using Mexico as a China bridge for Chinese products.

During the first Trump administration, the NAFTA agreement was renegotiated as the US Mexico Canada agreement, the USMCA, that took effect or took force in mid 2020. This agreement will come under review in 2026.

Ariana, what are the expectations for the future of this agreement under the Trump administration?

Ariana Salvatore: So, I think this USMCA review that's coming up in 2026 is going to be a really critical litmus test of the US-Mexico relationship, and we're going to learn a lot about this China bridge or buffer question that you mentioned. Just for some very brief context, that agreement as you mentioned was signed in 2020, but it includes a clause that lets all parties evaluate the agreement six years into a 16-year time horizon.

So, at that point, they can decide to extend the agreement for another 16 years. Or to conduct a joint review on an annual basis until that original 16 years lapses. So, although the agreement will stay in force until at least 2036, the review period, which is around June of [20]26, provides an opportunity for the signing parties to provide recommendations or propose changes to the agreement short of a full-scale renegotiation.

We do see some overlapping objectives between the two parties. For example, things like updating the foundation for digital trade and AI, ensuring the endurance of labor protections, and addressing Mexico's energy sector. But Trump's approach likely will involve confronting the auto EV disputes and could possibly introduce an element of immigration policy within the revision. We also definitely expect this theme of Chinese investment in Mexico to feature heavily in the USMCA review discussions.

Finally, Nik, keeping in mind everything that we've discussed today, with global supply chains getting rewired post the pandemic, Mexico has been a beneficiary of the nearshoring trend. Do you think this is going to change as we look ahead?

Nikolaj Lippmann: So, look, we [are] still underweight Mexico, but I think risk ultimately biased with the upside over time with regards to trade.

We need evidence to be able to lay it out, these scenarios; Mexico could end up doing quite well with Trump. But much work needs to be done south of the border with regards to all the areas that we just mentioned there, Ariana.

When we reflect on this over the next couple of years, there's a couple of things that really stand out. Number one is that first wave of reshoring or nearshoring, which was really focused on brownfield. It was bringing our manufacturing ecosystems where we already had existing infrastructure.

What is potentially next, and what we're going to be watching in terms of sort of policy maker incentives and so on, will be some of the greenfield manufacturing ecosystems. That could involve things like IT hardware, maybe EV batteries, and a couple of other really important sectors.

Ariana Salvatore: And that's something we might get some insight into when we hear personnel appointments from President-elect Trump over the coming months. Nik, thanks so much for taking the time to talk.

Nikolaj Lippmann: Thank you very much, Arianna.

Ariana Salvatore: 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.