Thoughts on the Market

Our expert panel explains whether the US election will impact energy policy, including how the Inflation Reduction Act’s possible fate and increased tariffs could transform the sector.

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

David Arcaro: I'm Dave Arcaro, Morgan Stanley's US Power and Utilities Analyst.

Andrew Percoco: And I'm Andrew Percoco, the North American Clean Tech Analyst here at Morgan Stanley.

Michael Zezas: And today we're discussing another key election related topic that generates a lot of political and market debate: Energy policy.

It's Thursday, October 17th at 10am in New York.

The outcome of the 2024 election will likely determine the direction of U.S. climate policy for years to come. David, what are the key focus areas for investors as they evaluate the various election outcomes on the utilities and clean energy industries?

David Arcaro: Yeah, Mike, investors are highly focused on the Inflation Reduction Act, the IRA, especially as it pertains to the election and the clean energy space. This was a law that was passed in 2022, and it really has supportive policies across the entire clean energy spectrum. It's got tax credits and incentives for solar, wind, offshore wind, green, hydrogen, nuclear, you name it. Battery storage. And some of those tax credits go all the way to 2032 and beyond in some cases.

So, it's a very supportive policy when it comes to the clean energy industry and the growth outlook. So, the big question is what's going to happen to the Inflation Reduction Act – depending on which administration is in place following the election.

Our core view is that the IRA stays in place; that the core wind, solar storage and nuclear tax credits all remain, regardless of the outcome of the election. And then separately, investors are focused on tariff policy as it pertains to clean energy. It is a global industry. A lot of the equipment and materials are imported around the world. And so, any changes to the tariff approach could have an impact on the space as well.

Michael Zezas: Got it. And so how does the outlook for renewables change under different election outcomes?

David Arcaro: Yeah, really, the outlook for renewables growth is not very different in our view, regardless of the outcome of the election.

We think it's a strong growth outlook either way. And part of that is because we've got policies that we expect to stay in place that will be supportive regardless of the outcome, as I mentioned with the Inflation Reduction Act. And then we've also got demand. It's a very strong demand backdrop for the renewable space – and that's because in the electric industry, we're seeing an inflection in electricity usage across the US.

It's been stagnant for years and years, but now with data center growth, with industrial production accelerating, and manufacturing and onshoring, we're seeing a big change in the growth outlook for electricity usage. And that means we need more power plants. We need more to be built, and renewables are going to be the predominant new resource for producing electricity in the US.

Some of these companies like data centers, they want renewables to power their operations. And most utilities, electric companies that are building power plants, they're going to be using renewables more than anything else. There are impediments to building fossil plants, it's challenging to permit and there's supply chain delays and issues.

So, we think there's a very strong growth outlook for renewables based on that demand and the policy support going forward, regardless of the outcome.

Michael Zezas: And Andrew, how about corporate tax policy, including renewable energy tax credits?

Andrew Percoco: I mean, as Dave mentioned, we think IRA repeal risk is very low, and I think the only scenario where IRA repeal is a relevant conversation is in a Republican sweep scenario. But even under this scenario, we would expect any repeal measures to be targeted in nature and not a wholesale repeal of the bill. So, the question then becomes, you know, what is safe and what's at risk of getting cut.

So, to start off with what's safe; maybe three items that I'll highlight. One would be domestic manufacturing tax credits. There's been a lot of bipartisan support for the onshoring of manufacturing. So, the clean energy manufacturing tax credits within the IRA look like they are on solid footing, regardless of the election outcome.

Now, why do domestic manufacturing tax credits have bipartisan support? One, there's a general view that we need to reduce our reliance on China for our energy infrastructure and, two, the job creation angle. The IRA has created over 150, 000 new jobs, and a lot of those jobs are in states where there is a large representation of Republican voters. So, the local pushback would be pretty severe if IRA was repealed in full.

Number two, area of IRA that we think is safe would be nuclear tax credits. There's a general understanding across both sides of the aisle that nuclear is an important and reliable form of clean energy, and that we need to support the existing fleet of assets.

And then third again, as Dave mentioned, solar storage and wind investment tax credits. These have been around for a while, well before the IRA was in place and they've had bipartisan support. They've been extended multiple times, even under past Republican administrations. So, we would not expect any changes to those core tax credits in a Republican sweep.

On the flip side, you know what's potentially at risk in a Republican sweep? Number one would be consumer facing tax credits like the EV tax credits. This is something that the Republicans have definitely taken aim at on the campaign trail.

Number two would be offshore wind. Former President Trump has definitely had [a] very candid view of offshore wind, and the issues that it poses on local communities. So, this could be another area where, they look for some targeted repeal. And then the third would just be delayed implementation of any unfinalized rules, by the time they take office.

Michael Zezas: Makes sense. And finally, what other key election implications should investors focus on at this point when it comes to clean energy?

Andrew Percoco: Yeah, I think the biggest would be around tariffs. It's frankly the hardest to predict but could have some pretty meaningful near-term implications for clean energy.

Just to zoom out for a second, the clean energy supply chain is global with a heavy concentration in China and Southeast Asia. So, if there is higher tariffs put in place against these regions, it could create some disruption in supply chains and impact the pace at which we deploy renewables in the US. But frankly, at the same time, it should just accelerate a trend that we're already seeing in the US, which is the onshoring of manufacturing, thanks in part due to the IRA.

So ultimately could create some near-term disruption but doesn't change the secular growth for the renewable space since developers in the US have already started to make the shift towards domestic supply.

Michael Zezas: Yeah, that makes sense, Andrew. And obviously tariffs have been top of mind for investors as we've talked about here. Well, David, Andrew, thanks for taking the time to talk.

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Mortgage rates aren’t directly influenced by Federal Reserve policy. However, the Fed’s recent cut likely will have a domino effect on the US housing market, say our Co-Heads of Securitized Products Research Jay Bacow and James Egan.

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

James Egan: And I'm Jim Egan, the other Co-Head of Securitized Products Research at Morgan Stanley. And on this episode of the podcast, we're going to discuss the impacts of a 50-basis point cut from the Fed on the US housing and mortgage markets.

It's Wednesday, October 16th at 1 pm in New York.

Now, Jay, the Fed cut 50 basis points at its last meeting. What are your views on the mortgage market in the aftermath of that cut?

Jay Bacow: We think that is constructive for mortgages and we recommended a long mortgage basis versus rates. The healthy economy and a Fed that doesn't want to fall behind the curve should be good for risk assets in general. We think there's a likelihood of vol possibly falling and that is constructive for agency mortgages in particular.

Now it's a positive narrative. But, the valuations matter, and we have to admit that the valuations are not that compelling with spreads on agency mortgages trading near the tights since the regional bank crisis. However, if you look further back, mortgages start to look attractive, particularly relative to other high quality fixed-income assets.

For instance, agency mortgages are basically trading at the average spread they've traded at since the GFC. Corporate credit, on the other hand, is trading within a few basis points of the tights since the GFC. If risk assets are going to do well, and we're certainly seeing that in corporate credit and in the stock market, we think mortgages are particularly priced attractively relative to most of them.

James Egan: Alright, so relative value for mortgages makes sense, but can you talk a little bit about the technicals here?

Jay Bacow: The technicals are where we feel more confident. One of the reasons why mortgage spreads have been wide for the past two years – it's an environment where the Fed and the domestic banks, the two largest holders of mortgages, have been reducing their holdings.

Now, we still expect the Fed to reduce their holdings of mortgages, but we think the bank demand is going to turn positive. That's due to not just clarity around the Basel III Endgame that should be coming soon, but more directly related to this conversation – as the Fed cuts rates that directly impacts the amount of yield that banks earn of the cash sitting at the Fed.

Now, that is projected to continue to go down as the Fed cuts rates. What's not projected to continually go down very much is the yield on the securities that they can be buying in mortgages. So, the incentive for them to move out of cash and into securities, and those securities likely to be mortgages, is picking up as the Fed cuts rates. And it's not just the banks that are going to be more active. It's also overseas investors. As the Fed cuts rates and the Bank of Japan hikes, the FX (foreign exchange) hedging costs, which is basically a function of the interest rate differential between the two banks is likely to decrease, which means that overseas investors will be more active.

A steeper curve is going to be positive for REIT demand. And then over time, as the Fed cuts rates and money market yields go down, those retail investors are likely to be incentivized to move out of money market funds into core funds with higher yields, which will be supportive of money manager demand – although that's likely a 2025 story.

James Egan: All right, Jay, thank you for that. But one of the questions that you and I have received a lot since the Fed's cut is: Okay, the Fed cut 50 basis points. Why haven't mortgage rates come down by 50 basis points on the follow?

Jay Bacow: Well, so, mortgage rates, obviously in the US, the vast majority of them are 30-year fixed rate mortgages. And so, if you have one, the Fed actions don't impact that. If you have an adjustable-rate mortgage, it will reset – but typically those resets happen every six months. Although you're probably getting asked about the prevailing mortgage rate; and the prevailing mortgage rate – because it's the 30-year fixed rate, it's not a function of Fed funds – but it's more of a function of the yields further out the curve. Although maybe Jim, you can do a better job explaining this.

James Egan: So, when it comes to interest rates and mortgages, Jay, as you mentioned, we're going to be more focused on the five- and 10-year part of the curve than we are on Fed funds.

To provide a little bit of an example there, from the fourth quarter of 2023 until the Wednesday morning that the Fed cut, 30-year mortgage rates had decreased by 180 basis points. The Fed had yet to cut a single basis point. But, just taking a step back from that cut specifically, mortgage rates have come down significantly from the fourth quarter of 2023.

Jay Bacow: Right, and those mortgage rates coming down significantly has improved affordability. But what's maybe a little surprising is that hasn't really led to a pickup in sales volumes. How should we think about that moving forward?

James Egan: So as mortgage rates have come down, we have seen an increase in mortgage applications, but that's been driven almost entirely by refinance applications.

Purchase applications, and that's going to be what's behind home sales, those have been more or less treading water for the past 12 months. This relationship makes sense, in our view. As mortgage rates have come down, housing remains unaffordable. It's just more affordable than it was in the second half of 2023.

But, if you were one of the people who bought a home over the past 24 months, and, to put that into context, that was the lowest number of home sales over a 24-month period since the second quarter of 2013. But if you were one of those people, there's a good chance that you're in the money to refinance right now.

Jay Bacow: And that's something that we're seeing in the data. We've talked about the truly refinance indicators on this podcast in the past, and it measures the share of mortgages that have at least 25 basis points of incentive to refinance after accounting for closing costs.

Right now, only about one in six of the outstanding borrowers have incentive to refinance. Now, that's up from pretty close to zero at the end of 2023, but if you just look at borrowers that have taken out their mortgage in the past two years, almost two-thirds of them have incentive to refinance.

Now, Jim, does that mean that purchase volumes are doomed to languish around these levels?

James Egan: No, but the reaction might not be as strong as some people are hoping for. While affordability has improved, it remains challenged. And the lock in effect has become a very popular phrase in the US housing and mortgage markets. And that's still in play. 75 per cent of the conventional mortgage universe still has a mortgage rate below 5 per cent.

Even with the prevailing rate at 6 per cent today, the effective mortgage rate on the outstanding universe is 200 basis points out of the money. That's better than 350 [basis points] out of the money like we saw last year. But that would still be the worst that it's been in 40 years.

Jay Bacow: And presumably, that is why we have this continually tight inventory.

James Egan: Exactly. Now, as rates come down, we are starting to see listings increase, but it's barely made a dent in the historically low nature of the existing housing supply. The existing home sales typically grow in the 12 to 24 months following affordability improvement, but not necessarily in that initial period while affordability is improving.

So relative to history, we're actually not underperforming that much from a sales perspective. And we should be beginning that 12 to 24 months sweet spot in the fourth quarter of [20]24. We just started that two to three weeks ago. While we expect existing home sales to increase, we think the growth is going to be modest relative to history and we're calling for 5 per cent growth in the coming 12 months.

On the home price side, a lot of this is in line with our current view. So, we think you're going to continue to see the pace of growth slow. It's already started to slow. We think we get from about 5 per cent today to 2 percent by the end.

Jay Bacow: All right, so the Fed cutting rates is not likely to cause mortgage rates to drop materially. We expect a modest pickup in housing activity. We expect home price growth to slow, but still end the year positive; and it should be supportive for mortgage spreads versus treasuries.

Jim, always a pleasure talking to you.

James Egan: Pleasure talking to you too, Jay.

Jay Bacow: 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.

Our Chief Korea and Taiwan Economist discusses the reforms needed to overcome Korea’s urgent demographic crisis.

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Welcome to Thoughts on the Market. I’m Kathleen Oh, Morgan Stanley’s Chief Korea and Taiwan Economist. Today I’ll discuss what’s needed to overcome Korea’s aging population crisis.

It’s Tuesday, Oct 15th, at 4 PM in Hong Kong. 

South Korea faces some of the world's most challenging demographics and will officially become a super-aged society next year – that’s more than 20 percent of the population 65 or older. The implications of this are so significant that the Korean government recently declared a national emergency, and we don’t think this is overstating the case. 

Korea’s low fertility rate is the primary culprit. In 2023 it plummeted to the lowest level globally and currently sits at 0.72. For reference, the total fertility rate of 2.1 children per woman is what’s necessary to maintain a stable population in general. By next year, Korea’s population will start declining and is projected to shrink by a third over the next 40 years as the working population halves. At this pace, the Bank of Korea forecasts that Korea’s potential growth could enter negative territory by 2040, down from 2 per cent in [20]24-25. 

So why does Korea have such a record-low fertility rate? In the short term, there are two key drivers: First, the declining number of marriages during the pandemic drove a rapid drop in births; having children out of wedlock is taboo in Korea. Once weddings resumed in 2022, Korea saw a slight but insufficient rebound in births. 

Second, housing prices have gone up 80 per cent in the past decade, which has discouraged young couples from having families. Families with first children feeling extra financial burdens to have [a] second child. Beyond the short term, structural factors have also played a role. After a compressed period of rapid economic growth, Koreans feel uncertain about the employment conditions and housing outlook. 

Tackling the low fertility rate has been on Korean policymakers’ agenda for the past 20 years. The government has invested more than $320 billion into solving the demographic challenge. And while these efforts have certainly raised awareness, they have yet to overcome the crisis. And why? Because Korea has not addressed the root causes of the problem -- income uncertainty, high childcare and education costs. 

It’s clear what’s needed here are structural reforms and Korea is clearly taking important steps towards overcoming the issue by tackling the fundamental problems now. Policymakers are working to reshape the pension system for the first time in 15 years. They are focusing on measures around improving work-life balance, reducing the gender wage gap, and increasing support for working parents. They are also considering lowering barriers to immigration, which could help alleviate talent shortages. They are also working on reducing the cost of private education. And finally, the government is also focused on improving the country’s capital market infrastructure. They are aiming to attract foreign investment, as well as to help households secure [a] source of asset accumulation, and lower borrowing costs for domestic players. 

Of course, it’s impossible to quickly reverse the downtrend and positive change will require multiple years - even decades. Korea’s government has set a medium-term goal of returning the fertility rate to 1.0 by 2030, which would delay working population decline by five years. And if the fertility rate reaches 2.1, that would delay the decline in the workforce by 20 years. Conversely, if Korea’s fertility rate remains at the current rate of 0.72, the population will halve by 2065 and the economy will start contracting in 2040, a worst-case scenario that the government is determined to avoid.

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 slump in tech stocks may explain the market rotation – but it’s the earnings season that investors need to watch, says CIO and Chief US Equity Strategist Mike Wilson.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the recent rotation toward more cyclical parts of the equity market.

It's Monday, Oct 14th at 11:30am in New York.

So let’s get after it.

Last Monday, we upgraded cyclicals relative to defensives after taking profits in our defensive  overweight two weeks prior. These calls come on the back of September's strong jobs report and our economists' expectation for the Fed to still cut interest rates into next year. The resilient labor report effectively reverses the softness we saw in labor markets over the summer which had re-introduced hard landing risks into the markets, driving big outperformance in bonds and defensive stocks. In short, it was a good time to lock in profits after an historically good run. 

Indeed, cyclical stocks have delivered better performance with these improved macro data.  Importantly, the rates market is confirming this move. Oftentimes, the rates market tends to hold  onto growth risks longer than the equity market. Thus, the recent move higher in yields following resilient data suggests the bond market pricing is shedding some of its growth concerns, and giving us more confidence in our cyclicals upgrade. 

Furthermore, our cyclical overweights at the sector level in Industrials, Financials and Energy are all exhibiting a positive correlation to rates. Conversely, defensives are exhibiting a negative correlation to yields. In other words, good macro data is still good for many large cap cyclical stocks, while it's bad for defensives. Thus, further stabilization in the economic surprise index should continue to  support quality cyclicals' relative performance even if it comes amid higher yields.

Meanwhile, positioning in cyclicals remains light amongst our institutional client base. This is  particularly true for Financials. In our view, this creates opportunity in a sector that we upgraded to overweight last week. This upgrade was based on rebounding capital markets activity, a better loan growth environment in 2025, an acceleration in buybacks post Basel Endgame re-proposal, and attractive relative valuation. Finally, we also factored in the notion that several large cap bank stocks had de-risked in mid-September with lowered guidance ahead of earnings season. Initial results from earnings season last week indicate that large cap banks are clearing that lowered hurdle. On the other side of the coin, positioning in defensives and quality growth remains extended. This is consistent with our conversations with clients who generally remain positioned for a soft macro growth regime.

Given the significant influence of the Magnificent 7 stocks on the overall direction of the S&P 500, investors remain focused on how this group of stocks will trade into year-end. It's notable this cohort has underperformed since the second quarter earnings season, and relative performance just took another leg lower.  The breadth among this group has been somewhat narrow with only one of the seven making new highs since the summer in both absolute and relative terms. In our view, this may be one of the reasons for the better performance in other areas of the market and is a potential driver of further broadening into cyclicals. Of course, if the market reverts back to these stocks, it’s a risk to our  cyclical upgrade.

Earnings season will be an important factor in terms of these rotations. The fundamental reason for the underperformance of the Magnificent 7 could simply be the deceleration in earnings growth from the very strong pace last year. If this underperformance continues, it could provide further fuel for the quality cyclicals to continue to do better as we expect. Conversely, if earnings revisions show relative strength for the Mag 7, these stocks will likely outperform once again and market leadership may narrow—like it did during [the] second quarter and all of 2023.

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 Head of Corporate Credit Research and Global Chief Economist explain why they’re watching the consumer savings rate, tariffs and capital expenditures.

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

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

Andrew Sheets: And today on this special episode of the podcast, we'll be discussing what could cause our optimistic view on the economy and credit to go wrong.

Andrew Sheets: It’s Friday, Oct 11th at 4pm in London.

Seth Carpenter: And as it turns out, I'm in London with Andrew.

Andrew Sheets: So, Seth you and your global economics team have been pretty optimistic on the economy this year. And have been firmly in the soft-landing camp. And I think we’ve seen some oscillation in the market's view around the economy over the course of the year, but more recently, we've started to see some better data and increasing confidence in that view.

So, this is actually maybe the perfect opportunity to talk about – well, what could go wrong? And so, what are some of the factors that worry you most that could derail the story?

Seth Carpenter: We have been pretty constructive all along the whole hiking cycle. In fact, we've been calling for a soft- landing. And if anything, where we were wrong with our forecast so far is that things have turned out even better than we dare hoped. But it's worth remembering part of the soft-landing call for us, especially for the US is that coming out of COVID; the economy rebounded employment rebounded, but not proportionally. And so, for a long time, up until basically now, US firms had been operating shorthanded. And so, we were pretty optimistic that even if there was something that caused a slowdown, you were not going to see a wave of layoffs. And that's usually what contributes to a recession. A slowdown, then people get laid off, laid off people spend less, the economy slows down more, and it snowballs.

So, I have to say, there is gotta be just a little bit more risk because businesses basically backfilled most of their vacancies. And so, if we do get a big slowdown for some reason, maybe there's more risk than there was, say, a year ago. So, what could that something be is a real question. I think the first one is just -- there's just uncertainty.

And maybe, just maybe, the restraint that monetary policy has imparted -- takes a little bit longer than we realized. It's a little bit bigger than we realized, and things are slowing down. We just haven't seen the full force of it, and we just slowed down a lot more.

Not a whole lot I can do about that. I feel pretty good. Spending data is good. The last jobs report was good. So, I see that as a risk that just hangs over my head, like the sword of Damocles, at all times.

Andrew Sheets: And, Seth, another thing I want to talk to you about is this analysis of the economy that we do with the data that's available. And yet we recently got some pretty major revisions to the US economic picture that have changed, you know, kind of our basic understanding of what the savings rate was, you know, what some of these indicators are.

How have those revisions changed what you think the picture is?

Seth Carpenter: So those benchmark revisions were important. But I will say it's not as though it was just a wholesale change in what we thought we understood. Instead, the key change that happened is we had information on GDP -- gross domestic product -- which comes from a lot of spending data. There's another bit of data that's gross domestic income that in some idealized economic model version of the world, those two things are the same -- but they had been really different. And the measured income had been much lower than the measured gross domestic product, the spending data. And so, it looked like the saving rate was very, very low.

But it also raised a bit of a red flag, because if the savings rate is, is really low, and all of a sudden households go back to saving the normal amount, that necessarily means they'd slow their spending a lot, and that's what causes a downturn.

So, it didn't change our view, baseline view, about where the economy was, but it helped resolve a sniggling, intellectual tension in the back of the head, and it did take away at least one of the downside risks, i.e. that the savings rate was overdone, and consumers might have to pull back.

But I have to say, Andrew, another thing that could go wrong, could come from policy decisions that we don't know the answer to just yet. Let you in on a little secret. Don't tell anybody I told you this; but later this year, in fact, next month, there's an election in the United States.

Andrew Sheets: Oh my goodness.

Seth Carpenter: One of the policies that we have tried to model is tariffs. Tariffs are a tax. And so, the normal way I think a lot of people think about what tariffs might do is if you put a tax on consumer goods coming into the country, it could make them more expensive, could make people buy less, and so you'd get a little bit less activity, a little bit higher prices.

In addition to consumer goods, though, we also import a lot of intermediate goods for production, so physical goods that are used in manufacturing in the United States to produce a final output. And so, if you're putting a tax on that, you'll get less manufacturing in the United States.

We also import capital goods. So, things that go into business CapEx spending in the United States. And if you put a tax on that, well, businesses will do less investment spending. So, there's a disruption to actual US production, not just US consumption that goes on. And we actually think that could be material. And we've tried to model some of the policy proposals that are out there. 60 per cent tariff on China, 10 per cent tariff on the rest of the world.

None of these answers are going to be exact, none of these are going to be precise, but you get something on the order of an extra nine-tenths of a percentage point of inflation, so a pretty big reversion in inflation. But maybe closing in on one and a half percentage points of a drag on GDP – if they were all implemented at the same time in full force.

So that's another place where I think we could be wrong. It could be a big hit to the economy; but that's one place where there's just lots of uncertainty, so we have to flag it as a risk to our clients. But it's not in our baseline view.

Seth Carpenter: But I have to say, you've been forcing me to question my optimism, which is entirely unfair. You, sir, have been pretty bullish on the credit market. Credit spreads are, dare I say it, really tight by historical standards.

And yet, that doesn't cause you to want to call for mortgage spreads to widen appreciably. It doesn't call for you to want to go really short on credit. Why are you so optimistic? Isn't there really only one direction to go?

Andrew Sheets: So, there are kind of a few factors the way that we're thinking about that. So, one is we do think that the fundamental backdrop, the economic forecast that you and your team have laid out are better than average for credit -- are almost kind of ideal for what a credit investor would like.

Credit likes moderation. We're forecasting a lot of moderation. And, also kind of the supply and demand dynamics of the market. What we call the technicals are better than average. There's a lot of demand for bonds. And companies, while they're getting a little bit more optimistic, and a little bit more aggressive, they're not borrowing in the kind of hand over fist type of way that usually causes more problems. And so, you should have richer than average valuations.

Now, in terms of, I think, what disrupts that story, it could be, well, what if the technicals or the fundamentals are no longer good? And, you know, I think you've highlighted some scenarios where the economic forecasts could change. And if those forecasts do change, we're probably going to need to think about changing our view. And that's also true bottom up. I think if we started to see Corporates get a lot more optimistic, a lot more aggressive. You know, hubris is often the enemy of the bond investor, the credit investor.

I don't think we're there yet, but I think if we started to see that, that could present a larger problem. And both, you know, fundamentally it causes companies to take on more debt, but also kind of technically, because it means a lot more supply relative to demand.

Seth Carpenter: I see. I see. But I wonder, you said, if our outlook, sort of, doesn't materialize, that's a clear path to a worse outcome for your market. And I think that makes sense.

But the market hasn't always agreed with us. If we think back not that long ago to August, the market had real turmoil going on because we got a very weak Non Farm Payrolls print in the United States. And people started asking again. ‘Are you sure, Seth? Doesn't this mean we're heading for a recession?’ And asset markets responded.

What happened to credit markets then, and what does it tell you about how credit markets might evolve going forward, even if, at the end of the day, we're still right?

Andrew Sheets: Well, so I think there have been some good indications that there were parts of the market where maybe investors were pretty vulnerably positioned. Where there was more leverage, more kind of aggressiveness in how investors were leaning, and the fact that credit, yes, credit weakened, but it didn't weaken nearly as much -- I think does suggest that investors are going to this market eyes wide open. They're aware that spreads are tight. So, I think that's important.

The other I think really fundamental tension that I think credit investors are dealing with -- but also I think equity investors are -- is there are certain indicators that suggest a recession is more likely than normal. Things like the yield curve being inverted or purchasing manager indices, these PMIs being below 50.

But that also doesn't mean that a recession is assured by any means. And so, I do think what can challenge the market is a starting point where people see indicators that they think mean a recession is more likely, some set of weak data that would seem to confirm that thesis, and a feeling that, well, the writing's on the wall.

But I think it's also meant, and I think we've seen this since September, that this is a real, in very simple terms, kind of good is good market. You know, I got asked a lot in the aftermath of some of the September numbers, internally at Morgan Stanley, 'Is it, is it too good? Was the jobs number too good for credit?'

And, and my view is, because I think the market is so firmly shifted to ‘we're worried about growth,’ that it's going to take a lot more good data for that fear to really recede in the market to worry about something else.

Seth Carpenter: Yeah, it's funny. Some people just won't take yes for an answer. Alright, let me, let me end up with one more question for you.

So when we think about the cycle, I hear as I'm sure you do from lots of clients -- aren't we, late cycle, aren't things coming to an end? Have we ever seen a cycle before where the Fed hiked this much and it didn't end in tears? And the answer is actually yes. And so, I have often been pointing people to the 1990s.

1994, there was a pretty substantial rate hiking cycle that doesn't look that different from what we just lived through. The Fed stopped hiking, held out at the peak for a while, and then the economy wobbled a little bit. It did slow down, and they cut rates. And some of the wobbles, for a while at least, looked pretty serious. The Fed, as it turns out, only cut 75 basis points and then held rates steady. The economy stabilized and we had another half decade of expansion.

So, I'm not saying history is going to repeat itself exactly. But I think it should be, at least from my perspective, a good example for people to have another cycle to look at where things might turn out well with the soft landing.

Looking back to that period, what happened in credit markets?

Andrew Sheets: So, that mid-90s soft-landing was in the modern history of credit -- call it the last 40 years -- the tightest credit spreads have ever been. That was in 1997. And they were still kind of materially tighter from today's levels.

So we do have historical evidence that it can mean the market can trade tighter than here. It's also really fascinating because the 1990s were kind of two bull markets. There was a first stage that, that stage you were suggesting where, you know, the Fed started cutting; but the market wasn't really sure if it was going to stick that landing, if the economy was going to be okay. And so, you saw this period where, as the data did turn out to be okay, credit went tighter, equities went up, the two markets moved in the same direction.

But then it shifted. Then, as the cycle had been extending for a while, kind of optimism returned, and even too much optimism maybe returned, and so from '97, mid-97 onwards, equities kept going up, the stock market kept rallying, credit spreads went wider, expected volatility went higher. And so, you saw that relationship diverge.

And so, I do think that if we do get the '90s, if we're that lucky, and hopefully we do get that sort of scenario, it was good in a lot of ways. But I think we need to be on the watch for those two stages. We still think we're in stage one. We still think they're that stage that's more benign, but eventually benign conditions can lead to more aggressiveness.

Seth Carpenter: I think that's really fair. So, we started off talking about optimism and I would like to keep it that you pointed out that the '90s required a bit of good luck and I would wholeheartedly agree with that.

So, I still remain constructive, but I don't remain naive. I think there are ways for things to go wrong. And there is a ton of uncertainty ahead, so it might be a rocky ride. It's always great to get to talk to you, Andrew.

Andrew Sheets: Great to talk to you as well, Seth.

And 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.

Mike Canfield, Morgan Stanley’s Head of Europe Sustainability Research, discusses why ensuring safe and responsible artificial intelligence is essential to the AI revolution.

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Mike Canfield: Welcome to Thoughts on the Market. I'm Mike Canfield, Morgan Stanley's Europe, Middle East and Africa Head of Sustainability Research.

Today I'll discuss a critical issue on a hot topic: How safe is AI?

It's Thursday 10th of October at 2pm in London.

AI is transforming the way that we live, work, and connect. It's really got the potential at every level and aspect of society, from personal decisions to global security. But as these systems become ever more integrated into our critical functions – whether that's healthcare, transportation, finance, or even defense – we do need to develop and deploy safe AI that keeps pace with the velocity of technological advances.

Market leaders, academic think tanks, NGOs, industry bodies, intergovernmental organizations have all attempted to codify what safe or responsible AI should look like. But at the most fundamental level, the guidelines and standards we've seen so far share a number of clear similarities. Typically, they focus on fostering innovation in practical terms, as well as supporting economic prosperity – but also asserting the need for AI systems to respect fundamental human rights and values and to demonstrate trustworthiness.

So where are we now in terms of regulations around the world?

The EU's AI Act leads the way with its detailed risk-based approach. It really focuses on transparency as well as risks to people and fundamental rights. In the USA, while there's no comprehensive federal regulation or legislation, there are some federal laws that offer some sector specific guidance on AI applications. Things like the National Defense Authorization Act of 2019 and the National AI Initiative Act of 2020. Alongside those, President Biden's published an executive order on AI, promoting safety, responsible innovation, and supporting Americans and their rights, including things like privacy. In Asia Pacific, meanwhile, countries are working to establish their own guidelines on consumer protection, privacy, and transparency and accountability.

In general, it’s very clear that policymakers and regulators increasingly expect AI systems developers to adopt what we'd call the socio-technical approach, focused on the interaction between people and technology. Having examined numerous existing regulations and foundational standards from around the world, we think a successful policymaking approach requires the combination of four core conceptual pillars.

We've called them STEP. That's Safety, Transparency, and Ethics and Privacy. With these core considerations, AI can take a step – pun intended – in the right direction. Within safety, the focus is on reliability of systems, avoiding harm to people and society, and preventing misuse or subversion. Transparency includes a component of explainability and accountability; so, systems allowing for future feedback and audits of outcomes. Ethically, the avoidance of bias, preventing discrimination, inclusion, and the respect for the rule of law are key components. Then finally, privacy considerations include elements like data protection, safeguards during operation, and allowing users consent in data used for training.

Of course, policymakers contend with a variety of challenges in developing AI regulations. Issues like bias, like discrimination, implementing guardrails without stifling innovation, the sheer speed at which AI is evolving, legal responsibility, and much more beyond. At its most basic, though, arguably the most critical challenge of regulating AI systems is that the logic behind outcomes is often unknown, even to the creators of AI models, because these systems are intrinsically designed to learn.

Ultimately, ensuring safety and responsibility in the use of AI is an essential step before we can really tap into ways AI could positively impact society. Some of these exciting opportunities include things like improving education outcomes, smart electric grid management, enhanced medical diagnostics, precision agriculture, and biodiversity monitoring and protection efforts. AI clearly has enormous potential to accelerate drug development, to advance material science research, to boost manufacturing efficiency, improve weather forecasting, and even deliver better natural disaster predictions.

In many ways, we need guardrails around AI to maximize its potential growth.

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

Our Global Head of Fixed Income and Thematic Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss how the upcoming US elections might impact economic policies in Asia.

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

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

Michael Zezas: Today, we'll talk about what the US election means for Asia's economy.

It's Wednesday, October 9th at 10am in New York.

Chetan, we're less than a month now from the US election, and when I think about what it means for Asia, perhaps the most immediate and direct impact would be via tariffs.

Now, our colleagues have already addressed some of this on the podcast, but I'm eager to hear your thoughts. And in the case of a Trump win and a significant tariff increase on China, how big of an impact do you think this policy would have on China's economy, and what particular areas of the economy might be most affected?

Chetan Ahya: Well, Mike, I think firstly the tariff numbers being floated, i.e. that if it is 60 per cent, it would mean an increase in tariff of about 35 percentage points over an existing number, which is at 25 per cent. So, the amount of tariffs that we're talking about this time are larger than what we saw in 2018-19. And in terms of implications, of course, it will depend upon exactly what is the magnitude of tariff that is being imposed, but we definitely think there will be a significant downside to China's growth; and we expect an increase in deflationary pressures.

Just to give you a bit of perspective of what happened in 2018-19, tariff resulted into China's growth slowing by a full percentage point from 6.9 per cent to 5.9 per cent; and at the same time, we saw that there was downward pressure on China's inflation dynamic. And the timing of tariffs this time does not seem to be great. China is going through an existing challenge of debt deflation loop. And we've seen that China's GDP deflator, which is a broader measure of prices, has been in deflation already for about seven quarters now. And so, in this context, tariffs will further add to its deflationary pressures and make that macro situation much more complicated.

Michael Zezas: Got it. And so, how do you think China might respond if it becomes the target of higher tariffs?

Chetan Ahya: So, we think China's policy makers could take up three sets of measures to mitigate the impact of tariffs.

Number one, there will be, of course, depreciation in its exchange rate, which will be offsetting some part of the tariff increase effect. And so, for example, the weighted average tariff increase was about 18 percentage points during 2018-19, and the RMB depreciation was about 11 per cent. So, there was a significant offset of that tariff increase by currency depreciation.

Number two, China could continue to take its effort to rewire trade flows and supply chain. So, for example, in 2018-19, we've seen a significant rewiring of exports from China to the US via Vietnam and Mexico, and we think this time that could be expanded to some more economies.

And number three, China also resorted to focusing on new markets, i.e. some of the other emerging markets other than US. And at the same time, they focused on introducing new export products; like in the last cycle, they focused on solar panels, lithium batteries, EVs, and old generation chips. So, in effect, they will try to expand their market base from US into other emerging markets. And at the same time, they will be focusing on new products to ensure that their market share in global goods exports is maintained.

So, Mike, we've been discussing the potential impact of a Trump win. But how would a Harris White House shape trade policy, vis-à-vis China and rest of Asia?

Michael Zezas: Yeah, I think a Harris White House would represent a lot of continuity with the Biden White House's approach toward Asia and China, specifically when it comes to trade. That is to say, there's a lot of support for continued use and expansion of non-tariff barriers – things like export controls, and inbound and outbound investment restrictions. And there's less interest in using higher tariffs than what we already have as a tool.

So, you can expect that. And I think you could also expect there to be kind of a broader reach out to develop economic relationships with Pan Asia as a means of enabling some of the transition that multinational companies would need to rewire their supply chains.

But if we take as a given that that might be Harris's approach to trade policy, Chetan, what's your outlook for Asia if she wins in November?

Chetan Ahya: Well, if Harris wins, that would eliminate the key risk to region's outlook in form of significant tariff implementation. And in this case, we expect status quo to our Asia forecast. And we would maintain our constructive outlook for the large economies in the region. And within the group, we think India and Japan are best positioned from a structural standpoint. While China, we were concerned about the debt deflation loop, but with the recent set of policy measures, we think that the risks are now more balanced as far as China macro-outlook is concerned.

Michael Zezas: Got it. Well, Chetan, thanks for taking the time to talk. This is obviously a very important topic as we get closer to the US election.

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.

The rhetoric around the US elections is heating up, and tariffs have become a central theme – to rally for or against. In Part II of our roundtable discussion, our chief economists break down national and global implications of this policy lever.

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

On this special episode of the podcast, we're going to continue our third roundtable discussion with Morgan Stanley's economists from around the world as we enter the fourth quarter of 2024.

It's Tuesday, October 8th at 10am in New York.

Jens Eisenschmidt: And 3pm in London.

Seth Carpenter: All right, so yesterday we covered topics about central banks, inflation, reflation, deflation, China's stimulus policies – a whole set of things. But today I really want to focus on the upcoming US elections and some of the possible implications around the world.

As of this recording, the race between Vice President Harris and former President Trump is essentially in a dead heat and it has left policymakers and market participants with few clear signals about what policy is going to be going forward.

One key policy lever is tariffs; and so Diego, I’m going to come to you. What has the US team said about tariffs and what it might mean for the economy?

Diego Anzoategui: Yes, I think the three key policy levers to consider are tariffs, as you mentioned Seth, immigration policy, and fiscal policy. Tariffs, in particular, are basically a presidential authority, so the outcome of the election is going to be very important there.

Fiscal policy will depend not only on the White House, but also on the Congress, which most polls suggest that it will be split between the two parties. So, we don't expect much there. And immigration policy is tricky because if you take a look at the data, immigration flows have been decreasing. And the key question here is whether the new policy is going to affect that already decreasing path

Seth Carpenter: For tariffs, I know that we've published -- that there's both a boost to inflation that can come, but also a hit to economic growth. And that boost to inflation likely comes first.

The logic is tariffs are taxes, and so they should be seen as a tax on consumption spending -- but also, on domestic CapEx spending and domestic manufacturing because a lot of the imports that are under tariff are either capital goods or intermediate goods that go into manufacturing here in the US.

Diego Anzoategui: Yeah, that's right. Of course, the details will matter a lot. So, suffice it to say, there's a lot of uncertainty.

Seth Carpenter: Okay, that's fair. Chetan, let me come back to you on this. This topic is particularly important for China's economy since the Trump campaign has pledged tariffs of up to 60 per cent on China, and then 10 per cent globally -- something that our public policy team believes could be a driver of a broader decoupling.

You've written a lot about tariffs, tariff structure, what it means for China, the deflationary path. Could you just elaborate a little bit for us?

Chetan Ahya: Yeah, absolutely. I think the timing of this tariff, if they do come up in November or sometime in 2025, couldn't have been coming at a worse time for China. As we've been discussing, China has already been going through this challenge of deflation, and tariffs essentially will mean additional deflationary pressures on China.

So that is one source of impact that we would be watching. The other would be what is the impact on global corporate confidence and China's corporate confidence. That can have additional negative impact in form of slowdown in investment. And one other thing to keep in mind is that in 2018-2019, China could respond, in terms of fiscal and monetary easing and offset some of the downside that came from tariffs. But in this cycle, considering the state of the property market, it would be very difficult for China to reflate that property market demand and offset the downside from tariff.

So essentially, we think the tariffs, if they come in this time, could be far more challenging for China, particularly for deflation management.

Seth Carpenter: Of course, tariffs are global and the Trump campaign has talked about not just tariffs on China. So, Jens, let me come to you. Maybe there are some implications here for Europe as well.

During former President Trump's administration, there were targeted tariffs that, met challenges of the WTO and retaliatory tariffs on American exports to Europe. Looking back on what happened in 2018 and 2019, what do you think could be ahead in the event that former President Trump wins the election again?

Jens Eisenschmidt: So, the episode in 2018 could be actually a template, even though it's probably limited in scopes because tariffs were much more limited that were applied back then. We've talked about around 1 per cent of total American-EU imports that back then were targeted; while now we are really talking about, at least in terms of proposals, everything.

So first to notice that when back then the impact was limited, it will be a little bit bigger now simply because more is targeted. And we think it could be around 30 basis points, shaping around 30 basis points, of European GDP.

Again, that's a very crude measure that depends on many things in particular on also the retaliation. And here for instance, we think EU would, of course, like last time, file a complaint with the World Trade Organization, you know, as a basis for then following negotiations around these tariffs.

Then, the EU would, of course, be looking into what type of tariffs it could put in terms of retaliation on US products entering the EU. And here we would observe first that a lot of that is actually oil, and it's unlikely that you would want to put tariffs on oil -- or more broadly energy goods. So also, natural gas.

Then that means we would look for the next product categories. But here, I think it's not so clear; no single product category stands out. But what stands out is that the US has a surplus in services exports to the EU. And here the EU could, in theory at least, come up with a strategy to retaliate through services regulation. Again, that would need to be seen, once we see these tariffs being implemented. But that certainly would be a road for the EU to take.

Seth Carpenter: Thanks Jens. It makes a lot of sense. And gentlemen, I want to thank you all for a terrific discussion today.

And thanks to our listeners. If you like Thoughts on the Market, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or a colleague today.

Morgan Stanley’s chief economists take stock of a resilient global economy that has weathered a recent period of market volatility, in Part I of our two-part roundtable.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. And on this special episode of the podcast, we'll hold our third roundtable discussion focusing on Morgan Stanley's global economic outlook as we enter the final quarter of 2024.

I am joined today by our economics team from three regions.

Chetan Ahya: I’m Chetan Ahya, Chief Asia Economist.

Jens Eisenschmidt: I’m Jens Eisenschmidt, Chief Europe Economist.

Diego Anzoategui: I’m Diego Anzoategui from the US Economics team.

It's Monday, October 7th at 10 am in New York.

Jens Eisenschmidt: And 3 pm in London.

Seth Carpenter: I have to say, a lot has happened since the last time we held this roundtable. To say the very least, we've had volatility in financial markets. But on balance, I kind of have to say the global economy has more or less performed the way we expected.

The US economy is cruising towards a soft landing. The labor market maybe is a touch softer than we expected, but consumer spending has remained resilient. In Asia, Japan's reflation story is largely intact, while China is still confronting that debt deflation cycle that we've talked about. And in Europe, the tepid growth we had envisioned -- well, it's continuing. Inflation is falling, but the ECB seems to be accelerating its rate cuts. So, let's get into the details.

Diego, I'm going to start with you and the US. The Fed cut interest rates in September for the first time this cycle, and they cut by 50 basis points instead of the 25 basis points that some people -- including us -- were expecting. So, the big question for you is, where does the Fed go from here?

Diego Anzoategui: So, we are looking for a string of 25 basis point cuts from the Fed as long as labor markets hold up. Inflation has come down notably and we expect a normalization of interest rates ahead. But, of course, we might be wrong again. Labor markets might cool too much, and in that case, one or two additional 50 basis point cuts might happen again.

Seth Carpenter: So, either the Fed glides into the soft landing or they pick up the pace and they cut faster.

So, Jens, let me turn to you and pivot to Europe. You recently changed your forecast for the ECB, and you're now looking for a rate cut in October. And that's following two cuts already that the ECB has done. So, what prompted your change? Is it like what Diego said about a softer outcome prompting a faster pace of cuts. What's likely to happen next for the ECB?

Jens Eisenschmidt: That's right. We changed our ECB call. And to understand why we have to go back to September. So already at the September meeting the ECB president, Lagarde, made clear in the press conference that the bank was a little bit less concerned about structurally high services inflation that is forecast to be persistently high still for some time to come -- mainly because there was more conviction that wages would come down eventually.

And so, they could really focus a little bit more, give a bit more attention to the growth side of things. Just as a reminder, the Fed has a dual mandate. So, it's growth and inflation. The ECB only has inflation. So basically, if the ECB wants to act on growth, it needs to be sure that inflation is under control. And then since September what happened is that literally every single indicator, leading indicator, for inflation was negative. We had lower oil prices, we had a stronger euro, and of course, also weaker activity in terms of the PMIs pointing to a cooling of the ongoing recovery.

So, all of that led us to revise our inflation forecast, and that means that ECB will very likely already be a target mid next year. That should lead to an acceleration of the rate cut cycle. And then it's only a question, will it be already in October or in December? And here comes the September inflation print in, which was softer in particular on the core or on the services component than expected. And we think that has tilted the balance; or will tilt the balance in favor of an October rate cut.

So, what we see now is October, December, January, March -- 25 basis points rate cuts by the ECB leading to a rate of 250. Then this being close to neutral, they will slow down again, quarterly rate cut pace. So, June, September, December, 25 basis points each -- leading to a final rate end of next year at 175.

Seth Carpenter: Okay, got it. So, inflation has come down in most developed market economies. Central banks are starting to cut. For the Fed, there's an open question about how much strength the labor market still has and whether or not they need to do 50 basis points or 25.

But I have to say, Chetan -- and I'm going to come to you because -- in Asia, we saw a lot of market turmoil in August, and that was partly prompted by the rate hike of the BoJ. So, here's a developed market economy central bank that's not cutting. In fact, they're starting to raise interest rates. So, what happened there? And what do you think happens with the BoJ going forward?

Chetan Ahya: Well, Seth, in our base case, we do expect BoJ to hike by another 25 basis points in January next year. And as regards to your question on what happened in terms of the volatility that we saw in the month of August? Essentially, as the BoJ took up its first rate hike, there was a lot of concern that BoJ will go in a consecutive manner, taking up successive rate hikes. But at the end of the day, what we saw was, BoJ realizing that there is a clear endogeneity between financial conditions and their reaction function. And as that communication was clearly laid out, we saw markets calming down. And now going forward, what we think BoJ will be watching will be the data on inflation and wages.

We think they would be waiting to see what happens to the inflation data in the month of November and October, i.e., whether there is a clear, rise in services inflation, which has been running at around 1.3 per cent. And they would want to see that wage pass through to services inflation is continuing.

And then secondly, they will want to see what is happening to the wage expectations from the workers in the next round of spring wage negotiations. The demand from workers will be clear by the end of this year, so sometime in December. And therefore, we think BoJ will look at that information and then take up a rate hike in the month of January next year.

Seth Carpenter: Okay, so if I step back for a second, even if there are a few parts of the puzzle that still need to fall into place, it sounds to me like you're saying the Japan reflation story is still intact. Is that fair?

Chetan Ahya: That's right. We think that, you know, the comment from the prime minister that came out a few days back; he's very clear that he wants to see a situation where Japan gets rid of deflation. So, we think that the policymakers are fully lined up to ensure that the reflation story remains intact.

Seth Carpenter: That's super helpful and it just absolutely contrasts with what we've been saying about China, where they have sort of the opposite story. There's been a debt deflation cycle that you and the Chinese team have really been highlighting for a long time now, talking about the challenges for policy.

We did get some news out of Beijing in terms of policy stimulus. Could you and break down for us what happened there and whether or not you think that's enough to really shift China's trajectory away from this debt deflation cycle?

Chetan Ahya: Yes, Seth, so essentially, we got three things from Chinese policy makers. Number one, they took up big monetary policy easing. Number two, they announced a package to support the equity markets. And number three, they announced some measures to support the property market.

Now we think that these measures are a positive and particularly the property market measures will be helpful. But in terms of real impediment for China's reflation story, we think that the key need of the hour is to take up aggressive fiscal easing to boost consumption. Monetary policy easing is helpful, but it's not really the key impediment to the reflation path.

Seth Carpenter: All right, so if I wanted to see the glass as half full, I would say, look at this! Beijing policymakers have turned the corners. They're acknowledging that there's some policy impetus that needs to be put into place. But if I wanted to see the glass as half empty, I could take away from what you just said, that there just needs to be more, maybe fiscal stimulus to directly promote household spending.

Is that that fair?

Chetan Ahya: That's absolutely right. What's happening in China is that there has been a big structural adjustment in the property sector because now the total population is declining. And so therefore there is a big demand hole that is being left by the weakness in housing sector.

Ideally, what they should be doing, as I was mentioning earlier, [is] that they should be taking a big fiscal easing to support consumption spending. But so far what we've been seeing is that they've been trying to fill that demand hole with more supply in form of investment in manufacturing and infrastructure sector.

And unfortunately, that's been actually making the deflation challenge more complex. So going forward, we think that, you know, we should be watching out what they do in terms of fiscal stimulus. There was a comment in the Politburo statement that they will take up fiscal easing. We suspect that the timing of that fiscal policy announcement could be by end of this month alongside National People's Congress meeting. And so, what will be the size of fiscal stimulus will be important to watch as well.

Currently, we think it could be one to two trillion RMB. But in our work that we did in terms of what is the scale of fiscal stimulus that is needed to boost consumption, we estimate that it should be somewhere around a 10 trillion RMB spread over two years.

Seth Carpenter: Got it. Thanks, Chetan. Super helpful.

Gentlemen, I have to say, we might have to stop here for the day. But tomorrow, I want to get [to] another topic, which is to say, the upcoming US election. It's got huge implications for the macroeconomy in the US and around the world. And I think we’re going to have to touch on it. But for now, we'll end the conversation here.

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

Following the US Federal Reserve’s September rate cut, labor data may have more impact on markets than further cuts. Andrew Sheets, Head of Corporate Credit Research, explains why.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss why what the Fed does next might not matter all that much. 

It’s Friday, October 4th, at 2 pm in London. 

Over recent months the Federal Reserve has been at the center of the global market debate. After keeping policy rates unchanged at the end of July, a decision the markets initially cheered, a string of weak data in early August drove concerns that Fed policy was behind schedule. The Fed then responded with a larger-than-expected half-percent interest rate cut in September. And so, given these swings, a common question for investors is, understandably: What will the Fed do next? 

But what if the Fed’s next move doesn’t matter all that much? 

Monetary policy is both powerful and weak. Powerful, because interest rates impact so many decisions across the economy, from buying a home, to financing equipment, to acquiring a competitor. And it’s also weak, because how interest rates impact these decisions can have a long and variable lag. It can be six to twelve months before the full impact of an interest rate cut is felt in the economy. And so that half percentage point cut by the Fed last month might not be fully felt in the US economy until June of 2025. 

That lag is one reason why the Fed’s next move may matter less. The second reason is what we think the market is worried about. We think a lot of the market’s volatility over the last two months has been driven by concerns that the US economy, particularly the labor market, is weakening right now. 

If interest rates are too high and the labor market is weakening, then cutting more rapidly in the coming months might not make a difference. Because of that lag, the help from lower rates simply wouldn’t arrive in time.

Meanwhile, there’s also a view that interest rates might need to fall quite a long ways to have the sort of impact that would be needed if the economy is really slowing down rapidly: by the Fed’s own Summary of Economic Projections (SEP), the policy rate that neither helps or hinders the economy could still be about 2 per cent lower than the current rate – even after that half a percentage point cut in September. Interest rates are well above what could be neutral. 

In short, if the data weaken materially over the coming months, more Fed cuts may not necessarily help in time. And if the data remain solid, Fed policy will have lots of time to adjust. It’s the data, not the Fed’s next action, that are most important at the moment. 

We also see support for this idea in history. It’s notable that some of the most aggressive US interest rate-cutting cycles – 2001, 2008, February of 2020 – overlapped with weak equity and credit markets. And it was smaller rate cutting cycles – in 1995-96, 1998 or 2019 – that overlapped with much better markets. And that makes sense; if one assumes that it’s the data rather than exactly how much the Fed is cutting rates that matter most to the market. 

All of this especially feels topical today. Today’s better than expected report on the US jobs market should support the case that Fed policy is on schedule, and larger adjustments aren’t needed. It’s good news. 

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 China Economist Robin Xing and Chief China Equity Strategist Laura Wang discuss how markets have responded to rate cuts and commitments to government spending, and what they could mean over the long term.

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Laura Wang: Welcome to Thoughts on the Market. I'm Laura Wang, Morgan Stanley's Chief China Equity Strategist. 

Robin Xing: And I'm Robin Xing, Morgan Stanley's Chief China Economist.

Laura Wang: All eyes have been on China this past week, and today we'll discuss why recent news from China's policymakers have commanded the attention of global markets.

It's Thursday, October the 3rd, at 4pm in Hong Kong.

So, Robin, China has been wrestling with the triple macro challenge of debt deflation and demographics -- what we call the three Ds -- for some time now. Last week, China's central bank, PBOC, announced a stimulus package that exceeded market expectations. And then later in the week, top China Communist Party officials, known as the Politburo, focused their monthly meeting on economics, which is not their usual practice.

This meeting was a positive surprise to both us and the market. Let's start with the PBOCs easing package. For listeners who haven't been following China's economy closely, what's our current view on China's economy and can you walk us through the policy measures that the central bank introduced?

Robin Xing: China's economy has been struggling lately and that's pushed the Beijing to pivot approach. Over the last 18 months, they have tried smaller, reactive measures. But now, they are doing something much bigger. On September 24, the People's Bank of China, PBOC, made a bold move, cutting interest rates and introducing new tools to support the stock market.

Now, these cuts might sound small, just 20 basis points, but they are pretty rare in China. They also cut the reserve requirement ratio, which is a fancy way of saying banks can lend more money by 50 basis points. And for the first time, the central bank gave forward guidance, signaling even more cuts could come by year end.

On top of that, the PBOC launched two big programs, a 500 billion yuan fund to help investors buy stocks, and a 300 billion yuan program to help companies buy back their own shares. These moves gave a much-needed boost to both the markets and consumer confidence.

Laura Wang: And how about the Politburo meeting that came on the heels of the PBOC announcement? What exactly did it focus on?

Robin Xing: The Politburo meeting was a rather critical moment. Normally, they don't even talk about the economy in September. But this year was different. It really signaled how urgent things have become.

They made it clear they are ready to spend more. The government is pledging to increase public spending because other parts of the economy, like corporates and consumers, are holding back. There is also a big focus on the housing market, which has been in decline since 2021. They are promising to stop that slide, and it's the strongest commitment we have seen so far.

Laura Wang: So, given everything we've seen from the PBOC and the Politburo, do you think this is a ‘whatever it takes moment’ to address the macro challenges facing China's economy?

Robin Xing: Not quite, but it's close. We are seeing the start of what's going to be a bumpy recovery. The deflation problem, where prices are falling and people are not spending, is complicated.

Beijing seems open to trying different approaches, but fixing the deeper issues -- like the struggling housing market and the local government debt -- it’s going to take a lot. In fact, we think China might need to spend about 1-1.5 trillion dollars over the next two years to really turn things around.

Right now, the measures they have announced are smaller than that. That's because these are new policies. And they still need to build consensus and work out the details. So, while this isn't a ‘whatever it takes moment’ yet the mindset has definitely shifted in that direction.

Laura Wang: In this case, what are the next steps you are monitoring for China's policymaker and how long will the various measures take to implement?

Robin Xing: We expect to see a supplementary budget of 1-2 trillion yuan announced at the upcoming NPC Standing Committee meeting in late October. This budget should focus on boosting consumer spending, increasing social welfare, and helping local governments managing their debt. We will likely see more monetary easing too.

As well as tweaks to the Housing Inventory Buy Back program. These steps should help the economy grow slightly faster, possibly hitting a 5 per cent quarter on quarter growth over the next two quarters, compared to the 3 per cent we have seen recently.

Looking ahead, we will get more clues at the December Central Economic Work Conference. That's when we might see the first signs of plans to use central government funds to tackle housing and local government debt issues. The full details could come in March 2025. If things don't improve quickly, and especially if social unrest starts to rise, Beijing may have to act even more aggressively.

We are keeping an eye on our social dynamics indicator, which tracks how people feel about jobs, welfare and income. If that dips further, it could push the government to ramp up stimulus measures.

Laura, turning it over to you. How are stock markets reacting to all this policy signaling from China?

Laura Wang: I would say to say that the market has responded very enthusiastically is an understatement. I'll give you some numbers.

On the first day of the PBOC announcement, the Shanghai Composite Index, as well as the Hong Kong Market Hang Seng Index, were both up by more than 4 per cent in one single day. Then with the further boost from the surprise Politburo meeting -- by now, both the Shanghai Composite Index and the Hang Seng Index have already been up by more than 21 per cent in just one week's time.

Robin Xing: Within the China stock market, which sectors and industries do you think will most benefit from the shift in policy?

Laura Wang: There are a few ways to position to benefit from this major market condition change. We have a list of companies that we believe will directly benefit from the PBOC market stabilization funding, given the funding's low cost compared to these companies implied re-rating opportunity, just by tapping into the funding and enhancing their shareholder returns.

For the potential reflationary fiscal efforts suggested by the Politburo meeting, as more details come out, I think sectors with good exposure to reflation, particularly the private consumption, will benefit the most -- given their still relatively low valuation, large market cap and high liquidity.

Robin Xing: Finally, Laura, what are your expectations for the markets in China and outside of China for the next few weeks and months?

Laura Wang: Clearly this rally so far is reflecting significant sentiment improvement and capitals that are willing to take a leap of faith and preposition for physical reflationary efforts ramp up. If the government can deliver these measures in a timely fashion, and more importantly, on top of that, communicate their commitment to winning this uphill battle against deflation, I think further valuation re-rating is quite possible for both the Asia market and the Hong Kong market by another 10 to 20 per cent.

To go beyond that level, we need to see clear signs of a corporate earnings growth reacceleration, which would require incrementally more easing to come along in the next few months. We should also monitor the housing market inventory level very closely because any earlier completion of this inventory digestion could suggest less drag on demand investment.

Obviously, there are still a lot of moving parts and it's still a very much evolving story from here. Robin, thanks for taking the time to talk.

Robin Xing: Great speaking with you, Laura.

Laura Wang: 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.

Thousands of U.S. dockworkers have gone on strike along the East Coast and Gulf Coast. Our Global Head of Fixed Income and Thematic Research Michael Zezas joins U.S. economist Diego Anzoategui to discuss the potential consequences of a drawn-out work stoppage.

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

Diego Anzoategui: And I'm Diego Anzoategui from the US Economics team.

Michael Zezas: And today, we'll be talking about the implications of this week's US dockworker strike on the US economy.

It's Wednesday, October 2nd, at 11am in New York.

Diego, as most of our listeners likely know, yesterday roughly 45,000 US dockworkers went on strike for the first time in perhaps decades at 36 US ports from Maine to Texas. And so, I wanted to get your initial read on the situation because we're obviously getting a lot of questions from clients concerned about what this could mean for growth and inflation.

Diego Anzoategui: Yeah, of course, there's a lot of uncertainty about this situation because we don't know how long the strike is going to last. But the strike can in principle hit economic growth and boost inflation -- but only if it is long lasting, right. Local producers and retailers, they typically have inventories of final and intermediate goods, so the disruption needs to be long enough so that those inventories go down to critical levels in order to see a meaningful macroeconomic impact.

But if the strike is long enough, we might see an important impact on economic activity and inflation. If we look at trade flows data, roughly 30 per cent of all goods imports and exports are handled by the East and Gulf ports.

Michael Zezas: So then let's drill down on that a bit. If the strike continues long enough and inventories decline, what are the shocks to economic growth that you're considering?

Diego Anzoategui: Yeah, I would think that there are two main channels through which the strike might hit economic activity. The first one is a hit to local production because of disruptions in the supply of capital goods and intermediate goods used for domestic production. We not only use the ports to bring final goods, but also intermediate and capital goods like machinery, basic metals, plastic, to name a few.

And the second channel is directly through exports. The East Coast and Gulf ports channel 84 per cent of exports by water. Industries producing energy, chemicals, machinery, cars, might be affected by these bottlenecks.

Michael Zezas: Right, so fewer potential imports of goods, and fewer potential productive capacity as a consequence. Does that have an impact on inflation from your perspective?

Diego Anzoategui: Yes, it can have an impact on inflation. Again, assuming that the strike is long lasting, right? I would expect acceleration in goods prices, in particular key inputs coming from the Eastern Gulf ports. And these are cars, electronics, clothes, furniture and apparel. All these categories roughly represent 13 per cent of the core PCE basket, the price index.

Also, you know, a meaningful share of food and beverages imports come through water. So, I would also expect an impact there in those prices. And in terms of what prices might react faster, I think the main candidate is food and beverages -- and especially perishable food that typically have lower inventory to sales ratios.

And if we start seeing an increase in those prices, I think that would be a good early signal that the disruptions are starting to bite.

Michael Zezas: That makes sense. And last question, what about the impact to the US workforce? What would be the impact, if any, on payroll data and unemployment data, reflecting workforce impact -- the types of data that investors really pay close attention to.

Diego Anzoategui: Yeah. So, we will likely see an impact on nonfarm payrolls, NFP, and the unemployment rate if the strike is long lasting. But even if there are not important disruptions, the strike itself can mechanically affect October's nonfarm payrolls print. They want to be released in November. Remember that strikers don't get paid, and they are not on the payroll; so they are not be[ing] counted by the establishment survey.

But a necessary condition to see this downward bias in the NFP reading is that the strike needs to continue next week, that is the second week of October, right. But know that The Fed tends to look through these short run fluctuations in NFP due to strikes -- because any drag we see in the October sprint will likely be followed by payback in November if the strike is short lived.

Michael Zezas: Got it. That makes a lot of sense. Diego, thanks for making the time to talk with us as this unfolds. Let's hope for a quick resolution here.

Diego Anzoategui: Thanks, Michael. Great speaking with you.

Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please be sure to rate and review us on the Apple Podcasts app. It helps more people find the show. 

Our US public policy and global economics experts discuss how an escalation of US tariffs could have major domestic and international economic implications.

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

Arunima Sinha: And I’m Arunima Sinha, from the Global Economics team.

Ariana Salvatore: Today we're talking tariffs, a major policy issue at stake in the US presidential election. We'll dig into the domestic and international implications of these proposed policies.

It's Tuesday, October 1st at 10am in New York.

In a little over four weeks, Americans will be going to the polls. And as we've noted on this podcast, it's still a close race between the two presidential candidates. Former president Donald Trump's main pitch to voters has to do with the economy. And tariffs and tax cuts are central to many of his campaign speeches.

Arunima Sinha: You're right, Ariana. In fact, I would say that tariffs have been the key theme he keeps on coming back to. You've recently written a note about why we should take the Republicans proposed policies on tariffs seriously. What's your broad outlook in a Trump win scenario?

Ariana Salvatore: Well, first and foremost, I think it's important to note that the President has quite a bit of discretion when it comes to trade policy. That's why we recommend that investors should take seriously a number of these proposals. Many of the authorities are already in place and could be easily leveraged if Trump were to win in November and follow through on those campaign promises. He did it with China in 2018 to 2019, leveraging Section 301 Authority, and many of that could be done easily if he were to win again.

Arunima Sinha: And could you just walk us through some of the specifics of Trump's tariff proposals? What are the options at the President's disposal?

Ariana Salvatore: Sure. So, he's floated a number of tariff proposals -- whether it be 10 per cent tariffs across the board on all of our imports, 60 per cent specifically on China or targeted tariffs on certain goods coming from partners like Mexico, for example. Targeted tariffs are likely the easiest place to start, especially if we see an incrementalist approach like we saw during the first Trump term over the course of 2018 to 2019.

Arunima Sinha: And how quickly would these tariffs be implemented if Trump were to win?

Ariana Salvatore: The answer to that really depends on the type of authorities being leveraged here. There are a few different procedures associated with each of the tariffs that I mentioned just now. For example, if the president is using Section 301 authorities, that usually requires a period of investigation by the USTR -- or the US Trade Representative --before the formal recommendation for tariffs.

However, given that many of these authorities are already in place, to the extent that the former president wants to levy tariffs on China, for example, it can be done pretty seamlessly. Conversely, if you were to ask his cabinet to initiate a new tariff investigation, depending on the authority used, that could take anywhere from weeks to months. Section 232 investigations have a maximum timeline of 270 days.

There's also a chance that he uses something called IEEPA, the International Emergency Economic Powers Act, to justify quicker tariff imposition, though the legality of that authority hasn't been fully tested yet. Back in 2019, when Trump said he would use IEEPA to impose 5 per cent tariffs on all Mexican imports, he called off those plans before the tariffs actually came into effect.

Arunima Sinha: And could you give us a little more specific[s] about which countries would be impacted in this potential next round of tariffs -- and to what extent?

Ariana Salvatore: Yeah, in our analysis, which you'll get into in a moment, we focus on the potential for a 10 per cent across the board tariff that I mentioned, in conjunction with the 60 per cent tariff on Chinese goods. Obviously, when you map that to who our largest trading partners are, it's clear that Mexico and China would be impacted most directly, followed by Canada and the EU.

Specifically on the EU, we have those section 232 steel and aluminum tariffs coming up for review in early 2025, and the US-MCA or the agreement that replaced NAFTA is set for review later in 2026. So, we see plenty of trade catalysts on the horizon. We also see an underappreciated risk of tariffs on Mexico using precedent from Trump's first term, especially if immigration continues to be such a politically salient issue for voters.

Given all of this, it seems that tariffs will create a lot of friction in global trade. What's your outlook, Arunima?

Arunima Sinha: Well, Arianna, we do expect a hit to growth, and a near term rise in inflation in the US. In the EU, our economists also expect a negative impact on growth. And in other economies, there are several considerations. How would tariffs impact the ongoing supply chain diversification? The extent of foreign exchange moves? Are bilateral negotiations being pursued by the other countries? And so on.

Ariana Salvatore: So, a natural follow up question here is not only the impact to the countries that would be affected by US tariffs, but how they might respond. What do you see happening there?

Arunima Sinha: In the note, we talked with our China economists, and they expect that if the US were to impose 60 per cent tariffs on Chinese goods, Beijing may impose retaliatory tariffs and some non-tariff measures like it did back in 2018-19. But they don't expect meaningful sanctions or restrictions on US enterprises that are already well embedded in China's supply chain.

On the policy side, Beijing would likely resort less to Chinese currency depreciation but focus more on supply chain diversifications to mitigate the tariff shock this time round. Our economists think that the risk of more entrenched deflationary pressures from potential tariff disruptions may increase the urgency for Beijing to shift its policy framework towards economic rebalancing to consumption.

In Europe, our economists expect that targeted tariffs will be met with challenges at the WTO and retaliatory tariffs on American exports to Europe, following the pattern from 2018-19, along with bilateral trade negotiations. In Mexico, our economists think that there could be a response with tariffs on agricultural products, mainly corn and soybeans.

Ariana Salvatore: So, bringing it back to the US, what do you see the macro impact from tariffs being in terms of economic growth or inflation?

Arunima Sinha: We did a fairly extensive analysis where we both looked at the aggregate impacts on the US as well as sectoral impacts that we'll get into. We think that a pretty reasonable estimate of the effect of both a 60 per cent tariff on China and a 10 per cent blanket tariff on the rest of the world is an increase of 0.9 per cent in the headline PCE prices that takes into effect over 2025, and a decline of 1.4 percentage points in real GDP growth that plays out over a longer period going into 2026.

Ariana Salvatore: So, your team is expecting two more Fed cuts this year and four by the first half of 2025. Thinking about how tariffs might play into that dynamic, do you see them influencing Fed policy at all?

Arunima Sinha: Well, under the tariff scenario, we think that it's possible that the Fed decides to delay cuts first and then speed up the pace of easing. So, in theory, the effect of a tariff shock is really just a level shift in prices. And in other words, it's a transitory boost to inflation that should fade over time.

Because it's a temporary shock. The Fed can, in principle look through it as long as inflation expectations remain anchored. And this is what we saw in the FOMC minutes from the 2018 meetings. In a scenario of increased tariffs, we think that the uncertainty about the length of the inflationary push may slow down the pace of cuts in the first half of 2025. And then once GDP deceleration becomes more pronounced, the Fed might then cut faster in the second half of [20]25 to avoid that big, outsized deceleration and economic activity.

Ariana Salvatore: And what about second order effects on things like business investment or employment? We talked about agriculture as a potential target for retaliatory tariffs, but what other US sectors and industries would be most affected by these type of plans?

Arunima Sinha: That's something that we have leaned in on, and we do expect some important second round effects. So, if you have lower economic activity, that would lower employment, that lowers income, that lowers consumption further -- so that standard multiplier effect.

So overall, in that scenario, with the 60 per cent tariffs on China, 10 per cent on the rest of the world that are imposed fully and swiftly, we model that real consumption would decline by 3 per cent, business investment would fall by 3.1 per cent, and monthly job gains would fall by between 50- and 70, 000.

At the sectoral level, this combination of tariffs have potential to increase average tariffs to the 25 to 35 per cent range for almost 50 per cent of the NAICS industries in the United States when first put into place. And we expect the biggest impacts on computers and electronics, apparel, and the furniture sectors; but this does not take into account any potential exclusion lists that might be put into place.

Ariana Salvatore: Finally, what does all this boil down to in terms of a direct impact to the US consumer wallet?

Arunima Sinha: So, the impact of higher tariffs on consumer spending would depend on many factors, and one of the most important ones is the price elasticity of demand. So how willing would consumers be to take on those higher prices from tariffs, or do we see a pullback in real demand? What we think will happen is that higher prices could reduce real consumption by as much as 2. 5 per cent. The impact on goods consumption is much more meaningful because imported goods are directly affected by tariffs, and we would expect to see a drag on real goods consumption of 5 per cent. But then you have lower labor income and higher production costs and services prices that is also going to bring down services consumption by 1.3 per cent.

Ariana Salvatore: So, it's important to keep in mind here that US tariff policy would undoubtedly have far reaching consequences. That means it's something that we're going to continue to follow very closely. Arunima, thanks so much for taking the time to talk.

Arunima Sinha: Great speaking with you, Ariana. Thank you,

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 CIO and Chief US Equity Strategist Mike Wilson takes a closer look at the potential ramifications of the sharp central bank policy shifts in the U.S., Japan and China.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what to expect from the sharp pivot in global monetary and fiscal policy.  

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

So let’s get after it. 

Over the past few months, Fed policy has taken on a more dovish turn. To be fair, bond markets have been telling the Fed that they are too tight and in many respects this pivot was simply the Fed getting more in line with market pricing. However, in addition to the 50 basis point cut from the Fed, budget deficits are providing heavy support; with August’s deficit nearly $90b higher than expected. Meanwhile, financial conditions continue to loosen and are now at some of the most stimulative levels seen over the past 25 years. 

Other central banks are also cutting interest rates and even the Bank of Japan, which recently raised rates for the first time in years, has backed off that stance – and indicated they are in no hurry to raise rates again. Finally, this past week the People’s Bank of China announced new programs specifically targeting equity and housing prices. After a muted response from markets and commentators, the Chinese government then followed up with an aggressive fiscal policy stimulus. Why now?  

Like the US, China is highly indebted but it has entered full blown deflation with both credit and equity markets trading terribly for the past several years. There is an old adage that markets stop panicking when policy makers start panicking. On that score, it makes perfect sense why China equity and credit markets have responded the most favorably to the changes made last week. European equity markets were also stronger than the US given European economies and companies have greater exposure to China demand. On the other hand, Japan and India traded poorly which also makes sense in my view since they were the two largest beneficiaries of investor outflows from China over the past several years. Such trends are likely to continue in the near term.  

For US equity investors, the real question is whether China’s pivot on policy will have a material impact on US growth. We think it’s fairly limited to areas like Industrial spending and Materials pricing and it’s unlikely to have any impact on US consumers or corporate investment demand. In fact, if commodities rally due to greater China demand, it may hurt US consumer spending. 

As usual, oil prices will be the most important commodity to watch in this regard. The good news is that oil prices were down last week due to an unrelated move by Saudi Arabia to no longer cap production in its efforts to get oil prices back to its $100 target. If prices reverse higher again and move toward $80/bbl due to either China stimulus or the escalation of tensions in the Middle East, it would be viewed as a net negative in my view for US equities.  

As discussed last week the most important variables for the direction of US equities is the upcoming labor market data and third quarter earnings season. Weaker than expected data is likely to be viewed negatively by stocks at this point and good news will be taken positively. In other words, investors should not be hoping for worse news so the Fed can cut more aggressively. 

At this point, steady 25 basis point cuts for the next several quarters in the context of growth holding up is the best outcome for stocks broadly. Meanwhile individual stocks will likely trade as much on idiosyncratic earnings and company news rather than macro data in the absence of either a hard landing or a large growth acceleration; both of which look unlikely in the near term. In such a scenario, we think large cap quality growth is likely to perform the best while there could be some pockets of cyclical strength in companies that can benefit from greater China demand. The best areas for cyclical outperformance in that regard remain in the Industrial and materials sectors.  

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. 

Credit likes moderation, and the Fed’s rate cut indicates its belief that the economy is heading for a soft landing. Our Chief Fixed Income Strategist warns that markets still need to keep an eye on incoming data.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the implications of the Fed’s 50 basis points interest rate cut for corporate credit markets. 

It's Friday, Sep 27th at 10 am in New York. 

For credit markets, understanding why the Fed is cutting is actually very critical. Unlike typical rate cutting cycles, these cuts are coming when the economic growth is still decelerating but not falling off the cliff. Typically, rate cuts have come in when the economy is already in a recession or approaching recession. Neither is the case this time. So the US expanded by 3 per cent in the second quarter; and the third quarter, it is tracking well over 2 per cent. 

So, these cuts do not aim to stimulate the economy but really to acknowledge that there’s been significant progress on inflation, and move the policy towards a much more normalized policy stance. In some way, this really reflects the Fed’s confidence in the inflation path. So that means, not cutting now would mean restraining the economy further through high real interest rates. So, this cut really reflects a growing faith by the Fed in achieving a soft landing. Also, the size of the cut, the 50 basis point cut as opposed to 25 basis points, shows the Fed’s willingness to go big in response to weaker data, especially in labor markets. 

So since the beginning of the year, we have been pretty constructive on spread products across the board, particularly corporate credit and securitized credit, even though valuations have been tightening. Our stance is based on the idea that credit fundamentals will stay reasonably healthy even if economic growth decelerates, as long as it doesn’t fall off the cliff. Further, we also believe that credit fundamentals will improve with rate cuts because stress in this cycle has mainly come from higher interest expenses weighing on both corporations and households. This is in stark contrast to other recent periods of stress in credit markets – such as 2008/09 when we had the financial crisis, 2015/16 we had the challenges in the energy sector and then 2020, of course, we faced COVID. 

So the best point of illustrating this would be through leveraged loans, which are floating-rate instruments. As the Fed started tightening in 2022, we saw increasing pressures on interest coverage ratios for leveraged loan borrowers. That led to a pick-up in downgrades and defaults in loans. As rate hikes ended, we started seeing stabilization of these coverage ratios, and the pace of downgrades and defaults slowed. And now, with rate cutting ahead of us and the dot plot implying 150 basis points more of cuts for the rest of this year and the next year to come, the pressure on interest coverage ratios are going to be easing, especially if the economy stays in soft landing mode. 

This suggests that while spreads are today tight, the fundamentals could even improve with rate cuts – that means the spreads could remain around these levels, or even tighten a bit further. After all, if you remember the mid-1990s, which was the the last time that the Fed achieved a soft landing, investment grade corporate credit spreads were about 30 basis points tighter relative to where we are today. 

That 'if' is a big if. If we are wrong on the soft landing thesis, our conviction about the spread products being valuable will prove to have been misplaced. Really the challenge with any landing is that we can’t be certain of the prospect until we actually land. Till then, we are really looking at incoming data and hypothesizing: are we heading into a soft or hard landing? 

So this means incoming data pose two-sided risks to the path ahead for credit spreads. If incoming data are weak – particularly employment data are weak – it is likely that faith in this soft landing construct will dim and spreads could widen. But if they are robust, we can see spreads tightening even further from the current tight levels. 

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

Our US Consumer Economist Sarah Wolfe lays out the impact of the Federal Reserve’s rate cut on labor market and consumers, including which goods could see a rise in spending over the next year.

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Welcome to Thoughts on the Market. I’m Sarah Wolfe, from the Morgan Stanley US Economics Team. 

Today, a look at what the Fed cut means for US consumers. 

It’s Thursday, September 26, at 2 PM in Slovenia. 

Earlier this week, you heard Mike Wilson and Seth Carpenter talk about the Fed cut and its impact on markets and central banks around the world. But what does it actually mean for US consumers and their wallets? Will it make it easier to pay off credit card debt and secure mortgages? We explore these questions in this episode. 

Looking back to last week, the FOMC cut rates by a larger chunk than many anticipated as risks from inflation have come down significantly while labor market risks have risen. Now, with inflation wrangled in, it’s time to start reducing the restrictiveness of policy to prevent a rise in the unemployment rate and a slump in economic growth. In fact, my colleague Mike Wilson believes the US labor data will be the most important factor driving US equities for the next three to six months. 

Despite potential risks, the current state of the U.S. labor market is still solid and that’s where the Fed wants it to stay. The health of the labor market, in my opinion, is best reflected in the health of consumer spending. If we look at this quarter, we’re tracking over 3 per cent growth in real consumption, which is a strong run rate for consumption by all measures. And if we look at how the whole year has been tracking, we’ve only seen a very modest slowdown in real consumer spending from 2.7 per cent last year to 2.5 per cent today. 

For a bit of perspective, if we go back to 2018 and 2019, when rates were much lower than they are today, and we had a tight labor market, consumption was running closer to 2 to 2.3 per cent. So we can definitively say, consumption is pretty solid today. 

What is most notable, however, is the slowdown in nominal consumption which takes into account unit growth and pricing. This has slowed much more notably this year from 5.6 per cent last year to 4.9 per cent today. It’s reflected by the significant progress we’ve seen in inflation this year across goods and services, despite solid unit growth – as reflected by stronger real consumer spending. 

Our US Economics team has been stressing that the fundamentals that drive consumption – which are labor income, wealth, and credit – would be cooler this year but still support healthy spending. When it comes to consumption, in my opinion, I think what matters most is labor income. A slowdown in job growth has stoked fears of slower consumer spending, but if you look at aggregate labor income growth and household wealth, across both equities and real estate, those factors remain solid. So, then we ask ourselves, what has driven more of the slowdown in consumer spending this past year?

And with that, let’s go back to interest rates. 

Rates have been high, and credit conditions have been tight – undeniably restraining consumer spending. Elevated interest rates have pushed banks to pull back on lending and have curbed household demand for credit. As a result, if you look at consumer loan growth from banks, it’s fallen from about 12 per cent in 2022 to 7 per cent last year, and just 3 per cent in the first half of this year. 

Tight credit is dampening consumption. When interest rates are high, people buy less -- especially on credit. And this is a key principle of monetary policy and it's used to lower inflation. But it can have adverse effects. The brunt of the pain has been borne by the lowest-income households which rely heavily on revolving credit for basic spending needs and more easily max out on their credit limits and fall delinquent. 

As such, as the Fed begins to lower interest rates, the rates charged on consumer loan products have started to moderate. And with a lag, we expect credit conditions to ease up as well, allowing households across the income distribution to begin to access more credit. We should first see a rebound in durable goods spending – like home furnishing, electronics, appliances, and autos. And then that should all be further supported by more activity in the housing market.  

While interest rates are on their way down, they are still relatively elevated, which means the rebound in consumption will take time. The good news, however, is that we do think we are moving through the bottom for durable goods consumption – with pricing for goods likely to stabilize next year and unit growth to pick back up.

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

With the US presidential race being as closely contested as it is, Michael Zezas explains why patience may be a virtue for investors following Election Day. 

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

Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why investors should prepare to wait to get clarity on the US election result. 

It's Wednesday, September 25th at 10:30am in New York. 

As we all know, markets dislike uncertainty; and one of the biggest potential catalysts between now and the end of the year is the results of the US presidential election. So it’s important for investors to know that the timing of knowing the outcome may not be what you expect. 

On most U.S. presidential election days, the outcome is known within hours of polls closing in the evening. That’s because while all votes may not yet have been counted, enough have to make a reasonable projection about the winner. 

But that’s not what happened in 2020. Vote counts were tight across many states. A condition that was compounded by the slowness of counting mail in ballots, which was a style of voting more widely adopted during the pandemic. As a result, news networks didn’t make a formal outcome projection until about four days after election day.

Rather than a reversion to the norm of quickly knowing the result for the 2024 election, we expect an outcome similar to 2020. It could be days before we reliably know a result.

The same dynamics as 2020 are in play. Polls show a very close race. And while more voters are likely to show up in person this year, voting by mail is still expected to represent a substantial chunk of ballots cast this cycle. That’s because many states' rules automatically send mail-in ballots to those who voted by that method in the last election. And some recent news out of Georgia underscores the potential for a slower result. The state just adopted a rule requiring all its votes to be hand-counted.

Now, this may not matter if either candidate has enough votes without Georgia to win the electoral college. But if Georgia is the deciding or tipping point state then a longer wait becomes possible. Per the 538 election forecast model, there’s about an 11 per cent chance that Georgia plays this role.

So, bottom line, investors may have to be patient this November. It could take days, or weeks, to reliably project an election outcome, and therefore start seeing its market effects.

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

From stock price fluctuations to concerns about deflation, the reactions to the Fed rate cut have been varied. But we still need to keep an eye on labor data, says Mike Wilson, our CIO and Chief US Equity Strategist.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the Fed’s 50 basis point rate cut last week, and the impact on markets.

It's Tuesday, Sept 24th at 11:30am in New York.

So let’s get after it. 

As discussed last week, I thought that the best short-term case for equities was that the Fed could deliver a 50 basis point cut without prompting growth concerns. Chair Powell was able to thread the needle in this respect, and equities ultimately responded favorably. 

However, I also believe the labor data will be the most important factor in terms of how equities trade over the next three to six months. 

On that score, the next round of data will be forthcoming at the end of next week. In my view, that data will need to surprise on the upside to keep equity valuations at their currently elevated level. More specifically, the unemployment rate will need to decline and the payrolls above 140,000 with no negative revisions to prior months.  

Meanwhile, I am also watching several other variables closely to determine the trajectory of growth. Earnings revision breadth, the best proxy for company guidance, continues to trend sideways for the overall S&P 500 and negatively for the Russell 2000 small cap index. Due to seasonal patterns, this variable is likely to face negative headwinds over the next month.

Second, the ISM Purchasing Managers Index has yet to reaccelerate after almost two years of languishing. And finally, the Conference Board Leading Economic Indicator and Employment Trends remain in downward trends; this is typical of a later cycle environment.

Bottom line, the Fed's larger than expected rate cut can buy more time for high quality stocks to remain expensive and even help lower quality cyclical stocks to find some support. The labor and other data now need to improve in order to justify these conditions though, through year end.

It's also important to point out that the August budget deficit came in nearly $90 billion above forecasts, bringing the year-to-date deficit above $1.8 trillion. We think this fiscal policy has been positive for growth but has resulted in a crowding out within the private economy and financial markets.

This is another reason why a recession is the worst-case scenario even though some argue a recession is better than high price levels or inflation for 80-90 per cent of Americans. A recession will undoubtedly bring debt deflation concerns to light, and once those begin, they are hard to reverse. The Fed understands this dynamic better than anyone as first illustrated in Ben Bernanke's famous speech in 2002 entitled “Deflation, Making Sure It Doesn’t Happen Here.” In that speech, he highlighted the tools the Fed could use to avoid deflation including coordinated monetary and fiscal policy.

We note that gold continues to outperform most stocks including the high-quality S&P 500. Specifically, gold has rallied from just $300 at the time of Bernanke’s speech in 2002 to $2600 today. The purchasing power of US dollars has fallen much more than what conventional measures of inflation would suggest.

As a result, gold, high-quality real estate, stocks and other inflation hedges have done very well. In fact, the newest fiat currency hedge, crypto, has done the best over the past decade. Meanwhile, lower quality cyclical assets like commodities, small cap stocks and commercial real estate have done poorly in both absolute and relative terms; and are losing serious value when adjusted for purchasing power.

The bottom line, we expect this to continue in the short term until something happens to change investors' view about the sustainability of these policies. In order to reverse these trends, either organic growth in the private economy needs to reaccelerate and we’ll see a rotation back to the lower quality cyclical assets; or recession arrives, and we finish the cycle and reset all asset prices to levels from which a true broadening out can occur.

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 Chief Economist, Seth Carpenter, explains why, despite last week’s big Fed move, there’s still plenty of uncertainty in global markets and questions about how other central banks will respond. 

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

Today, I'll be talking about the Fed meeting, where they cut rates for the first time in this cycle, and what it means for the economy around the world.

It's Monday, September 23rd at 10am in New York.

The Fed cut rates by 50 basis points; but we did not see a huge shift in its reaction function. Rather, the 50 basis points was to show a commitment to not falling behind the curve -- to use Chair Powell's words. From here, the most likely path, from my perspective, is a string of 25 basis point cuts. Powell has again demonstrated that the Fed can move gradually, or quickly, depending on perceptions of risk.

But for now, judging from Powell, or other policy makers comments, the Fed still sees the economy as healthy in the labor market; as solid. But another payroll print of 100, 000 or softening in consumer spending, well, that would tip the balance. So, the market debate will continue to focus on the pace of rate cuts and the ultimate landing zone.

Our baseline is a touch more front loaded than the dot plot would imply; with us expecting the funds rate to reach just below 3.5 per cent in the middle of next year, rather than the end of next year. The Fed's projections have declines in the target rate into 2026 and beyond, but I have to say the dispersion in the dots that they put up shows just how much consensus is yet to be built within the committee. And, as a result, the phrase data dependency, well, that's not a term that we want to drop from the lexicon anytime soon.

The magnitudes of the changes differ, but a comparison that we have made often here is to the 1990s, and that cutting cycle eventually it paused as the economy stabilized and continued to grow. So, there are lots of options for where we go next.

Globally, central banks will be adapting and reacting both to global financial conditions like this Fed rate cut, as well as their domestic outlook. Among emerging market economies, Brazil and Indonesia make for useful case studies. With an eye on defending its policy credibility and on market expectations, the central bank in Brazil hiked rates to 10-and-three-quarters per cent this week after a cutting cycle and then a long pause. A weaker currency is the external push, but strong domestic growth is the internal consideration and both of those imply some inflation risks.

The Bank of Indonesia cut rates after a strong appreciation in the currency, which lowered the risk from inflations, and it really enabled them to change their footing.

Now, for DM central banks, the 50 basis point cut really doesn't materially shift our expectations for what's going to happen. If we are right, and ultimately we get a string of 25 basis point cuts, there's little reason for other developed market central banks to really adjust what they're doing. In Europe, we're waiting for inflation data to confirm the slowdown after the softening of wages that we've seen. So, we have high conviction that there's a cut in September, and we expect another cut in December.

Now, more cutting by the Fed might lead to a stronger Euro, which would reinforce that inflation trend, but I don't think it would be enough to really change the path and prompt more aggressive cutting from the ECB. After skipping a rate move in September, given all the question marks they still see about inflation in the UK, we think the Bank of England restarts their cuts in November.

The split decision at this most recent meeting shows that the MPC is not making frequent adjustments to its plan based on small tweaks to the incoming data. And finally, for the Bank of Japan, we expect them to stay on hold until January. The meeting for the Bank of Japan was primarily about communication, and indeed, Governor Ueda's comments did not prompt the type of reaction that we saw at the July meeting. So, if we're right, and the Fed's path is mostly, like we think it will be, these other developed market central banks don't have to make big changes.

So, the Fed didn't really fully recalibrate its outlook. Instead, what it did was signal a willingness, but just a willingness, to make large shifts; with no clear indication that the fundamental strategy has changed.

The market implications seem like they could be clear. With the Fed easing, amid economic conditions that remain resilient, that should be positive for risk assets. But the Fed is also trying to prevent complacency, and I have to say, uncertainty is plentiful. If for no other reason, we've got an election coming up, and that makes forecasting what happens in 2025 very difficult.

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

Our Chief Latin American Equity Strategist explains how potential changes in Mexico’s regulatory approach could have implications for the country’s equity markets.

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Welcome to Thoughts on the Market. I’m Nikolaj Lippmann, Morgan Stanley’s Chief Latin American Equity Strategist. Today I’ll talk about Mexico’s recent judicial reform and its potential impact on equities market.

It’s Friday, September 20, at 10am in Mexico City.

Mexico has made significant changes to its judicial system. After winning two-thirds majority in both houses – enough to allow for constitutional changes – Mexico policymakers have embarked on a robust reform agenda. Their first stop is a comprehensive reform of the judicial branch, which aims at replacing roughly 2,000 senior judges including the entire Supreme Court. 

New judges will no longer be appointed but will now be elected by popular vote. This is practically unprecedented in a global context, and while the executive branch might still try to filter future candidates, this new system will likely create a real risk to checks and balances on the judicial branch as well as to expertise and procedure. Additional reforms, including the elimination of independent regulatory bodies, would likely compound these risks. 

The judicial reform could have a material impact on Mexican equities. So much so, that we think Mexico goes from being an investor favorite to a ‘show me’ story where investors are less likely to give the market the benefit of the doubt. This is likely to result in a derailing or lower set of multiples being paid by investors in Mexican equities or higher risk premium required to invest. 

Essentially, the judicial reforms could add fiscal, labor and concession/regulatory risk for Mexican companies, even though Mexico has deep manufacturing ecosystems, and has been well-positioned from the transition to [a] multipolar world. Just to give you a sense. Mexico has already sailed past China in terms of manufacturing exports to the United States, and are now approaching the levels of the entire European Union in terms of manufacturing export to the US. 

These new reforms will raise significant investor concerns, so much so that we’ve downgraded Mexican equities to underweight, a second downgrade since June. Mexican equities have sold off roughly 20 per cent in the past three months, in dollar terms. And we think the judicial reform may contribute to further decline. All in, we see significantly greater potential for negative outcomes than positive outcomes going forward.

Looking ahead, we see three key challenges for Mexico: 

First, the new judicial structure would raise concerns about the independence of the judicial branch. 

Second, the United States-Mexico-Canada Agreement, the USMCA, is up for review in 2026, and Mexico's judicial reform could mean a much deeper revision. Mexico has committed to maintaining independent regulatory bodies for a number of areas, such as telecom, electricity, in competition. The judicial reform could complicate this commitment. 

Electricity is a key challenge for Mexico, and it requires immediate investments. Our nearshoring investment thesis stands, but the electricity-related challenges are becoming more pronounced, and they won’t be helped by investor concerns around the judicial reform. 

So all in, some businesses will be at greater risk from these developments. We expect technology, digitalization, real estate companies to be at the least level of risk, or the lowest level of risk. Domestic concessions could be at more risk. 

We will continue to bring you relevant updates as Mexico reforms unfold. 

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

Investors came away from Morgan Stanley’s recent Industrials Conference with a more optimistic outlook than they expected, based on perspectives including freight transportation’s momentum and AI’s impact on the growth of data centers.

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

Ravi Shanker: I'm Ravi Shanker, Morgan Stanley's Freight Transportation and Airlines Analyst.

Chris Snyder: And I'm Chris Snyder, the U.S. Industrial Analyst.

Michelle Weaver: Today, we'll talk about key themes for Morgan Stanley's recently concluded industrials conference in Laguna Beach.

It's Thursday, September 19th at 10am in New York.

Last week, we were all out in Laguna Beach at the industrials conference. There were about 500 different industrials investors, along with 156 corporates, which gave us a pretty comprehensive read on what's going on in the industrial sector.Investor sentiment around industrials was pretty poor heading into the conference, and the overall tone of management, though, seemed better than feared in presentations.

Chris, your coverage includes companies with exposure to a wide range of end markets. What did you learn about the cycle from your discussions with company management?

Chris Snyder: Yeah, I think you categorized it well: consistent, largely unchanged, but better than feared. Morgan Stanley did a poll ahead of the conference. And only 5 percent of investors thought that the conference would be bullish for industrial risk sentiment. Coming out of the conference, 60 percent of industrial investors are bullish on risk sentiment into the end of the year. So, I think it kind of shows that sentiment was in a very bad place and ‘better than feared’ is the right way to categorize it.

We've generally been surprised at the lack of optimism around the industrial cycle in the market. The industrial economy has been in contraction for almost two years now, and it seems like we're on the verge of a rate cut cycle, which has historically been a tailwind for the cycle.

You know, in our coverage, business is driven by a combination of investments and then production of goods; and the companies we’re seeing real bifurcation on that. On the investment side -- and that's things like data center, new manufacturing facilities with all the US reshoring momentum -- that business remains strong. And on the production side of the house, that business remains soft. And that's generally in line with our call. We prefer CapEx exposure, particularly those that are tied into energy efficiency.

Michelle Weaver: Great. That's really positive to hear that the investment side is still doing well. Ravi, your freight coverage is very macro as well -- in that the freight companies move all the stuff that other companies are making. How does demand from shippers look? And what are freight companies saying about the cycle?

Ravi Shanker: Yeah, from a freight transportation perspective, I guess, no news was good news out in Laguna; largely because we have already started to see an improvement in the freight cycle, at the end of 1Q going into 2Q. And I think the market was just waiting to see if that would sustain through 3Q. The data has been supportive so far, and the good news was most of the trucking companies did validate the fact that we have seen a continuation of seasonality from 2Q into 3Q.

And looking forward, they're also anticipating a fairly decent peak season, probably the most robust peak season we have had in two or three years. And I use the word robust on a relative basis because it's not going to be the greatest peak season ever. But certainly, better than we've had the last couple of years. But that momentum should continue into 2025.

So, nobody really was high fiving out there. But certainly, noted the fact that we are seeing a continued improvement in the cycle; and that momentum should continue into next year.

Michelle Weaver: One of Morgan Stanley Research's three key themes for the year is technology, diffusion and AI; and this theme came up repeatedly throughout the conference.

Chris, some of your companies have significant exposure to data centers, which have seen a huge boost in demand from AI. What does the growth opportunity look like for Multi's names with exposure to data centers?

Chris Snyder: Yeah, data center is a growth opportunity for my industrials’ coverage. And they primarily are driven by the investment side. How much data centers are we building? And they sell a lot of the equipment that goes into the data centers. And what we're seeing now is that there's a huge focus on energy efficiency within the data center. You know, obviously it helps improve their cost profile, but also as there's growing concerns around load growth and electricity allotment.

And what that's doing is it's driving demand towards the high end of the spectrum, which is where our big public companies compete. You know, they're the ones that are always spending R&D and innovating and driving energy efficiency for the customer. So, we think there's a mix up opportunity behind it.

In terms of growth rates, you know, most of the companies are talking to about 15 percent kind of plus as the growth rate going forward or where they are exposed. And the conference brought, you know, really positive updates. There was no talk of slowdown. And generally, it sounds like momentum remains firm and growth will continue.

Michelle, what were some of the other ways companies discussed AI or how they're leveraging the technology?

Michelle Weaver: Yeah. So, when I think about how companies have been adopting AI so far, not just within industrials, but within the broader market, it's largely been about things that are plug and play solutions; something like taking a chat bot, putting that on your website, and then you don't need as many customer service representatives.

So, when I'm at these kind of events, I always like to listen for more unique or differentiated ways of adopting AI. And I heard about a really interesting case from a company that holds about half of the global market for luxury seating. Processing leather is a super important part of manufacturing seats and has typically been really labor intensive and skilled labor at that. But this company is using AI to scan cow hides to determine what the optimal use for them is, and then inventory them.

Before that, a worker had to individually mark the leather for imperfections and then determine how to cut around that. So, I thought that was a pretty interesting use of AI.

But now I want to turn over to the consumer exposed pockets of industrials. Discretionary spending has been slowing as multiple years of high prices have been weighing on consumers. But overall, I thought the commentary around the consumer at the conference seemed pretty mixed, and we saw a big divide between the high-end and low-end consumers.

Ravi, what did you hear from the airlines around travel demand?

Ravi Shanker: Unlike the transportation side where what we heard was fairly consistent with expectations, I think things were much better than expected on the airline side largely because the airlines came out and validated the fact that demand continues to remain very robust -- pretty much across the board. But as you mentioned, definitely at the high end, the premium traveler continues to travel.

International is rebounding post Olympics. Corporate is normalizing as well, and some of the low-cost carriers did mention that they were seeing some weakness on the low-end consumer side. Although it was unclear to them if that was actual demand weakness or a function of too much capacity in the marketplace.

But they did come out and validate that demand continues to remain very robust; and with capacity continuing to come out of the marketplace and be more balanced with demand, you have seen pricing inflect positive for all the airlines for the first time in several quarters. So definitely, a pretty supportive backdrop for airline demand. And that is going to show up in airline numbers in the third and fourth quarters as well, we think.

Michelle Weaver: As someone who's been in the airports a lot recently, I can definitely feel that demand has held up well. Chris, some of your companies also sell consumer products. What does consumer demand look like in your space?

Chris Snyder: I would say stable, but at soft levels. And I think a lot of the tailwinds that Ravi is seeing on the service side of the house in airlines is actually coming at the expense of my companies who sell consumer goods. You know, if you look at the consumer wallet share, service mix has not gotten back to the levels that we saw in 2019 and we think that will remain a headwind for goods purchasing going forward.

Michelle Weaver: Ravi, Chris, thank you for taking the time to talk.

Ravi Shanker: Thanks so much for having me.

Chris Snyder: Thank you.

Michelle Weaver: And to our listeners, thanks for tuning in. 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.

While the electoral impact of last week’s US presidential debate is unclear, our Global Head of Fixed Income and Thematic Research offers two guiding principles to navigate the markets during the election cycle.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about takeaways from the US presidential campaign debate. 

It's Wednesday, September 18th at 10:30am in New York. 

Last week, Vice President Harris and Former President Trump met in Philadelphia for debate. Investor interest was high, and understandably so. As our Chief Economist Seth Carpenter has previously highlighted in his research, visibility remains low when it comes to the outlook for the US in 2025. 

That’s because the election could put the country on policy paths that take economic growth in different directions. And of course, the last presidential debate in June led to President Biden’s withdrawal, changing the race dramatically. So, any election-related event that could provide new information about the probability of different outcomes and the resulting policies is worth watching. 

But, as investors well know from tracking data releases, earnings, Fedspeak, and more, potential catalysts often remain just that – potential. For the moment, we’re putting last week’s debate in that category. 

Take its impact on outcome probabilities. It could move polls, but perhaps not enough for investors to view one candidate as the clear favorite. For weeks, the polls have been signaling an extremely tight race, with only a small pool of undecided voters. While debates in past campaigns have modestly strengthened a candidate’s standing in the polls, in this race any lead would likely remain within the margin of error. 

On policy, again we don’t think the debate taught us anything new. Candidates typically use these widely watched events to influence voters’ perceptions. The details of policies and their impact tend to take a back seat to assertions of principles and critiques of their opponents. This is what we saw last week. 

So if the debate provided little new information about the impact of the election on markets, what guidance can we offer? Here again we repeat two of our guiding principles for this election cycle. 

First, between now and Election Day, expect the economic cycle to drive markets. The high level of uncertainty and the lack of precedent for market behavior in the run-up to past elections suggest sticking to the cross-asset playbook in our mid-year outlook. In general, we prefer bonds to equities. While our economists continue to expect the US to avoid a recession, growth is slowing. That bodes better for bonds, where yields may track lower as the Fed eases, as opposed to equities, where earnings may be challenged as growth slows. 

Second, lean into market moves that election outcomes could accelerate. For several months, Matt Hornbach and our interest rate strategy team have been calling for a steeper yield curve, driven by lower yields in shorter-maturity bonds. They have been guided by our economists’ steadfast view that the Fed would start cutting rates this year as inflation eases. We doubt that policies in Democratic win scenarios would change this trend, and a Republican win could accelerate it in the near term, as higher tariffs would imply pressure on growth and possibly further Fed dovishness. Pricing that path could steepen the yield curve further. 

And of course, there’s still several weeks before the election to get smart on the economic and market impacts of a range of election outcomes. We’ll keep you updated here. 

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

Our US Public Policy Strategist explains the potential impact of the upcoming presidential election on the healthcare sector, including whether the outcome is likely to drive a major policy shift.

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Welcome to Thoughts on the Market. I’m Ariana Salvatore, Morgan Stanley’s US Public Policy Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll focus on what the US election means for healthcare. 

It’s Tuesday, September 17th at 10am in New York. 

Around elections what we tend to see is voters rank healthcare pretty high among their priority list. And for that reason it’s not surprising that it generates significant debate as well as investor concern – about everything from drug pricing to potential sweeping reforms. We think that the 2024 election is unlikely to transform the US healthcare system. But there are still policies to watch that could change depending on the outcome. We outlined these in a recent note led by our equity research colleagues Erin Wright and Terence Flynn. 

To start, we think bipartisan policies should continue uninterrupted, regardless of the election outcome. Certain regulations requiring drug price and procedural transparency, for example, which affect hospitals and health plans, are unlikely to change if there is a shift of power next year. We’ve seen some regulations from the Trump era kept in place by the Biden administration; and similarly during the former president’s term there were attempts at bipartisan legislation to modify the Pharmacy Benefit Management model. 

There are some healthcare policies that could be changed through the tax code, including the extension of the COVID-era ACA subsidies. In President Biden’s fiscal year [20]25 budget request, he called for an extension of those enhanced subsidies; and Vice President Kamala Harris has proposed a similar measure. As we’ve said before on this podcast, we think tax policy will feature heavily in the next Congress as lawmakers contend with the expiring Tax Cuts and Jobs Act. So many of these policies could come into the fold in negotiations. 

Aside from these smaller potential policy changes, we think material differences to the healthcare system as we know it right now are a lower probability outcome. That’s because the creation of a new system - like Medicare for All or a Public Option - would require unified Democratic control of Congress, as well as party unanimity on these topics. Right now we see a dispersion among Democrats in terms of their views on this topic, and the presence of other more motivating issues for voters; mean[ing] that an overhaul of the current system is probably less likely. Similarly, in a Republican sweep scenario, we don't expect a successful repeal of the Affordable Care Act as was attempted in Trump’s first administration. 

The makeup of Congress certainly is important, but there are some actions that the President can leverage unilaterally to affect policy here. For example, former President Trump issued several executive orders addressing transparency and the PBM model. 

If we look at some key industries within Healthcare, our equity colleagues think Managed Care is well positioned heading into this relatively more benign election cycle. Businesses and investors are focusing on candidates' approaches to the Medicare Advantage program and the ACA Exchange, which has subsidies set to expire at the end of 2025. 

Relative to prior elections, Biopharma should see a lower level of uncertainty from a policy perspective given that the Inflation Reduction Act, or the IRA, in 2022 included meaningful drug pricing provisions. We also think a full-scale repeal of the IRA is unlikely, even in a Republican sweep scenario. So, expect some policy continuity there. 

Within Biotech, the path to rate cuts is likely a more significant driver of near-term Small and Mid-Cap sentiment rather than the 2024 election cycle. Our colleagues think that investors should keep an eye on two election-related factors that could possibly impact Biotech including potential changes to the IRA that may impact the sector and changes at the FTC, or the Federal Trade Commission, that could make the M&A environment more challenging. 

As always, we will continue to keep you abreast of new developments as the election gets closer. 

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.

With the Federal Reserve poised to make its long-awaited rate cut this week, our CIO and Chief US Equity Strategist tells us why investors have pivoted their concerns from high inflation to slowing growth. 

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what to expect as the Fed likely begins its long-awaited rate cutting cycle this week.  

It's Monday, Sept 16th at 10:30am in New York.

So let’s get after it.

After nearly 12 months of great anticipation, the Fed is very likely to start its rate  cutting cycle this week. The old adage that it is often easier to travel than arrive may apply as markets appear to have priced an aggressive Fed cutting cycle into the  middle of next year while assuming a soft-landing outcome for the economy.

More specifically, the two-year US Treasury yield is now 180 basis points below the Fed Funds Rate which is in line with the widest spread in 40 years, a level associated with a hard landing. This is the bond market's way of messaging to the Fed that they are late in getting started with rate cuts. This doesn't mean the Fed can't get ahead of it, but they may need to move faster to keep investors' hopes alive.

As a result, the odds of a 50 basis point cut have increased over the past week but it’s still well below a certainty. This is unusual going into an FOMC meeting and is setting markets up for a greater surprise either way. How the markets react to what the Fed does this week will have an even greater influence on investor sentiment than usual, in my view. Ideally, rates should rise at both the front and back end if the bond market likes the Fed’s actions because it signals they aren’t as far behind in trying to orchestrate a soft landing. Conversely, a fall in rates will be a vote of lower confidence. 

On the other side of the ledger, we have the equity market which appears to be highly convicted that the Fed has already secured the soft landing, at least at the index level. Today, the S&P 500 trades at 21x forward earnings, which also assumes a healthy path of 10 percent earnings growth in 2024 and 15 percent growth in 2025.  

Under the surface, the market has skewed much more defensively as it worries more about growth and less about high inflation. I have commented extensively in this podcast about this shift that started in April and why we have been persistently recommending defensive quality for months. With the significant outperformance of defensive sectors since April, the internals of the equity market may not be betting on a soft landing and reacceleration in growth as the S&P 500 index suggests.

Keep in mind that the S&P 500 is a defensive, high-quality index of stocks and so it typically  holds up better than most stocks as growth slows in a late cycle environment like  today. These growth concerns will likely persist unless the data turn around, irrespective of what the Fed does this week.

In the 11 Fed rate cutting cycles since 1973, eight were associated with recessions while only three were not. The performance over the following year was very mixed with half negative and half positive with a very wide but equal skew. Specifically, the average performance over the 12 months following the start of a Fed rate cutting cycle is 3.5 percent – or about half of the longer-term average returns. The best 12-month returns were 33 percent, while the worst was a negative 31 percent.  

Bottom line, it’s generally a toss-up at the index level. The analysis around style and sectors is clearer. Value tends to outperform growth into the first cut and underperform growth thereafter. Defensives tend to outperform cyclicals both before and after the cut. Large caps also tend to outperform small caps both before and after the first rate cut. These last two factor dynamics are supportive of our defensive and large cap bias as Fed cuts often come in a later cycle environment. It’s also why we are sticking with it. 

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.

After sending global markets in a brief tailspin in early August, the Bank of Japan is once again the center of attention. Our Global Chief Economist and Chief Asia Economist discuss the central bank’s next steps to help ease volatility and inflation.

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

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

Seth Carpenter: And on today's episode, Chetan and I are going to be discussing the Bank of Japan and the role it has been playing in recent market turmoil.

It's Friday, September 13th at 12.30pm in New York.

Chetan Ahya: And it's 5.30pm in London.

Seth Carpenter: Financial markets have been going back and forth for the past month or so, and a lot of what's been driving the market movements have been evolving expectations of what's going on at central banks. And right at the center of it has been the Bank of Japan, especially going back to their meeting at the very end of July.

So, Chetan, maybe you can just level set us about where things stand with the Bank of Japan right now? And how they've been communicating with markets?

Chetan Ahya: Well, I think what happened, Seth, is that Bank of Japan (BoJ) saw that there was a significant progress in inflation and wage growth dynamic. And with that they went out and told the markets that they wanted to start now increasing rate hikes. And at the same time, the end was weakening.

And to ensure that they kind of convey to the markets that they want to be now taking rates higher, the governor of the central bank came out and indicated that they are far away from neutral.

Now while that was having the desired effect of bringing the yen down, i.e. appreciated. But at the same time, it caused a significant volatility in the equity markets and make it more challenging for the BoJ.

Seth Carpenter: Okay, so I get that. But I would say the market knew for a long time that the Bank of Japan would be hiking. We've had that in our forecast for a while. So, do you think that Governor Ueda really meant to be quite so aggressive? That meeting and his comments subsequently really were part of the contribution to all of this market turmoil that we saw in August. So, do you think he meant to be so aggressive?

Chetan Ahya: Well, not really. I think that's the reason why what we saw is that a few days later, when the deputy governor Uchida was supposed to speak, he tried to walk back that hawkishness of the governor. And what was very interesting is that the deputy governor came out and indicated that they do care for financial conditions. And if the financial conditions move a lot, it will have an impact on growth and inflation; and therefore, conduct of monetary policy.

In that sense, they conveyed the endogeneity of financial conditions and their reaction function. So, I think since that point of time, the markets have had a little bit of reprieve that BoJ will not take up successive rate hikes, ignoring what happens to the financial conditions.

Seth Carpenter: But this does feel a little bit like some back and forth, and we've seen in the market that the yen is getting a little bit whipsawed; so the Bank of Japan wants to hike, and markets react strongly. And then the Bank of Japan comes out and says, ‘No, no, no, we're not going to hike that much,’ and markets relax a little bit. But maybe that relaxation allows them to hike more.

It kind of reminds me, I have to say, of the 2014 to 2015 period when the Federal Reserve was getting ready to raise interest rates for the first time off of the zero lower bound after the financial crisis. And, you know, markets reacted strongly -- when then chair Yellen started talking about hiking and because of the tightening of financial conditions, the Fed backed down.

But then because markets relaxed, the Fed started talking about hiking again. Do you think that's an apt comparison for what's going on now?

Chetan Ahya: Absolutely, Seth. I think it is exactly something similar that is going on with Bank of Japan.

Seth Carpenter: So, I guess the question then becomes, what happens next? We know with the Fed, they eventually did hike rates at the end of 2015. What do you think we're in line for with the Bank of Japan, and is it likely to be a bumpy ride in the future like it has been over the past couple months?

Chetan Ahya: Well, so I think as far as the market’s volatility is concerned, we do think that the fact that the BoJ has come out and indicated that their reaction function is such that they do care about financial conditions. Hopefully we should not see the same kind of volatility that we saw at the start of the month of August.

But as far as the next steps are concerned, we do see BoJ taking up one more rate hike in January 2025. And there is a risk that they might take up that rate hike in December.

But the reason why we think that they will be able to take up one more rate hike is the fact that there is continued progress on wage growth and inflation; and wage growth is the most important variable that BoJ is tracking.

We just got the last month's wage growth number. It has risen up to 3 percent. And going forward, we think that as the BoJ gets comfort that next year's wage negotiations are also heading in the right direction, they will be able to take one more rate hike in January 2025.

Well, Seth, I think, you know, when we are talking about this volatility that we saw in the financial markets and particularly yen, the other side of this story is what the Fed has to do, and what is Fed indicating in terms of its policy path. And we saw that, after the nonfarm payrolls data, Governor Waller was indicating that the Fed could consider front-loading its rate cuts. What are your thoughts on that?

Seth Carpenter: So, we do think the Fed's getting ready to start cutting rates. Our baseline is that they move at 25 increments per meeting, from now through the middle of next year. I would take Governor Waller's comments though about front-loading cuts -- which I took to mean, you know, the possibility of 50 basis point rate moves -- very much in context, and with a grain of salt.

When he gave that speech, I think what he was trying to do, and I think the last paragraph of that speech really bears it out. He was saying there's a lot of uncertainty here. He said, if the data suggests that they need to front load rates, then he would advocate for it. But he also said that, if the data implied that they need to cut at consecutive meetings, he'd be in favor of that as well. So, he was saying that the data are going to be the thing that drives the policy decisions.

But thanks for asking that question. And thanks to the listeners. If you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

Our Head of Corporate Credit Research looks at the Fed’s approach to rate cuts, seasonal trends and the US election to explain why the next month represents a crucial window for credit’s future. 

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss why the next month is a critical window for credit.

It's Thursday, September 12th at 9am in New York. 

We’ve liked corporate credit as an asset class this year and think the outlook over the next 6-12 months remains promising. At a high level, credit likes moderation, and that continues to be exactly what Morgan Stanley’s economists are forecasting; with moderate growth, moderate inflation, and moderating policy in the US and Europe. Meanwhile, at the ground level, corporate balance sheets are in good shape, and demand for fixed income remains strong, dynamics that we think are unlikely to shift quickly. 

But this good credit story is now facing a critical window. As we’ve discussed recently on this program, the Fed has taken a risk with monetary policy, continuing to keep interest rates elevated despite increasing indications that they should be lower. U.S. inflation has been coming down rapidly, to the point where the market now thinks the rate of inflation over the next two years will be below what the Fed is targeting. The labor market is slowing, and government bond markets are now assuming that the Fed will have to make much more significant adjustments to policy. 

And so, this becomes a race. If the economic data can hold up for the next few months, while the Fed does make those first gradual rate cuts, it will help reassure markets that monetary policy is reasonable and in-line with the underlying economy. But if the data weakens more now, the market is vulnerable. Monetary policy works with a lag, meaning rate cuts are not going to help anytime soon. And so, it becomes easier for the market to worry that growth is slowing too much, and that the cavalry of rate cuts will be too late to arrive. 

The second immediate challenge is so-called seasonality. Over almost a century, September has seen significantly weaker performance relative to any other month. Seasonality always has an element of mysticism to it, but in terms of specific reasons why markets tend to struggle around this time of year, we’d point to two factors. First, after a summer lull, you tend to see a lot of issuance, including corporate bonds issuance. And for Equities, September often sees more negative earnings revisions, as companies aim to bring full-year estimates in line with reality. Lots of supply and weaker earnings revisions are often a tough combination. 

A final element of this critical window is the approaching US election. This appears to be an extremely close race between candidates with very different policy priorities. If investors get more nervous that monetary policy is mis-calibrated, or seasonality is unhelpful, the approaching election provides yet another reason for investors to hold back. 

All of this is why we think the next month is a critical window for credit, and why we’d exercise a little bit more caution than we have so far this year. But we also think any weakness is going to be temporary. By early November, the US election will be over, and we think growth will be holding up, inflation will keep coming down, and interest rate cuts will be well underway. And while September is historically a bad month for stocks and credit, late-October onward is a different and much better story. Any near-term softness could still give way to a stronger finish to the year. 

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.

Office buildings continue to struggle in the post-pandemic era, but our Chief Fixed Income Strategist notes that other properties have turned a corner. 

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about how the challenges facing the US commercial real estate markets have evolved and talk about where they are headed next.

It's Wednesday, Sep 11th at 10 am in New York.

Over the last year and half, the challenges of commercial real estate, or CRE in short, have been periodically in the spotlight. The last time we discussed this issue here was in the first quarter of this year. That was in the aftermath of loan losses announced by a regional bank that primarily focused on rent-stabilized multifamily and CRE lending in the New York metropolitan area. At the same time, lenders and investors in Japan, Germany and Canada also reported sizable credit losses and write-down related to US commercial real estate.

At that time, we had said that CRE issues should be scrutinized through the lenses of lenders and property types; and that saw meaningful challenges in both – in particular, regional banks as lenders and office as a property type.

Rolling the calendar forward, where do things stand now?

Focusing on the lenders first, there is some good news. While regional bank challenges from their CRE exposures have not gone away, they are not getting any worse. That means incremental reserves for CRE losses have been below what we had feared. Our economists’ expectations of Fed’s rate cuts on the back of their soft-landing thesis, gives us the conviction that lower rates should be an incremental benefit from a credit quality perspective for banks because it alleviates pressure on debt service coverage ratios for borrowers. Lower rates also give banks more room to work with their borrowers for longer by providing extensions. For banks, this means while CRE net charge-offs could rise in the near term, they are likely to stabilize in 2025.

In other words, even though the fundamental deterioration in terms of the level of delinquencies and losses may be ahead, the rate of change seems to have clearly turned. In that sense, as long as the rate cuts that we anticipate materialize, the worst of the CRE issues for regional banks may now be behind us.

From the lens of property types, it is important not to paint all property types with the same brushstroke of negativity. Office lots remain the pain point. Looking at the payoff rates in CMBS pools gives us a granular look at the performance across different property types.

Overall, 76 per cent of the CRE loans that matured over the past 12 months paid off, which is a pretty healthy rate. However, in office loans, the payoff rate was just 43 per cent. Other property types were clearly much better. For example, 100 per cent of industrial property loans, 96 per cent of multi-family loans, 89 per cent of hotel loans that matured in the last 12 months paid off. The payoff rates in retail property loans were a bit lower but still pretty healthy at 76 per cent, in clear contrast to office properties. Delinquency rates across property types also show a similar trend with office loans driving the lion’s share of the overall increase in delinquencies.

In short, the secular headwinds facing the office market have not dissipated. Office property valuations, leasing arrangements and financing structures must adjust to the post-pandemic realities of office work. While this shift has begun, more is needed. So, there is really no quick resolution for these challenges which we think are likely to persist. This is especially true in central business district offices that require significant capex for upgrades or repurposing for use as residential housing.

Overall, we stick to our contention that commercial real estate risks present a persistent challenge but are unlikely to become systemic for the economy. 

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

With the generational shift in the US housing market underway, our analysts discuss the impact this trend will have on residential real estate investing.

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Ron Kamdem: Welcome to Thoughts on the Market. I'm Ron Kamdem, head of Commercial Real Estate Research and the US Real Estate Investment Trust team within Morgan Stanley Research.

Lauren Hochfelder: And I'm Lauren Hochfelder, Co-Chief Executive Officer of Morgan Stanley Real Estate Investing, the global private real estate investment arm of the firm.

Ron Kamdem: And on this special episode of Thoughts on the Market, we’ll discuss the tangible impact of shifting demographics on the residential real estate investing space.

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

So, Lauren, for several years now, we've been hearing about millennials overtaking the baby boomers. As a reminder, millennials are people between the age of 28 and 43. So someone like me. And there’s about 72 million millennials right now. Baby boomers are around 59 to 78; and there's about 69 million at the moment. This demographic shift will have a profound impact on all sectors of the economy, including residential housing. So, let's lay the foundation first. What are the current needs of baby boomers and millennials when it comes to their homes?

Lauren Hochfelder: Yeah, this is such an interesting moment, Ron, because as you say, their needs are shifting. Over the last 15 years, what have millennials wanted? They have wanted multifamily. They have wanted rental apartment units. And by the way, they've wanted, generally speaking, small ones in cities.

Ron Kamdem: Yup.

Boomers? They have been disproportionately residing in single family homes that they own, and that they've owned for a long time. But here we are, as millennials reach peak household formation years and boomers approach their 80-year-old mark. There's a real shift.

We have millennials growing up and growing out, and boomers growing older. And that means millennials need more space; boomers need more services. Housing with increased care options. And that really leads to three things.

One, pockets of oversupply of multifamily. Developers develop to the rearview mirror; and we have way too much of what they wanted yesterday and too little of what they wanted to what they want tomorrow. The second is increased demand for single family rental in more suburban locations to meet the needs of those millennials. And the third is increased demand for senior housing for the boomers.

Ron Kamdem: Excellent. So, when we look at the next five to ten years, let's consider each of these generations. Demand for senior housing is increasing significantly. Where are we in this process, and what's your expectation for the next decade?

Lauren Hochfelder: Look, we think this is the golden age for senior housing. The demand wave is upon us, supply is way down. And by the way, labor costs, which have been a real headwind, are finally abating. New construction of senior housing has basically fallen off a cliff. It is down 75 per cent from its peak; if you look at the first quarter of this year, it's basically at GFC levels. And third, the senior wealth effect. Not only do seniors need this product, they can afford it.

They have been in those homes, they've owned those homes for a very long time, and over that period, home prices have appreciated. So, seniors are in a position where they can really afford to move into these senior living facilities.

Ron Kamdem: And what about millennials? As they get older, how are their housing needs evolving?

Lauren Hochfelder: I'd say three things. It's they need more space. So single family rental versus multifamily. The second is migratory shifts, right? It's no longer -- I have to live in San Francisco or New York. You're seeing real growth in the southeast and Texas. And the third is this preference to rent. Now, a lot of that's affordability driven.

Ron Kamdem: Right.

Lauren Hochfelder: But I think there's also mobility. There's just general preference. I mean, this is a generation that doesn't own a landline, right? So, they want to rent. They don't want to buy.

Ron Kamdem: So, given these trends as an actual real estate investor, how do you view the supply and demand dynamics within residential investing? And where do you see the biggest opportunities?

Lauren Hochfelder: Look, I think housing in general is attractive to invest in. There's simply too little of it. But you really can't paint a broad brush. You need to invest in the type of housing with the best outlook. And you and I can sit here and debate what's going to happen with interest rates. But what is not debatable is that these two large age groups are going to drive demand disproportionately.

And so rather than speculating on interest rates, let's calculate the number of people in these generations. And so that means that we want to invest in single family. We want to invest in seniors housing, and we want to invest in the markets where these groups want to live.

So, let's turn it around. We've been talking about this growing senior population and, you know, we and my side of the business. We've been investing in a lot of senior housing communities. But how does this affect your world? You cover the entire US public real estate investment trust universe. How are you thinking about these things?

Ron Kamdem: So, our investors are really focused on secular trends that they can invest over a long period of time. And there's really two that I would like to call out. So, the first is the rise of senior housing communities.

As you mentioned earlier, if you think about the US population, the population that's 65 and over is really the addressable market. And we do expect that number to rise to about 21 per cent of the population or 71 million people.

Lauren Hochfelder: So, think about one in four people being eligible or appropriate for senior housing. It's amazing.

Ron Kamdem: That’s an incredible demand function.

Now, the second piece of it is historically these seniors have actually shied away from senior housing. So, the first sort of trend and inflection point that I want to call out is we do think there's an opportunity for penetration race -- not only to flatten out, but to start increasing. And that's driven exactly by your earlier comment, which is affordability. Remember, about 75 per cent of seniors actually own their own homes, and they've seen a significant amount of price appreciation. Since 2010, their home prices have gone up 80 per cent, which is about two times the rate of inflation.

Second investable trend is the move of outpatient services outside of the hospital setting. So, if you go back to the eighties, only about 16 per cent of services were being done outside of the hospital. In 2020, that number was close to 68 per cent and we think that's going to keep rising. The reason being because of surgical advances, there's a lot of projects that can be done outside of the hospital. Whether it's, you know, knee replacements, trigger finger surgery, cataract surgeries, and so forth. In addition to that, the expansion of Medicare coverage has allowed for reimbursement of these services, again, outside of the hospital.

So, we think these are trends that are in place that should continue over the next sort of decade and drive more demand to the healthcare real estate space.

Lauren Hochfelder: So, what should we be nervous about? What concerns you?

Ron Kamdem: Look, I think on the senior housing side, there's always two factors that we focus on. So, the first is labor. This remains a very labor-intensive industry. But in the US, historically, people coming out of college, they're not necessarily going into the health care space. So, there's been moments of labor shortages. This happened exactly after the pandemic. Luckily, today, the labor situation has abated and you're seeing sort of labor costs back to inflationary type levels.

The second piece of it is just the age of the facilities. Now, keep in mind, there's still a lot of facilities with the average age of about 41, right. And everybody has in the back of their mind, these older facilities with older carpets and so forth. So, when we're thinking about investing in the space, we're always focused on the newer assets, the better quality that are going to provide a better experience for the tenant.

Lauren Hochfelder: So, given these shifts, what segments of your world are poised to benefit the most?

Ron Kamdem: The real estate public market, there's about 160 REITs across 16 different subsectors; and the senior housing subsector is by far the most compelling in our minds. If you think about the REIT market, the average sort of earnings growth is 3 to 4 per cent. However, the senior housing sector, we think you can get 10 per cent or more growth over the next three to five years. The reason being when the pandemic hit, this was an industry that saw occupancy go from 90 per cent to 75 per cent.

There was a moment in time where people thought you'd never put any seniors in the facility again. Well, the exact opposite has happened, and now we're seeing occupancy gains of about 300 basis points of about 3 per cent every year. On top of some pricing power, call it 5, 6 or 7 per cent. So, we're looking at a sector where we think organically you can grow sort of high single digits. With a little bit of operating leverage, you can get to a total earning growth of double digits, which is very compelling relative to the rest of the REIT market.

Lauren Hochfelder: Let's go back to your generation, as you said. Let's go back to the millennials. How do those shifting needs affect which part of the universe you would invest in?

Ron Kamdem: One of the things that I think every real estate owner’s thinking about is how to integrate their platform so that they're more millennial friendly. They're going online. They're using their phones, and I think we're seeing a much bigger investment in marketing dollars on a web presence, on a web platform, and on a mobile friendly app, certainly to be able to interface with that millennial and help with customer acquisitions.

So, I would say that's probably the biggest difference -- is how you target that population in a different way than you did historically.

Lauren Hochfelder: Yeah, I mean we all shop online, shouldn't we get our homes online, right?

Ron Kamdem: That's right. All right, Lauren. Well, thanks for taking the time to talk.

Lauren Hochfelder: Yeah, this been great, Ron. I always enjoy us catching up.

Ron Kamdem: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. It helps more people to find the show.

*****

Lauren Hochfelder is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley.

Following weaker-than-expected August jobs data, our CIO and Chief U.S Equity Strategist lays out how the Federal Reserve can ease concerns about a possible hard landing.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the labor market’s impact on equity markets.

It's Monday, Sept 9th at 11:30am in New York. So let’s get after it.

Last week, I wrote a detailed note discussing the importance of the labor data for equity markets. Importantly, I pointed out that since the materially weaker than expected July labor report, the S&P 500 has bounced more than other "macro" markets like rates, currencies and commodities. In the absence of a reacceleration in the labor data, we concluded the S&P 500 was trading out of sync with the fundamentals. 

Over the past week, we received several labor market data points, which were weaker than expected. First, the Job Openings data for July was softer than expected coming in at 7.7mm versus the consensus expectation of 8.1mm. In addition, June's initial result was revised lower by 274k. This essentially supported the view that the weak payrolls data in July may, in fact, not be related to weather or other temporary issues. 

Second, the job openings rate fell to 4.6%, which is very close to the 4.5% level Fed Governor Waller has cited as a threshold below which the unemployment rate could rise much faster. Third, the Fed's Beige Book came out last week. It indicated that activity remains sluggish with 9 of the 12 Federal Reserve districts reporting flat or declining activity in August, though commentary on labor markets was more neutral, rather than negative. These data sync nicely with the Conference Board’s Employment Trends Index, which I find to be a very objective aggregate measure of the labor market's direction. This morning, we received the latest release for August Conference Board labor market trends and the trend remains down, but not necessarily recessionary. 

Of course, the main event last week was Friday's monthly jobs and unemployment reports, where the payroll survey number came in below consensus at 142k. In addition, last month's result was revised lower from 114k to 89k. Meanwhile, the unemployment rate fell by only a couple of basis points leaving investors unconvinced that July’s labor weakness was overstated. 

Given much of these labor and other growth data have continued to skew to the downside, the macro markets (like rates, currencies, and Commodities) have been trading with more concern about potential hard landing risks. Perhaps nowhere is this more obvious than with 2-year US Treasuries. As of Friday, the spread between the 2-year Treasury yields and the Fed Funds Rate matched the widest levels in the past 40 years. This pricing suggests the bond market believes the Fed is behind the curve from an easing standpoint. On Friday, the equity market started to get in sync with this view and questioned whether a 25bp cut in September would be an adequate policy response to the labor data. In the context of an equity market that is still quite rich and based on well above average earnings growth assumptions, the correction on Friday seems quite appropriate. 

In my view, until the bond market starts to believe the Fed is no longer behind the curve, labor data reverses course and improves materially or additional policy stimulus is introduced, it will be difficult for equity markets to trade with a more risk on tone. This means valuations are likely to remain challenged for the overall index, while the leadership remains more defensive and in line with our sector and stock recommendations. We see two ways in which the Fed can get ahead of the curve—either faster cutting than expected which is unlikely in the absence of recessionary data; or the labor data starts to improve in a convincing manner and 2-year yields rise. Given the Fed is in the blackout period until next week’s FOMC meeting, and there are not any major labor data reports due for almost a month, volatility will likely remain elevated and valuations under pressure overall. This all brings our previously discussed fair value range for the S&P 500 of 5000-5400 back into view.

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 Head of Corporate Credit Research, Andrew Sheets, expects a sticky but shallow cycle for defaults on loans, with solid quality overall in high-grade credit.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss some longer-term thoughts on the credit market and the economic cycle.

It's Friday, September 6th at 2pm in London.

Concerns around US growth have risen, an issue that will probably persist even after today’s US Payrolls report came roughly inline with expectations. At Morgan Stanley, we continue to expect moderate slowing in growth, not a slump. By the middle of next year, our economists see growth slowing to a still respectable 2% growth rate, and a total of seven rate cuts.

While growth is set to slow, we think corporate balance sheet metrics are unusually good in the face of this slowing. Indeed, the credit quality of the US investment grade and BB credit markets, which represent the vast majority of corporate credit outstanding, have actually improved since the Fed started hiking rates.

Now, looking ahead, there's understandable concern that these currently good credit metrics won't be sustainable as companies will have to refinance the very cheap borrowing that they received immediately after COVID, with the more expensive costs of today's currently higher yields. But we actually think balance sheets will be reasonably robust in light of this reset, and so their ultimate rate sensitivity could be relatively low.

One reason is that a wave of refinancing means companies have already tackled a significant portion of their upcoming debt, reducing the so-called rollover or refinancing risk. Interest coverage for floating rate borrowers has stabilized and should actually improve as the Fed starts to lower rates.

The debt service costs for higher rated companies will increase as cheaper debt matures and has to be replaced with more expensive borrowing; but we stressed this is a pretty slow process given the long-term nature of a lot of this borrowing. And so, overall, we think the headwinds from higher debt costs are going to be manageable, with the problems largely confined to a smaller cohort of the lowest quality issuers.

We think all of that will drive a so-called sticky but shallow default cycle, with defaults driven by higher borrowing costs at select issuers rather than a single problem sector or particularly poor corporate earnings. And there are also some important offsets. Morgan Stanley's forecast suggests that the Fed will be cutting rates, which will reduce overall borrowing costs over the medium term. And another notable theme over the last two years is that more defaults have been becoming so-called restructurings rather than bankruptcies. These restructurings are more likely to leave a company operating -- just under new ownership -- and create less negative feedback into the real economy.

Now, against all this, we're mindful that credit spreads are tight, i.e. lower than average. But importantly, we don't think this reflects some sort of euphoria from either the lenders or the borrowers.

All-in borrowing costs for corporates remain high, and that's made corporates less likely to be aggressive or increase their leverage. Indeed, since COVID, the overall high yield bond and loan markets have actually shrunk. Leverage buyout activity has been muted and corporate leverage has gone sideways.

These are not the types of things you see when corporates are being particularly aggressive and credit unfriendly. Credit markets love moderation and that's very much what Morgan Stanley's economic forecasts over the medium term expect. Spreads may be tight. But we think they're currently supported by strong fundamentals, modest supply, and improving technicals.

Today's roughly inline payroll number won’t resolve the uncertainty around growth, but longer term, we think the picture remains encouraging.

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 US Public Policy and Global Commodities strategists discuss how the outcome of the election could affect energy markets in the US and around the world.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US public policy strategist.

Martijn Rats: And I'm Martijn Rats, Global Commodity Strategist.

Ariana Salvatore: Today we'll be talking about a topic that's coming into sharper focus this fall. How will the US presidential election shape energy policy and global energy markets?

It's Thursday, September 5th at 10am in New York.

Martijn Rats: And 3pm in London.

Ariana Salvatore: As we enter the final leg of the US presidential campaign, Harris and Trump are getting ready to go head-to-head on a number of key topics. Healthcare, housing, the state of the economy, foreign policy; and also high on the agenda -- energy policy.

So, Martijn, let's set the stage here. Prices at the gas pump in the US have been falling over recent weeks, which is atypical in the summer. What's happening in energy markets right now? And what's your expectation for the rest of the year?

Martijn Rats: Yeah, it's a relevant question. Oil prices have been quite volatile recently. I would say that objectively, if you look at the market for crude oil, the crude oil market is tight right now. We can see that in inventories, for example, they are buying large drawing, which tell[s] you, the demand is outstripping supply.

But there are two things to say about the tightness in the crude oil market. First of all, we're not quite seeing that tightness merit in the markets for refined products. So, get the market for gasoline, the market for diesel, et cetera. At the moment, the global refining system is running quite hard.

But they're also producing a lot of refined product. A lot of gasoline, a lot of diesel. They're pushing that to their customers. Demand is absorbing that, but not quite in a convincing manner. And you can see that in refining margins. They have been steadily trending down all summer.

The second thing to say about the tightness and crude is that it's largely driven by a set of factors that will likely to be somewhat temporary. Seasonally demand is at its strongest -- that helps. The OPEC deal is still in place. And as far as we can see in high frequency data, OPEC is still constraining production.

And then thirdly, production has been growing in a number of non-OPEC countries. But that absent flows and the last couple of months have seen somewhat of a flat spot in non-OPEC supply growth.

Now, those factors have created the tightness that we're seeing currently in the third quarter. But if you start to think about the oil market rolling into the fourth quarter and eventually 2025, a lot of these things going to reverse. The seasonal demand tailwinds that we are currently enjoying; they turn into seasonal demand headwinds in four q[uarter]and one q[uarter] -- seasonally weaker quarters of the year. Non-OPEC production will likely resume its upward trajectory based on the modeling of projects that we've done. That seems likely. And then OPEC has also said that they will start growing production again with the start of the fourth quarter.

Now, when you put that all together, the market is in deficit now. It will return to a broadly balanced state in the fourth quarter, but then into a surplus in 2025. Prices look a little into the future. They discount the future a little bit

Now, as the US election approaches, investors are increasingly concerned how a Trump versus Harris win would affect energy policy and markets going forward. Ariana, how much and what kind of authority does the US president actually have in terms of energy policy? Can you run us through that?

Ariana Salvatore: Presidential authorities with respect to energy policy are actually relatively limited. But they can be impactful at the margin over time. What we tend to see actually is that production and investment levels are reasonably insulated from federal politics.

Only about 25 per cent of oil and 10 per cent of natural gas is produced on federal land and waters in the US. You also have this timing factor. So, a lot of these changes are really only incremental; and while they can affect levels at the margin, there's a lag between when that policy is announced and when it could actually flow through in terms of actual changes to supply levels. For example, when we think of things like permitting reform, deregulation and environmental review periods and leasing of federal lands, these are all policy options that do not have immediate impacts; and many times will span across different presidential administrations.

So, you might expect that if a new president comes into office, he or she could reverse many of the executive actions taken by his or her predecessor with respect to this policy area.

Martijn Rats: And what have Trump and Harris each said so far about energy policy?

Ariana Salvatore: So, I would say this topic has been less prevalent in Harris's campaign, unless we're talking about it in the context of the energy transition overall. She hasn't laid out yet specific policy plans when it comes to energy; but we think it's safe to assume that you could see her maintain a lot of the Biden administration's clean energy goals and the continued rollout of bills like the Inflation Reduction Act, which contained a whole host of energy tax credits toward those ends.

Now, conversely, Trump has focused on this a lot because he's been tying energy supply to inflation, making the case that we can lower inflation and everyday costs by drilling more. His policy platform, and that of the GOP has been to increase energy production across the board. Mainly done by streamlining, permitting and loosening restrictions on oil, natural gas, and coal.

Now, to what I said before, some of that can be accomplished unilaterally through the executive branch. But other times it might require the consent of Congress, and consent from states -- because sometimes these permitting lines cross state borders.

So, Martijn, from your side, how quickly can US policy, whether it's driven by Trump or Harris, affect energy markets and change production levels and therefore supply?

Martijn Rats: Yeah, like you just outlined, the answer to that question is only gradually. Regulation is important, but economics are more important. If you roll the clock back to, say, early 2021, when President Biden has just took office; on day one, he famously canceled the permit for the Keystone XL pipeline.

But if you now look back, at the last four years, start to finish; American oil production, grew more under Biden, than any other president in the history of the United States. With the exception of Obama, who, of course, enjoyed the start of the shale revolution.

Production is close, to record levels, which were set just before COVID, of course. So, in the end, the measures that President Biden put in place, have had only a very limited impact on oil production. The impact that the American president can have is only -- it's only gradual.

Ariana Salvatore: So, as we've mentioned, expanding energy development has been a massive plank of Trump's campaign platform. And listeners will also remember that during his term in office, he supported energy development on federal land. If Trump wins in November, what would it mean for oil supply and demand both in the US and globally?

Martijn Rats: Admittedly, it's somewhat of a confusing picture. So, if you look at oil supply, you have to split it in perhaps a domestic impact and an international impact. Domestically, Donald Trump has famously said recently that he would return the oil industry to “Drill baby drill,” which is this, this shorthand metaphor for, abundant drilling in an effort to significantly accelerate oil production.

But as just mentioned, there is little to be unleashed because during President Biden, the American oil industry hasn't really been constrained in the first place.

A lot of American EMP companies are focused on capital discipline. They're focused on returns on free cashflow on shareholder distributions. With that come constraints to capital expenditure budgets that probably were not in place several years ago with those CapEx constraints, production can only grow so fast.

That is a matter of shareholder preference. That is a matter of returns. And regulation can change that a little bit, but not so much.

If you look at the perspective outside the United States, it is also worth mentioning that in the first Trump presidency, President Trump famously put secondary sanctions on the export of crude oil from Iran. At the time that significantly constrained crude oil supply from Iran, which in 2018 played a key role in driving oil prices higher.

Now, it's an open question, whether that policy can be repeated. The flow of oil around the world has changed since then. Iranian oil isn't quite going to the same customers as it did back then. So, whether that policy can be replicated, remains to be seen. But whilst the domestic perspective -- i.e. an attempt to grow production -- could be interpreted as a potential bearish factor for the price of oil, the risk of sanctions outside the United States could be interpreted as a potential bullish risk for oil.

And this is, I think, also why the oil market struggles to incorporate the risks around the presidential election so much. At the moment, we're simply confronted with a set of factors. Some of them bearish, some of them bullish, but it remains hard to see exactly which one of them played out. And, at the moment they don't have a particular skew in one direction.

So, we're just confronted with options, but little direction.

Ariana Salvatore: Makes sense. So, I think that makes this definitely a policy area that we'll be paying very close attention to this fall. I suppose we'll also both be tuning into the upcoming debate, where we might get a better sense of both sides policy plans. If we do learn anything that changes our views, we'll be sure to let you know.

Martijn, thanks for taking the time to talk

Martijn Rats: 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.

Despite a flurry of election news, little may have changed for investors weighing the possible outcomes. Our Head of Fixed Income and Thematic Research, Michael Zezas, explains why this is the case as we move closer to Election Day.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about recent developments in the US election.

It's Wednesday, September 4th at 10:30am in New York. 

While news headlines might make it seem a lot has changed in recent weeks around the US election, in our view not much has changed at all. And that’s important for investors to understand as they navigate markets between now and Election Day on November 5th. Let me explain. 

In recent weeks, we've had the Democratic convention, fresh polls, and a third party candidate withdraw from the race and endorse former President Trump. But all appear to reflect only marginal impacts on the probabilities of different electoral outcomes. 

Take the withdrawal of independent candidate Robert F Kennedy Junior, which does not appear to be a game changer. Historical precedent is that third party candidates rarely have a path to even winning one state's electoral votes. Further, in polls voters tend to overstate their willingness to support third parties ahead of election day. And it's also not clear that Kennedy withdrawing clearly benefits Democrats or Republicans.  

Kennedy originally ran for President as a Democrat, and so was thought to be pulling from likely Democratic voters. However, polls suggest his supporter’s next most likely choice was nearly split between Trump and Harris.  

So while it’s possible that Kennedy’s decision to endorse Trump upon dropping out could be meaningful, given how close the race is, we’re unlikely to be able to observe that potentially marginal but meaningful effect until after the election has passed. And such effects could easily be offset by small shifts favoring Democrats, who are showing some polling resiliency in states where just a couple months ago the election was not assumed by experts to be close.  

For example, Cook Political Report, a site providing non-partisan election analysis, shifted its assessment of the Presidential election outcome in North Carolina from “lean Republican” to a “toss-up.” Similarly, in recent weeks the site has shifted states like Arizona, Nevada, and Georgia into that same category from “lean Republican.” These shifts are mirrored in several other polls released last week showing a close race in the battleground states. 

So, for all the changes and developments in the last week, we think we’re left with a Presidential race that’s difficult to view as anything other than a tossup. To borrow a term from the world of sport – it’s a game of inches. Small improvements for either side can be decisive, but as observers we may not be able to see them ahead of time.  

And so that brings us back to our guidance for investors navigating the run up to the election. Let the democratic process unfold and don’t make any major portfolio shifts until more is known about the outcome. That means the economic cycle will drive markets more than the election cycle in the next couple months. 

In our view, that favors bonds over stocks. Lower inflation enables easier monetary policy and lower interest rates, good for bond prices; but growth concerns should weigh on equities.  

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

While venture capital is taking a more cautionary approach with crypto startups, the buzz around GenAI is only increasing.

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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what private markets can tell us about the viability and investability of disruptive technologies. 

It’s Tuesday, the 3rd of September, at 2pm in London. 

For the past three years we have been tracking venture capital funding to help stay one step ahead of emerging technologies and the companies that are aiming to disrupt incumbent public leaders. Private growth equity markets are -- by their very definition – long-duration, and therefore highly susceptible to interest rate cycles. 

The easy-money bubble of 2021 and [20]22 saw venture funding reach nearly $1.2trillion dollars – more than the previous decade of funding combined. However, what goes up often comes down; and since their peak, venture growth equity capital deployment has fallen by over 60 percent, as interest rates have ratcheted ever higher beyond 5 percent. 

So as interest rates fall back towards 3.5 percent, which our economists expect to happen over the coming 12 months, we expect M&A and IPO exit bottlenecks to ease. And so too the capital deployment and fundraising environment to improve. 

However, the current funding market and its recovery over the coming months and years looks more imbalanced, in our view, than at any point since the Internet era. Having seen tens- and hundreds of billions of dollars poured into CleanTech and health innovations and battery start-ups when capital was free; that has all but turned to a trickle now. On the other end of the spectrum, AI start-ups are now receiving nearly half of all venture capital funding in 2024 year-to-date. 

Nowhere is that shift in investment priorities more pronounced than in the divergence between AI and crypto startups. Over the last decade, $79billion has been spent by venture capitalists trying to find the killer app in crypto – from NFTs to gaming; decentralized finance. As little as three years ago, start-ups building blockchain applications could depend on a near 1-for-1 correlation of funding for their projects with crypto prices. Now though, despite leading crypto prices only around 10 percent below their 2021 peak, funding for blockchain start-ups has fallen by 75 percent. 

Blockchain has a product-market-fit and a repeat-user problem. GenerativeAI, on the other hand, does not. Both consumer and enterprise adoption levels are high and rising. Generative AI has leap-frogged crypto in all user metrics we track and in a fraction of the time. And capital providers are responding accordingly. Investors have pivoted en-masse towards funding AI start-ups – and we see no reason why that would stop. 

The same effect is also happening in physical assets and in the publicly traded space. Our colleague Stephen Byrd, for example, has been advocating for some time that it makes increasing financial sense for crypto miners to repurpose their infrastructure into AI training facilities. Many of the publicly listed crypto miners are doing similar maths and coming to the same outcome. 

For now though, just as questions are being asked of the listed companies, and what the return on invested capital is for all this AI infrastructure spend; so too in private markets, one must ask the difficult question of whether this unprecedented concentration around finding and funding AI killer apps will be money well spent or simply a replay of recent crypto euphoria. It is still not clear where most value is likely to accrue to – across the 3000 odd GenerativeAI start-ups vying for funding. 

But history tells us the application layer should be the winner. For now though, from our work, we see three likely power-law candidates. The first is breakthroughs in semiconductors and data centre efficiency technologies. The second is in funding foundational model builders. And the third, specifically in that application layer, we think the greatest chance is in the healthcare application space. 

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

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

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

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

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

Original Release Date August 8, 2024: Our Head of Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.

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Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare? 

It’s Thursday, August the 8th, at 4pm in London.   

As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system. 

Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years, according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.

The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face. 

Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day. 

BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.

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

As the US Federal Reserve mulls a forthcoming interest rate cut, our Head of Corporate Credit Research and Global Chief Economist discuss how it is balancing inflationary risks with risks to growth.

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

Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley’s Global Chief Economist.

Andrew Sheets: And today on the podcast, we'll be discussing the Federal Reserve, whether its policy is behind the curve and what's next.

It's Thursday, August 29th at 2pm in London.

Seth Carpenter: And it's 9am in New York.

Andrew Sheets: Seth, it's always great to talk to you. But that's especially true right now. The Federal Reserve has been front and center in the markets debate over the last month; and I think investors have honestly really gone back and forth about whether interest rates are in line or out of line with the economy. And I was hoping to cover a few big questions about Fed policy that have been coming up with our clients and how you think the Fed thinks about them.

And I think this timing is also great because the Federal Reserve has recently had a major policy conference in Jackson Hole, Wyoming where you often see the Fed talking about some of its longer-term views and we can get your latest takeaways from that.

Seth Carpenter: Yeah, that sounds great, Andrew. Clearly these are some of the key topics in markets right now.

Andrew Sheets: Perfect. So, let's dive right into it. I think one of the debates investors have been having -- one of the uncertainties -- is that the Fed has been describing the risk to their outlook as balanced between the risk to growth and risk to inflation. And yet, I think for investors, the view over the last month or two is these risks aren't balanced; that inflation seems well under control and is coming down rapidly. And yet growth looks kind of weak and might be more of a risk going forward.

So why do you think the Fed has had this framing? And do you think this framing is still correct in the aftermath of Jackson Hole?

Seth Carpenter: My personal view is that what we got out of Jackson hole was not a watershed moment. It was not a change in view. It was an evolution, a continuation in how the Fed's been thinking about things. But let me unpack a few things here.

First, markets tend to look at recent data and try to look forward, try to look around the corner, try to extrapolate what's going on. You know as well as I do that just a couple weeks ago, everyone in markets was wondering are we already in recession or not -- and now that view has come back. The Fed, in contrast, tends to be a bit more inertial in their thinking. Their thoughts evolve more slowly, they wait to collect more data before they have a view. So, part of the difference in mindset between the Fed and markets is that difference in frequency with which updates are made.

I'd say the other point that's critical here is the starting point. So, the two risks: risks to inflation, risks to growth. We remember the inflation data we're getting in Q1. That surprised us, surprised the market, and it surprised the Fed to the upside. And the question really did have to come into the Fed's mind -- have we hit a patch where inflation is just stubbornly sticky to the upside, and it's going to take a lot more cost to bring that inflation down. So those risks were clearly much bigger in the Fed’s mind than what was going on with growth.

Because coming out of last year and for the first half of this year, not only would the Fed have said that the US economy is doing just fine; they would have said growth is actually too fast to be consistent with the long run, potential growth of the US economy. Or reaching their 2 per cent inflation target on a sustained basis. So, as we got through this year, inflation data got better and better and better, and that risk diminished.

Now, as you pointed out, the risk on growth started to rise a little bit. We went from clearly growing too fast by some metrics to now some questions -- are we softened so much that we're now in the sweet spot? Or is there a risk that we're slowing too much and going into recession?

But that's the sense in which there's balance. We went from far higher risks on inflation. Those have come down to, you know, much more nuanced risks on inflation and some rising risk from a really strong starting point on growth.

Andrew Sheets: So, Seth, that kind of leads to my second question that we've been getting from investors, which is, you know, some form of the following. Even if these risks between inflation and growth are balanced, isn't Fed policy very restrictive? The Fed funds rate is still relatively high, relative to where the Fed thinks the rate will average over the long run. How do you think the Fed thinks about the restrictiveness of current policy? And how does that relate to what you expect going forward?

Seth Carpenter: So first, and we've heard this from some of the Fed speakers, there's a range of views on how restrictive policy is. But I think all of them would say policy is at least to some degree restrictive right now. Some thinking it's very restrictive. Some thinking only modestly.

But when they talk about the restrictiveness of policy in the context of the balance of these risks, they're thinking about the risks -- not just where we are right now and where policy is right now; but given how they're thinking about the evolution of policy over the next year or two. And remember, they all think they're going to be cutting rates this year and all through next year.

Then the question is, over that time horizon with policy easing, do we think the risks are still balanced? And I think that's the sense in which they're using the balance of risks. And so, they do think policy is restrictive.

They would also say that if policy weren't restrictive, [there would] probably be higher risks to inflation because that's part of what's bringing inflation out of the system is the restrictive stance of policy. But as they ease policy over time, that is part of what is balancing the risks between the two.

Andrew Sheets: And that actually leads nicely to the third question that we've been getting a lot of, which is again related to investor concerns -- that maybe policy is moving out of line with the economy. And that's some form of the following: that by even just staying on hold, by not doing anything, keeping the Fed funds rate constant, as inflation comes down, that rate becomes higher relative to inflation. The real policy rate rises. And so that represents more restrictive monetary policy at the very moment, when some of the growth data seems to be decelerating, which would seem to be suboptimal.

So, do you think that's the Fed's intention? Do you think that's a fair framing of kind of the real policy rate and that it's getting more restrictive? And again, how do you think the Fed is thinking about those dynamics as they unfold?

Seth Carpenter: I do think that's an important framing to think -- not just about the nominal level of interest rates; you know where the policy rate is itself, but that inflation adjusted rate. As you said, the real rate matters a lot. And inside the Fed as an institution there, that's basically how most of the people there think about it as well. And further, I would say that very framing you put out about -- as inflation falls, will policy become more restrictive if no adjustment is made? We've heard over the past couple of years, Federal Reserve policymakers make exactly that same framing.

So, it's clearly a relevant question. It's clearly on point right now. My view though, as an economist, is that what's more important than realized inflation, what prices have done over the past 12 months. What really matters is inflation expectations, right? Because if what we're trying to think about is -- how are businesses thinking about their cost of capital relative to the revenues are going to get in the future; it's not about what policy, it's not about what inflation did in the past. It's what they expect in the future.

And I have to say, from my perspective, inflation expectations have already fallen. So, all of this passive tightening that you're describing, it's already baked in. It's already part of why, in my view, you know, the economy is starting to slow down. So, it's a relevant question; but I'm personally less convinced that the fall in inflation we've seen over the past couple of months is really doing that much to tighten the stance of policy.

Andrew Sheets: So, Seth, you know, bringing this all together, both your answers to these questions that are at the forefront of investors' minds, what we heard at the Jackson Hole Policy Conference and what we've heard from the latest FOMC minutes -- what does Morgan Stanley Economics think the Fed's policy path going forward is going to be?

Seth Carpenter: Yeah. So, you know, it's funny. I always have to separate in my brain what I think should happen with policy -- and that used to be my job. But now we're talking about what I think will happen with policy. And our view is the Fed's about to start cutting interest rates.

The market believes that now. The Fed seems from their communication to believe that. We've got written down a path of 25 basis point reduction in the policy rate in September, in November, in December. So, a string of these going all the way through to the middle of next year to really ease the stance of policy, to get away from being extremely restrictive, to being at best only moderately restrictive -- to try to extend this cycle.

I will say though, that if we're wrong, and if the economy is a bit slower than we think, a 50 basis point cut has to be possible.

And so let me turn the tables on you, Andrew, because we're expecting that string of 25 basis point cuts, but the market is pricing in about 100 basis points of cuts this year with only three meetings left. So that has to imply at least one of those meetings having a 50 basis point cut somewhere.

So, is that a good thing? Would the market see a 50 basis point cut as the Fed catching up from being behind the curve? Or would the market worry that a bigger cut implies a greater recession risk that could spook risk assets?

Andrew Sheets: Yeah, Seth, I think that's a great question because it's also one where I think views across investors in the market genuinely diverge. So, you know, I'll give you our view and others might have a different take.

But I think what you have is a really interesting dynamic where kind of two things can be true. You know, on the one hand, I think if you talk to 50 investors and ask them, you know, would they rather for equities or credit have lower rates or higher rates, all else equal -- I think probably 50 would tell you they would rather have lower rates.

And yet I think if you look back at history, and you look at the periods where the Federal Reserve has been cutting rates the most and cutting most aggressively, those have been some of the worst environments for credit and equities in the modern era. Things like 2001, 2008, you know, kind of February of 2020. And I think the reason for that is that the economic backdrop -- while the Fed is cutting -- matters enormously for how the market interprets it.

And so, conditions where growth is weakening rapidly, and the Fed is cutting a lot to respond to that, are generally periods that the market does not like. Because they see the weaker data right now. They see the weakness that could affect earnings and credit quality immediately. And the help from those lower rates because policy works with lag may not arrive for six or nine or twelve months. It's a long time to wait for the cavalry.

And so, you know, the way that we think about that is that it's really, I think the growth environment that’s going to determine how markets view this rate cutting balance. And I think if we see better growth and somewhat fewer rate cuts, the base case that you and your team at Morgan Stanley Economics have -- which is a bit fewer cuts than the market, but growth holding up -- which we think is a very good combination for credit. A scenario where growth is weaker than expected and the Fed cuts more aggressively, I think history would suggest, that's more unfriendly and something we should be more worried about.

So, I do think the growth data remains extremely important here. I think that's what the market will focus most on and I think it's a very much good is good regime that I think is going to determine how the market views cuts. And fewer is fine as long as the data holds up.

Seth Carpenter: That make a lot of sense, and thanks for letting me turn the tables on you and ask questions. And for the listeners, thank you for listening. If you enjoy this show, leave us a review wherever you listen to podcast. And share Thoughts on the Market with a friend or a colleague today.

While mortgage rates have come down, our Co-heads of Securitized Products Research say the US housing market still must solve its supply problem.

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Jim 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 Securitize Products Research.

Jim Egan: Along with my colleagues bringing you a variety of perspectives, today Jay and I are here to talk about the US housing and mortgage markets.

It's Wednesday, August 28th, at 10 am in New York.

Now, Jay, mortgage rates declined pretty sharply in the beginning of August. And if I take a little bit of a step back here; while rates have been volatile, to say the least, we're about 50 basis points lower than we were at the beginning of July, 80 basis points lower than the 2024 peak in April, and 135 basis points below cycle peaks back in October of 2023.

Big picture. Declining mortgage rates -- what does that mean for mortgages?

Jay Bacow: It means that more people are going to have the ability to refinance given the rally in mortgage rates that you described. But we have to be careful when we think about how many more people. We track the percentage of homeowners that have at least 25 basis points of incentive to refinance after accounting for things like low level pricing adjustments. That number is still less than 10 percent of the outstanding homeowners. So broadly speaking, most people are not going to refinance.

Now, however, because of the rally that we've seen from the highs, if we look at the percentage of borrowers that took out a mortgage between six and 24 months ago -- which is really where the peak refinance activity happens -- over 30 percent of those borrowers have incentive to refinance.

So recent homeowners, if you took your mortgage out not that long ago, you should take a look. You might have an opportunity to refinance. But, for most of the universe of homeowners in America that have much lower mortgage rates, they're not going to be refinancing.

Jim Egan: Okay, what about convexity hedging? That's a term that tends to get thrown around a lot in periods of quick and sizable rate moves. What is convexity hedging and should we be concerned?

Jay Bacow: Sure. So, because the homeowner in America has the option to refinance their mortgage whenever they want, the investor that owns that security is effectively short that option to the homeowner. And so, as rates rally, the homeowner is more likely to refinance. And what that means is that the duration -- the average life of that mortgage is outstanding -- is going to shorten up. And so, what that means is that if the investor wants to have the same amount of duration, as rates rally, they're going to need to add duration -- which isn't necessarily a good thing because they're going to be buying duration at lower yields and higher prices. And often when rates rally a lot, you will get the explanation that this is happening because of mortgage convexity hedging.

Now, convexity hedging will happen more into a rally. But because so much of the universe has mortgages that were taken out in 2020 and 2021, we think realistically the real convexity risks are likely 150 basis points or so lower in rates.

But Jim, we have had this rally in rates. We do have lower mortgage rates than we saw over the summer. What does that mean for affordability?

Jim Egan: So, affordability is improving. Let's put numbers around what we're talking about. Mortgage rates are at approximately 6.5 percent today at the peak in the fourth quarter of last year, they were closer to 8 percent.

Now, over the past few years, we've gotten to use the word unprecedented in the housing market, what feels like an unprecedented number of times. Well, the improvement in affordability that we'd experience if mortgage rates were to hold at these current levels has only happened a handful of times over the past 35 to 40 years. This part of it is by no means unprecedented.

Jay Bacow: Alright, now we talked about mortgage rates coming down and that means more refi[nance] activity. But what does the improvement in mortgage rates do to purchase activity?

Jim Egan: So that's a question that's coming up a lot in our investor discussions recently. And to begin to answer that question, we looked at those past handful of episodes. In the past, existing home sales almost always climb in the subsequent year and the subsequent two years following an improvement in affordability at the scale that we're witnessing right now.

Jay Bacow: So, there's precedent for this unprecedented experience

Jim Egan: There is. But there are also a number of differences between our current predicament and these historical examples that I'd say warrant examination. The first is inventory. We simply have never had so few homes for sale as we do right now. Especially when we're looking at those other periods of affordability improvement.

And on the affordability front itself, despite the improvement that we've seen, affordability remains significantly more challenged than almost every other historical episode of the past 40 years, with the exception of 1985. Both of these facts are apparent in the lock in effect that you and I have discussed several times on this podcast in the past.

Jay Bacow: All right. So just like we think we are a 150 basis points away from convexity hedging being an issue, we're still pretty far away from rates unlocking significant inventory. What does that mean for home sales?

Jim Egan: So, the US housing market has a supply problem, not a demand problem. I want to caveat that. Everything is related in the US housing market. For instance, high mortgage rates that put pressure on affordability -- but they've also contributed to this lock-in effect that has led to historically low inventory.

This lack of supply has kept home prices climbing, despite high mortgage rates, which is keeping affordability under pressure. So, when we say that housing has a supply problem, we're not dismissing the demand side of the equation; just acknowledging that the binding constraint in the current environment is supply.

Jay Bacow: Alright, so if supply is the binding constraint, then what does that mean for sales?

Jim Egan: As rates come down, inventory has been increasing. When combined with improvements in affordability, this should catalyze increased sales volumes in the coming year. But the confluence of inputs in the housing market today render the current environment unique from anything that we've experienced over the past few decades.

Sales volumes should climb, but the path is unlikely to be linear and the total increase should be limited to call it the mid-single digit percentage point of over the coming year.

Jay Bacow: Alright, and now lastly, Jim, home prices continue to set an all time high but there's the absolute level of prices and the pace of home price appreciation. What do you think is going to happen?

Jim Egan: We're on the record that this increased supply, even if it's only at the margins, and even if we're close to historic lows, should slow down the pace of home price appreciation. We've begun to see that year-over-year home price growth has come down from 6.5 percent to 5.9 percent over the past three months. We think it will continue to come down, finishing the year at +2 percent.

Jay Bacow: Alright, Jim, thanks for those thoughts. And to our listeners, thank you for listening.

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

Our CIO and Chief US Equity Strategist explains why there’s pressure for the August jobs report to come in strong -- and what may happen to the market if it doesn’t. 

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the importance of economic data on asset prices in the near term.

It's Tuesday, Aug 27th at 11:30am in New York.

So let’s get after it. 

The stock rally off the August 5th lows has coincided with some better-than-expected economic data led by jobless claims and the ISM services purchasing manager survey. This price action supports the idea that risk assets should continue to trade with the high frequency growth data in the near term. Should the growth data continue to improve, the market can stay above the fair value range we had previously identified of 5,000-5,400 on the S&P 500. 

In my view, the true test for the market though will be the August jobs report on September 6th. 

A stronger than expected payroll number and lower unemployment rate will provide confidence to the market that growth risks have subsided for now. Another weak report that leads to a further rise in the unemployment rate would likely lead to growth concerns quickly resurfacing and another correction like last month. On a concerning note, last week we got a larger than expected negative revision to the payroll data for the 12 months ended in March of this year. These revisions put even more pressure on the jobs report to come in stronger. 

Meanwhile, the Bloomberg Economic Surprise Index has yet to reverse its downturn that began in April and cyclical stocks versus defensive ones remain in a downtrend. We think this supports the idea that until there is more evidence that growth is actually improving, it makes sense to favor defensive sectors in one's portfolio. Finally, while inflation data came in softer last week, we don't view that as a clear positive for lower quality cyclical stocks as it means pricing power is falling. 

However, the good news on inflation did effectively confirm the Fed is going to begin cutting interest rates in September. At this point, the only debate is how much?

Over the last year, market expectations around the Fed's rate path have been volatile. At the beginning of the year, there were seven 25 basis points cuts priced into the curve for 2024 which were then almost completely priced out of the market by April. Currently, we have close to four cuts priced into the curve for the rest of this year followed by another five in 2025. There has been quite a bit of movement in bond market pricing this month as to whether it will be a 25 or 50 basis points cut when the Fed begins. More recently, the rates market has sided with a 25 basis points cut post the better-than-expected growth and inflation data points last week.

As we learned a couple of weeks ago, a 50 basis points cut may not be viewed favorably by the equity market if it comes alongside labor market weakness. Under such a scenario, cuts may no longer be viewed as insurance, but necessary to stave off hard landing risks. As a result, a series of 25 basis points cuts from here may be the sweet spot for equity multiples if it comes alongside stable growth.

The challenge is that at 21x earnings and consensus already expecting 10 percent earnings growth this year and 15 percent growth next year, a soft-landing outcome with very healthy earnings growth is priced. Furthermore, longer term rates have already been coming down since April in anticipation of this cutting cycle. Yet economic surprises have fallen and interest rate sensitive cyclical equities have underperformed. In my view this calls into question if rate cuts will change anything fundamentally.

The other side of the coin is that defensive equities remain in an uptrend on a relative basis, a dynamic that has coincided with normalization in the equity risk premium. In our view, we continue to see more opportunities under the surface of the market. As such, we continue to favor quality and defensive equities until we get more evidence that growth is clearly reaccelerating in a way that earnings forecasts can once again rise and surpass the lofty expectations already priced into valuations.

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 US Thematic Strategist discusses surging confidence as the political landscape evolves, back-to-school spending starts strong and travel providers enjoy post-COVID demand. 

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's US thematic strategist. Along with my colleagues bringing you a variety of perspectives, today I'll give you an update on how recent market volatility and the upcoming US election are affecting the US consumer.

It's Monday, August 26th at 10am in New York.

A few weeks ago, we saw really sharp volatility. It was partially sparked by the unwind of the yen carry trade. But there are also renewed fears about a growth slowdown for the US or a possible US recession. Our economists do not think we are going into a recession though, and they have reaffirmed their longstanding view of a soft landing for the economy as a base case. And they think there's a slowdown, but not a slump.

From the more company side, this earning season showed that the US consumer is softening incrementally; but they're not falling off a cliff. Spending is slowing this year, but it's on the heels of what was really high spending over the last couple of years.

We did see some softness during second quarter results around the consumer. Consumer confidence is still intact, and our most recent survey in July showed a pretty strong improvement in sentiment. We think that this is partially a function of the political environment. We ran the survey from July 25th to 29th, shortly after President Joe Biden dropped out of the race and endorsed Vice President Kamala Harris. And we saw the biggest improvement in sentiment was for those who consider themselves middle of the road politically.

Their net sentiment toward the economy improved from negative -23 percent to -1 percent. Net expectations are also really positive for those who identify as liberal. Net sentiment for very liberal respondents is +34 percent, while it's +20 percent for more somewhat liberal ones. Expectations for conservatives are still negative though, but they have improved since the prior wave of our survey.

So, we do think that some of this increase in excitement and increase in confidence has been around the renewed political environment, renewed interest in the race.

As we get close to the end of summer, we note two other key trends. Back to school shopping and travel. So, for back-to-school shopping, we're seeing pretty positive results from our survey. Consumers are reporting they're planning to spend more this back-to-school season versus last year. We saw an increase of 35 percent in spending intentions. And then when we think about the different back to school categories people are spending on, apparel saw the biggest net increase in spending plans versus last year. But we also saw an increase for school supplies and electronics. So, all things very important as the kids go back to school or people go off to college.

Travel's been one part of the market that's held up super well post pandemic. People were very excited to get out there and go on vacations. And we saw, frankly, an unexpected positive level of demand for the past few years, and we didn't see that faster catch up in demand that a lot of people were expecting post pandemic. I know myself; I've been very excited to travel the last few summers. But this earning season we're starting to see more of a mixed bag within the travel space.

Hotels across the board flag softening demand for leisure stays, but business travel has held up well. We saw a different story among the airlines though; several management teams were really emphasizing continued strong demands for air travel. And our survey is supportive of these comments and show that travel intentions remain stable and strong, and plans to follow through on travel that involve a flight also remain robust.

The next three months leading up to the US election will certainly be interesting though, and we'll continue to bring you updates.

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

Although markets have recovered over the last few weeks after a sudden drop, our Head of Corporate Credit Research warns that investors are still skeptical about the growth outlook.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today we’ll discuss the big round trip for markets and why we’re not out of the woods.

It's Friday, August 23rd at 2pm in London.

The last few weeks have been a rollercoaster. July ended on a high with markets rallying as the Federal Reserve kept interest rates unchanged. Things turned almost immediately thereafter as weak data releases fanned fears that maybe the Fed was being just a little too nonchalant on the economy, making its patience withholding rates high look like a vice, rather than a virtue. A late summer period where many investors were out probably amplified the moves that followed. And so at the morning lows on August 5th, the S&P 500 had fallen more than 8 percent in just 3 trading days, and expected volatility had jumped to one of its highest readings in a decade. 

But since those volatile lows, markets have come back. Really come back. Stock prices, credit spreads, and those levels of expected volatility are all now more or less where they ended July. It was an almost complete round-trip. We have a colleague who got back from a two-week vacation on Monday. The prices on their screen had barely changed. 

The reason for that snapback was the data. Just as weak data in the aftermath of the Fed’s meeting drove fears of a policy mistake, better data in the days since have improved confidence. This has been especially true for data related to the US consumer, as both retail sales and the number of new jobless claims have been better than expected. 

This round-trip in markets has been welcome, especially for those, like ourselves, who are optimistic on credit, and see it well-positioned for the economic soft-landing that Morgan Stanley expects. 

But it is also a reminder that we’re not out of the woods. The last few weeks couldn’t be clearer about the importance of growth for the market outlook. This is a crucial moment for the economy, where U.S. growth is slowing, the Fed’s rates are still highly restrictive, and any help from cutting those rates may not be felt for several quarters. 

At Morgan Stanley we think that growth won’t slow too much, and so this will ultimately be fine for the credit market. But incoming data will remain important, and recent events show that the market’s confidence can be quickly shaken. Even with the sharp snapback, for example, cyclical stocks, which tend to be more economically sensitive, have badly lagged more defensive shares – a sign that healthy skepticism around growth from investors still remains. 

The quick recovery is welcome, but we’re not out of the woods, and investors should continue to hope for solid data. Good is good. 

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 Bank of Japan jolted global markets after its recent decision to raise interest rates. Our experts break down the effects the move could have on the country’s economy, currency and stock market.

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

Daniel Blake: And I'm Daniel Blake, from the Asia Pacific and Emerging Market Equity Strategy Team.

Chetan Ahya: On this episode of the podcast, we will cover a topic that has been a big concern for global investors: Japan's rate hike and its effect on markets.

It's Thursday, August 22nd at 6pm in Hong Kong.

On July 31st, Japan's central bank made a bold move. For only the second time in 17 years, it raised interest rates. It lifted its benchmark rates to around 0.25 percent from its previous range of 0 to 0.1 percent. And at the press conference, BOJ Governor Ueda struck a more hawkish tone on the BOJ rate path than markets anticipated. Compounded with investors concern about US growth, this move jolted global equity markets and bond markets. The Japan equity market entered the quickest bear market in history. It lost 20 percent over three days.

Well, a lot has happened since early August. So, I'm here with Daniel to give you an update.

Daniel Blake: Chetan, before I can give you an update on what the market implications are of all this, let's make sense of what the macro-outlook is for Japan and what the Bank of Japan is really looking to achieve.

I know that following that July monetary policy meeting, we heard from Deputy Governor Uchida san, who said that the bank would not raise its policy rates while financial and capital markets remain unstable.

What is your view on the Bank of Japan policy outlook and the key macro-outlook for Japan more broadly?

Chetan Ahya: Well, firstly, I think the governor's comments in the July policy meeting were more hawkish than expected and after the market's volatility, deputy governor did come out and explain the BOJ's thought process more clearly. The most important point explained there was that they will not hike policy rates in an environment where markets are volatile -- and that has given the comfort to market that BOJ will not be taking up successive rate hikes in an early manner.

But ultimately when you're thinking about the outlook of BOJ's policy path, it will be determined by what happens to underlying wage growth and inflation trend. And on that front, wage growth has been accelerating. And we also think that inflation will be remaining at a moderate level and that will keep BOJ on the rate hike path, but those rate hikes will be taken up in a measured manner.

In our base case, we are expecting the BOJ to hike by 25 basis points in January policy meeting next year, with a risk that they could possibly hike early in December of this year.

Daniel Blake: And after an extended period of weakness, the Japanese yen appreciated sharply after the remarks. What drove this and what are the macro repercussions for the broader outlook?

Chetan Ahya: We think that the US growth scare from the weaker July nonfarm payroll data, alongside a hawkish BOJ Governor Ueda's comments, led markets to begin pricing in more policy rate convergence between the US and Japan. This resulted in unwinding of the yen carry trade and a rapid appreciation of yen against the dollar.

For now, our strategists believe that the near-term risk of further yen carry trade unwinding has lessened. We will closely watch the incoming US growth and labor market data for signs of the US slowdown and its impact on the yen. In the base case, our US Economics team continues to see a soft landing in the US and for the Fed to cut rates by three times this year from September, reaching a terminal of 3.625 by June 2025.

Based on our US and BOJ rate path, our macro strategists see USD/JPY at 146 by year end. As it stands, our Japan inflation forecast already incorporates these yen forecasts, but if yen does appreciate beyond these levels on a sustainable basis, this would impart some further downside to our inflation forecast.

Daniel Blake: And there's another key event to consider. Prime Minister Kishida san announced on August 14th that he will not seek re-election as President of The Liberal Democratic Party (LDP) in late September, and hence will have a new leader of Japan. Will this development have any impact on economic policy or the markets in your view?

Chetan Ahya: The number of potential candidates means it's too early to tell. We think a major reversal in macro policies will be unlikely, though the timing of elections will likely have a bearing on BOJ.

For example, after the September party leadership election, the new premier could then call for an early election in October; and in this scenario, we think likelihood of a BOJ move at its September and October policy meeting would be further diminished.

So, Daniel, keeping in mind the macro backdrop that we just discussed, how are you interpreting the recent equity market volatility? And what do you expect for the rest of 2024 and into 2025?

Daniel Blake: We do see that volatility in Japan, as extreme as it was, being primarily technically driven. It does reflect some crowding of various investor types into pockets of the equity market and levered strategies, as we see come through with high frequency trading, as well as carry trades that were exacerbated by dollar yen positions being unwound very quickly.

But with the market resetting, and as we look into the rest of 2024 and 2025, we see the two key engines of nominal GDP reflation in Japan and corporate reform still firing. As you lay out, the BOJ is trying to find its way back towards neutral; it's not trying to end the cycle. And corporate governance is driving better capital allocation from the corporate sector.

As a result, we see almost 10 percent earnings growth this year and next year, and the market stands cheap versus its historical valuation ranges.

So, as we look ahead, we think into 2025, we should see the Japanese equity benchmark, the TOPIX index, setting fresh all-time highs. As a result, we continue to prefer Japan equities versus emerging markets. And we recommend that US dollar-based investors leave their foreign exchange exposure unhedged, which will position them to benefit from further strengthening in the Japanese yen.

Chetan Ahya: So, which parts of the market look most attractive following the BOJ's rate hike and market disruptions to you?

Daniel Blake: Yes, we do prefer domestic exposures relative to exporters. They'll be better protected from any further strengthening in the Japanese yen, and we also see a broad-based corporate governance reform agenda supporting shareholder returns coming out of these domestic sectors. They'll benefit from that stronger, price and wage outlook with an improved margin outlook.

And we also see that capex beneficiaries with a corporate reform angle are likely to do well in this overall agenda of pursuing greater economic security and digitalization. So that includes key sectors like defense, real estate, and construction.

And Chetan, what would you say are the key risks to your view?

Chetan Ahya: We think the key risk would be if the US faces a deeper slowdown or an outright recession. While Japan is better placed today than in the past cycles, it would nonetheless be a setback for Japan's economy. In this scenario, Japan’s export growth would face downward pressures given weakening external demand.

The Japanese corporate sector has also around 17 percent of its revenue coming from North America. Besides a deeper Fed rate cut cycle, will mean that the policy rate differentials between the US and Japan will narrow significantly. This will pose further appreciation pressures on the yen, which will weigh on inflation, corporate profits, and the growth outlook.

And from your perspective, Daniel, what should investors watch closely?

Daniel Blake: We would agree that the first order risk for Japan equities is if the US slips into a hard landing, and we do see that the dollar yen in that outlook is likely to fall even further. Now we shouldn't see any FX (foreign exchange) driven downgrades until we start bringing the yen down below 140, but we would also see the operating environment turning negative for Japan in that outlook.

So, putting that aside, given our house view of the soft landing in the US economy, we think the second thing investors should watch is certainly the LDP leadership election contest, and the reform agenda of the incoming cabinet.

Prime Minister Kishida san's tenure has been focused on economic security and has fostered further corporate governance reform alongside the Japan Stock Exchange. And this emphasis on getting household savings into investment has been another key pillar of the new capitalism strategy. So, these focus areas have been very positive for Japan equities, and we should trust -- but verify -- the commitment of a new leadership team to these policy initiatives.

Chetan Ahya: Daniel, it was great to hear your perspective. This is an evolving story. We'll keep our eye on it. Thanks for taking the time to talk.

Daniel Blake: Great speaking with you, Chetan.

Chetan Ahya: 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 a colleague today.

This week’s Democratic National Convention in the US may be light on policy details, but our Global Head of Fixed Income and Thematic Research explains that the party’s economic agenda is fairly clear as the elections draw closer.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what investors need to know about U.S. political party conventions.

It's Wednesday, Aug 21st at 10:30am in New York. 

This week, the Democratic Party is meeting in Chicago for its National Convention. Conventions for major political parties typically feature speeches from key policymakers, both past and present. So it would seem to be a forum where someone could learn what policies the party plans to implement if it takes control of the government following the November election. But you should expect more political messaging than policy signal.

That’s because the focus of these conventions tends to be more about persuading voters – and that means key policy details typically take a back seat to statements of political values widely shared by the party in order to send a consistent public message. In that sense, an observer may not learn much new about where there’s party consensus on key policy details that markets care about, including specific new taxes that might be implemented, which tax breaks might be extended, how these choices might affect the deficit, and more. That in turn means we may not learn much about what policies could plausibly be implemented if Democrats win the White House and Congress in the November election. 

The good news is that we don’t think a convention is required to have a good sense about this. We’ve previously done the work on the plausible policy path resulting from a Democratic victory by examining statements of elected officials and filtering for areas of consensus among Democratic lawmakers. And we’ve also looked at expected legislative catalysts in 2025 and 2026, such as the expiry of key provisions of the Tax Cuts and Jobs Act. In short, we think the plausible policy path resulting from Democrats sweeping the election would mean relative stability on trade and energy policy; and some deficit expansion driven by tax cut extensions only partially offset by new taxes on corporations and high income earners. 

Net-net, our economists think this outcome would create less uncertainty for the U.S. growth outlook than a Republican sweep, where potential for substantial new tariffs would interact with greater tax cut extensions and deficit expansion. And while we don’t expect the convention will challenge our thinking here, we’ll of course be tracking it and report back if it does. 

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

Original release date July 23, 2024: Our Head of Global Autos & Shared Mobility discusses what makes humanoid robots a pivotal trend with implications for the global economy.

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Welcome to Thoughts on the Market. I’m Adam Jonas, Morgan Stanley’s Head of Global Autos & Shared Mobility. Today I’ll be talking about an unusual but hotly debated topic: humanoid robots. 

It’s Tuesday, July 23rd, at 10am in New York.

We've seen robots on factory floors, in displays at airports and at trade shows – doing work, performing tasks, even smiling. But over the last eighteen months, we seem to have hit a major inflection point. 

What's changed? Large Language Models and Generative AI. The current AI movement is drawing comparisons to the dawn of the Internet. It’s begging big, existential questions about the future of the human species and consciousness itself. But let’s look at this in more practical terms and consider why robots are taking on a human shape. 

The simplest answer is that we live in a world built for humans. And we’re getting to the point where – thanks to GenAI – robots are learning through observation. Not just through rudimentary instruction and rules based heuristic models. GenAI means robots can observe humans in action doing boring, dangerous and repetitive tasks in warehouses, in restaurants or in factories. And in order for these robots to learn and function most effectively, their design needs to be anthropomorphic. 

Another reason we're bullish on humanoid robots is because developers can have these robots experiment and learn from both simulation and physically in areas where they’re not a serious threat to other humans. You see, many of the enabling technologies driving humanoid robots have come from developments in autonomous cars. The problem with autonomous cars is that you can't train them on public roads without directly involving innocent civilians – pedestrians, children and cyclists -- into that experiment. 

Add to all of this the issue of critical labor shortages and challenging demographic trends. The global labor total addressable market is around $30 trillion (USD) or about one-third of global GDP. We’ve built a proprietary US total addressable market model examining labor dynamics and humanoid optionality across 831 job classifications, working with our economics team; and built a comprehensive survey across 40 sectors to understand labor intensity and humanoid ability of the workforce over time. 

In the United States, we forecast 40,000 humanoid units by 2030, 8 million by 2040 and 63 million by 2050 – equivalent to around $3 trillion (USD) of salary equivalent. But as early as 2028 we think you're going to see significant adoption beginning in industries like manufacturing, production, warehousing, and logistics, installation, healthcare and food prep. 

Then in the 2030s, you’re going to start adding more in healthcare, recreational and transportation. And then after 2040, you may see the adoption of humanoid robots go vertical. Now you might say –  that’s 15 years from now. But just like autonomous car – the end state might be 20 years away, but the capital formation is happening right now. And investors should pay close attention because we think the technological advances will only accelerate from here. 

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 Global Chief Economist explains what stricter immigration policy in key markets around the world could mean for economic growth and inflation.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss a key driver of the global economy, migration.

It's Monday, August 19th at 10am in New York.

Migration has always been an important feature of the global economy.

Not surprisingly, migrants typically move from lower income countries to higher income countries and for more than 50 years, it has added something like three-tenths of a percent per year to the growth of high-income economies. But in recent years, migration trends have been hit by a couple of major events.

One was COVID. International travel restrictions during the pandemic slowed, or stopped, migration for a while. Despite a strong rebound over the past two years, many economies still have not fully recovered to pre-COVID migration trends. Another is geopolitical unrest. The Ukrainian refugee crisis, for example, is the largest population displacement in Europe since WWII with increasingly global repercussions.

But how does immigration affect economies? One way that I frame the discussion is that immigration can boost both aggregate supply and aggregate demand. It's likely some of each -- and the relative importance of those two affects how inflationary or disinflationary the phenomenon is.

In 2023, with a very large influx of immigrants into the US labor market, the economy was able to grow rapidly while still seeing inflation fall. The supply effect dominated the demand effect. In Australia, by contrast, with more of the immigrants in school or otherwise not in the labor market, prices -- especially for housing -- have gone up because demand was relatively more important.

But some of the effects will only play out over time. Across many developed market economies, economic activity has risen less than population, meaning that measured productivity is lower. But we think that is just a lagged effect of the response of capital investment to the rise in labor. Over a longer time horizon, immigration can also offset demographic declines. Since 2021 population growth in many high-income economies has turned negative, if you exclude immigrants. Sustaining economic growth and managing government debt loads are made much more difficult with an aging, and then declining population, as a baseline.

We assume that immigration will revert to pre-COVID trends in 2024 and [20]25 for most economies. This delta is largest for the economies with the highest immigration rates, like Canada or Australia; but for other economies, policies, cultural norms, those will determine the path for immigration.

The key, however, is that immigration can be a critical component of demographic trends. In the US, the best estimate of net immigration was about 3.3 million people in 2023, and we assume it will taper from there to something closer to 2.5 million in 2025. That addition to the labor market created what Fed Chair Powell called “a bigger, but not tighter economy.”

For people following the economy in real time, the extra availability of labor is also why we have argued that the rise in the unemployment rate over the past year or so is not the harbinger of recession that it has been in past cycles.

Now, looking ahead, one key risk to our forecasts -- well everywhere around the world -- would be an abrupt tightening in immigration policy that causes the flow of workers to fall quickly or even end. Such a scenario would imply a much sharper economic slowdown and possibly higher inflation in the economies where the supply boost has dominated. That's yet another reason why elections and government policy remain key to the economic outlook.

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

Our Head of Corporate Credit Research explains how corporate balance sheets have remained resilient post-COVID, and why that could continue in the face of a potential economic slowdown.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss how corporate balance sheets are in a better place to handle a potential growth slowdown. 

It's Friday, August 16th at 2pm in London. 

Much of the volatility over the last several weeks has been centered around fears that excessively high interest rates from the Federal Reserve will now cause the US economy to slow too quickly. Morgan Stanley’s economists are more optimistic and believe that the data will hold up, leading the Fed to start a gradual rate cutting cycle in September, rather than a more radical course-correction. Against this backdrop, good economic data is good for markets and vice versa. 

But even though we remain optimistic at Morgan Stanley about a soft landing in the US economy, our economists still expect growth to slow. How prepared are corporate balance sheets for that slowing, and how worried should we be that this could lead to higher rates of default? 

A good place to start is thinking about how optimistic companies were heading into any slowdown of the economy. Overconfidence is often the enemy of credit investors, as rose-tinted glasses can lead companies to make too many unwise acquisitions or investments, funded with too much debt. 

Yet across a variety of metrics, this isn’t what we see. Despite some of the lowest interest rates in human history, the level of debt to cash-flow for US and European companies has been pretty stable over the last five years. Excess capital held by banks remains historically high. And Merger and Acquisition activity, another key measure of corporate confidence, remains well below the long run trend – even after a pick up this year, as my colleague Ariana Salvatore discussed on this program earlier in the week. 

So, despite the strong recovery in the US economy and the stock market over the last four years, many corporate boardrooms have remained cautious, a good thing when considering their financial risk. 

Where Corporate debt did increase, it was often in places that we think could withstand it. Large-cap Technology and Pharmaceuticals issuers have taken out more debt over the last several years, relative to history, but it's been a pretty modest amount from a pretty low historical starting point. The Utility sector has also taken on more debt recently, but the stable nature of its business may make this easier to handle. 

While companies across the ratings spectrum generally didn’t increase their leverage over the last several years, they did take advantage of refinancing the debt they already had at historically low rates. And this is important for thinking about the stress that higher interest rates could eventually produce. 

The average maturity in the US Investment Grade index is about 11 years, and that means that, for many companies, potentially less than one-tenth of their overall debt resets to the current interest rate every year. That means companies may still have many years of enjoying the low interest rates of the past, and that helps smooth the adjustment to higher interest rates in the future. 

The lack of corporate confidence since COVID means that corporate balance sheets are generally in a better place if the economy potentially slows. But while this is helpful overall, it’s important to note that it doesn’t apply in all cases. We still see plenty of dispersion between winners and losers, driving divergence under the hood of the credit market. Even if balance sheets are stronger overall, there is plenty of opportunity to pick your spots. 

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 US Public Policy and Currency experts discuss how different outcomes in the upcoming U.S. elections could have varying effects on the strength of the dollar.

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

Andrew Watrous: And I'm Andrew Watrous, G10 Currency Strategist.

Ariana Salvatore: On this episode of the podcast, we'll discuss an issue that's drawing increasing attention from investors leading up to the U.S. election -- and that is the U.S. dollar and how a Harris or Trump administration could impact it.

It's Thursday, August 15th at 10am in New York.

Earlier this year, Morgan Stanley experts came on this show to discuss the current strength of the US dollar, which has had quite a historic run.

Now we all know there are numerous ways in which politics could affect the currency. But before we get into the details there, Andrew, can you just set the stage here a little bit and give some context to listeners on where the dollar is right now and what's been driving that performance?

Andrew Watrous: Yeah, the dollar's been rising this year. So, if you look at a trade weighted gauge of the US dollar, it's up about 3 percent, so far. And part of that US dollar strength is because growth expectations for the US have risen since January. There's a survey of Wall Street economists, and if you look at their median forecast for the US growth, it's moved up about one percentage point since January.

And as a result of that strong US growth, we've seen Fed policy expectations move higher. We started this year with the market pricing the Fed to be below 4 percent by December. And that expectation for where the Fed is going to be in December has moved up about 1 percentage point since January.

So, robust US growth and a higher near-term Fed policy rate expectation have made the US more attractive as an investment destination. And that's boosted the US dollar broadly as capital flows to the US.

Ariana Salvatore: That makes sense. Now, thinking about the balance of the year, it's impossible to look ahead and not consider how the US election could impact or change this trend that you've been talking about. As we get closer to November, investors are also starting to question just what will happen to the dollar in a Republican or Democratic win. What's been our approach to thinking through that question?

Andrew Watrous: So, if you look at policies proposed by the Republican presidential campaign, a number of those policies, if implemented, would probably boost the US dollar.

First, higher tariffs on goods imported from our trading partners could weigh on expectations for growth abroad. That would make the US more attractive in comparison, maybe send capital to the US as a safe haven due to policy uncertainty. And of all the scenarios we look at, we think that one where the Republicans control both Congress and the White House would be the scenario in which the federal government spends the most and issues the most debt.

More spending would likely make US growth expectations and bond yields higher in comparison to what we'd see in the rest of the world. So, a Republican presidential administration could attempt to offset some of that US dollar strength; but in the near term we think that the US dollar should go up if a Republican White House looks increasingly likely. And on the other side, the dollar could go down if the likelihood of a Democratic White House looks increasingly likely -- as some positive risk premium around trade and fiscal policy is reduced.

Ariana Salvatore: Okay, so you mentioned quite a few policy variables there. Let's take those issue areas one by one. On trade policy and geopolitical risk, it wouldn't surprise us from the policy side to see a potential Trump administration introduce tariffs, just given the rhetoric we've seen on the campaign trail. We've talked about the potential impact from 10 per cent universal -- targeted or one-for-one tariffs -- which all come with varying degrees of economic impacts.

On the currency side, Andrew, walk us through your thought process on how the risks to growth expectations from tariffs could factor into dollar positive or negative outcomes.

Andrew Watrous: So, a lot of our thinking on this is shaped by what we saw in 2018 and 2019, when there were trade tensions. During that period, the dollar moved higher, starting in spring 2018 until the end of 2019, and a big part of that dollar strength was probably due to trade tensions between the US and China. Those tensions meant that investors were probably more hesitant to take on risk outside the US than they otherwise may have been. That's why the US dollar kept rising during that period, despite the Fed cutting rates three times in 2019. And in 2018 and 2019, we saw expectations for growth in countries outside the US moving lower -- in part because of trade tensions during that period.

So, from speaking to my colleagues in the economics department here at Morgan Stanley, it seems pretty plausible that something similar happens to expectations for growth outside the US, again, if another trade war looks increasingly likely. And that drop in what people expect for growth outside the US would probably boost the US dollar as the US looks more attractive in comparison.

Ariana Salvatore: Got it. Now, shifting gears slightly to the fiscal policy outlook. We've said that the Republican sweep outcome is the most likely to lead to the greatest degree of fiscal expansion, and that's because we think lawmakers are going to have to contend with the expiring Tax Cuts and Jobs Act. We think that in a divided government outcome, or a Democratic sweep, some of those tax measures are still on the table, but it'll probably be a narrower extension from a deficit standpoint.

So, Andrew, what would a fiscally expansionary regime mean for the dollar?

Andrew Watrous: So, as you mentioned, the most fiscally expansionary scenario would be a Republican sweep scenario. And we did some research into capital flows; and the Treasury data show that historically, higher US spending is associated with net inflows of private capital into the US. And if you look at the pace of US spending versus the pace of spending in Europe, if you look at that differential -- that differential is positively correlated to movements in Euro. So faster US spending means lower Euro relative to spending in Europe.

Ariana Salvatore: So, we expect that a Republican administration's policies might strengthen the dollar in summary. But it's possible that they don't like that dollar strength. We've heard Trump talk about the benefits of a weaker currency for exports, for example. So, what might a Republican presidential administration try to do to maybe offset some of the strength?

Andrew Watrous: Yeah, so if we’re right and the Republican policies do strengthen the dollar, that Republican administration could try to offset that dollar strength with a number of policy tools. And those might be effective in weakening the US dollar against one or more of our trading partners. But we don't think that the market expectation of those dollar negative policy options would fully offset the effect of other Republican policies, which would boost the dollar.

There are legal, logistical, and political challenges associated with a lot of those dollar negative policy options. So, for example, former US Trade Representative Lighthizer has reportedly expressed doubt about the viability of broad international coordinated intervention against the US dollar. He said that no policy advisor that he knows of is working on a plan to weaken the dollar. And former President Trump reportedly rejected a 2019 proposal to intervene against the dollar from former White House Trade Advisor Peter Navarro.

Ariana Salvatore: Got it. So, sounds like we have a lot of moving pieces here and we will keep refining our views as we get some more policy clarity in the coming months. 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.

The rise in unused office space has triggered suggestions about converting commercial real estate into residential buildings. But our US Real Estate Research analyst lists three major challenges.

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Welcome to Thoughts on the Market. I’m Adam Kramer, from the Morgan Stanley U.S. Real Estate Research team. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss a hot real estate topic. Whether the surplus of vacant office space offers a logical solution to the national housing shortage.

It’s Wednesday, August 14, at 10am in New York.

Sitting here in Morgan Stanley’s office at 1585 Broadway, Times Square is bustling and New York seems to have recovered from COVID and then some. But the reality inside buildings is a little bit different. 

On the one hand, 14 percent of U.S. office space is sitting unused. Our analysis shows a permanent impairment in office demand of roughly 25 percent compared to pre-COVID. And on the other hand, we have a national housing shortage of up to 6 million units. So why not simply remove obsolete lower-quality office stock and replace it with much-needed housing? On the surface, the idea of office-to-residential conversion sounds compelling. It could revitalize struggling downtown areas, creating a virtuous cycle that can lead to increased local tax revenues, foot traffic, retail demand and tourism.

But is it feasible?

We think conversions face at least three significant challenges. First, are the economics of conversion. In order for conversions to make sense, we would need to see office rents decline or apartment rents rise materially – which is unlikely in the next 1-2 years given the supply dynamics — and office values and conversion costs would need to decline materially. 

Investors can acquire or develop a multifamily property at roughly $600 per square foot. Alternatively, they can acquire and convert an existing office building for a total cost of nearly $700 per square foot, on average. The bottom line is that total conversion costs are higher than acquisition or ground-up development, with more complexity involved as well. 

The second big challenge is the quality of the buildings themselves. Numerous elements of the physical building impact conversion feasibility. For example, location relative to transit and amenities. Buildings in suboptimal locations are unlikely to be considered. Whether the office asset is vacant or not is also a factor. Office leases are typically longer duration, and a building needs to be close to or fully vacant for a full conversion. And lastly, physical attributes such as architecture, floor-plate depth, windows placement, among others. 

And finally, regulation presents a third major hurdle. Zoning and building code requirements differ from city to city and can add substantive time, cost, complexity, and limitations to any conversion project. That said, governments are in a unique position to encourage conversions — for example, via tax incentives – and literally remake cities short on affordable housing but with excess, underutilized office space.

We have looked at conversion opportunities in three key markets: New York, San Francisco, and Washington, D.C. In Manhattan, active office to residential conversions have been concentrated in the Financial District, and we think this trend will continue. We also see the East Side of Manhattan as a uniquely untapped opportunity for future conversions, given higher vacancy today. This would shift existing East Side office tenants to other locations, boosting demand in higher-quality office neighborhoods like Park Avenue and Grand Central.

In San Francisco, we are concerned about other types of real estate properties beyond just office. Retail, multifamily, and lodging in the downtown area are taking longer to recover post-COVID, and we think this will limit conversions in the market. 

And finally, in Washington, D.C. we think conversion would work best for older, Class B/C office buildings on the edges of pre-existing residential areas. 

In these three markets, and others, conversions could work in specific instances, with specific buildings in specific sub-markets. But on a national basis, the economic and logistic challenges of wide-scale conversions make this an unlikely solution.

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 US Public Policy Strategist expects a robust M&A cycle, regardless of the outcome of the US election. But rising antitrust concerns could create additional scrutiny on possible future deals. 

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Welcome to Thoughts on the Market. I’m Ariana Salvatore, from Morgan Stanley’s US Public Policy Research Team. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the impact of the US election on M&A. 

It’s Tuesday, August 13th, at 10am in New York.

2023 saw the lowest level of global mergers and acquisitions – or M&A – in more than 30 years, relative to the overall size of the economy. But we believe that the cycle is currently reversing in a significant way and that politics won't halt the "Return of M&A." 

Why? Because M&A cycles are primarily driven by broader factors. Those include macroeconomics, the business cycle, CEO confidence and financing conditions. More specifically, unusually depressed volumes, open new issue markets, incoming rate cuts and the bottom-up industry trends are powerful tailwinds to an M&A recovery and can offset the political headwinds. 

So far this year we’ve seen an increase in deal activity. Announced M&A volume was up 20 per cent year-over-year in the first half of [20]24 versus [20]23, and we continue to expect M&A volumes to rise in 2024 as part of this broader, multi-year recovery. 

That being said, one factor that can impact M&A is antitrust regulation. Investors are reasonably concerned about the ways in which the election outcome could impact antitrust enforcement – and whether or not it would even be a tailwind or a headwind. If you think about traditional Republican attitudes toward deregulation, you might think that antitrust enforcement could be weaker in a potential Trump win scenario; but when we look back at the first Trump administration, we did see various antitrust cases pursued across a number of sectors. 

Further, we’ve seen this convergence between Republicans and Democrats on antitrust enforcement, specifically the vice presidential pick JD Vance has praised Lina Khan, the current FTC chair, for some of her efforts on antitrust in the Biden administration. In that vein, we do think there are certain circumstances that could cause a deal to come under scrutiny regardless of who wins the election. 

First, on a sector basis, we think both parties share a similar approach toward antitrust for tech companies. Voters across the ideological spectrum seem to want their representatives to focus on objectives like 'breaking up big tech' and targeting companies that are perceived to have outsized control. 

We also think geopolitics is really important here. National security concerns are increasingly being invoked as a consideration for M&A involving foreign actors, in particular if the deal involves a geopolitical adversary like China. We’ve seen lawmakers invoke these kind of concerns when justifying increased scrutiny for proposed deals. 

Finally, key constituencies' positions on proposed deals could also matter. The way that a deal might impact key voter cohorts – think labor unions, for example – could also play a role in determining whether or not that deal comes under extra scrutiny. 

We will of course keep you updated on any changes to our M&A outlook. 

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.

Recent market volatility has made headlines, but our Global Chief Economist explains why the numbers aren’t as dire as they seem.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about central banks, the Bank of Japan, Federal Reserve, data and how it drove market volatility.

It's Monday, August 12th at 10am in New York.

You know, if life were a Greek tragedy, we might call it foreshadowing. But in reality, it was probably just an unfortunate coincidence. The BOJ's website temporarily went down when the policy announcement came out. As it turns out, expectations for the BOJ and the Fed drove the market last week. Going into the BOJ meeting consensus was for a September hike, but July was clearly in play.

The market's initial reaction to the decision itself was relatively calm; but in the press conference following the decision, Governor Ueda surprised the markets by talking about future hikes. Some hiking was already priced in, and Ueda san's comments pushed the amount priced in up by another, call it 8 basis points, and it increased volatility.

In the aftermath of that market volatility, Deputy Governor Yoshida shifted the narrative again, by stressing that the BOJ was attuned to market conditions and that there was no fundamental change in the BOJ's strategy. But this heightened attention on the BOJ's hiking cycle was a critical backdrop for the US non farm payrolls two days later.

The market knew the BOJ would hike, and knew the Fed would cut, but Ueda san's tone and the downside surprise to payrolls ignited two separate but related market risks: A US growth slowdown and the yen carry trade.

The Fed's July meeting was the same day as the BOJ decision, and Chair Powell guided markets to a September rate cut. Prior to July, the FOMC was much more focused on inflation after the upside surprises in the first quarter. But as inflation softened, the dual mandate came into a finer balance. The shift in focus to both growth and inflation was not missed by markets; and then payrolls at about 114, 000 in July. Well, that was far from disastrous; but because the print was a miss relative to expectations on the heel of a shift in that focus, the market reaction was outsized.

Our baseline view remains a soft landing in the United States; and those details we discussed extensively in our monthly periodical. Now, markets usually trade inflections, but with this cycle, we have tried to stress that you have to look at not just changes, but also the level of the economy. Q2 GDP was at 2.6 per cent. Consumer spending grew at 2.3 per cent. And the three-month average for payrolls was at 170, 000 -- even after the disappointing July print.

Those are not terribly frightening numbers. The unemployment rate at 4.3 per cent is still low for the United States. And 17 basis points of that two-tenths rise last month; well, that was an increase in labor force participation. That's hardly the stuff of a failing labor market.

So, while these data are backward looking, they are far from recessionary. Markets will always be forward looking, of course; but the recent hard data cannot be ignored. We think the economy is on its way to a soft landing, but the market is on alert for any and all signs for more dramatic weakness.

The data just don't indicate any accelerated deterioration in the economy, though. Our FX Strategy colleagues have long said that Fed cuts and BOJ hikes would lead to yen appreciation. But this recent move? It was rapid, to say the least. But if we think about it, the pair really has only come into rough alignment with the Morgan Stanley targets based on just interest rate differentials alone.

We also want to stress the fundamentals here for the Bank of Japan as well. We retain our view for cautious rate hikes by the BOJ with the next one coming in January. That's not anything dramatic because over the whole forecast that means that real rates will stay negative all the way through the end of 2025.

These themes -- the deterioration in the US growth situation and the appreciation of the yen -- they're not going away anytime soon. We're entering a few weeks of sparse US data, though, where second tier indicators like unemployment insurance claims, which are subject to lots of seasonality, and retail sales data, which tend to be volatile month to month and have had less correlation recently with aggregate spending, well, they're going to take center stage in the absence of other harder indicators.

The normalization of inflation and rates in Japan will probably take years, not just months, to sort out. The pace of convergence between the Fed and the BOJ? It's going to continue to ebb and flow. But for now, and despite all the market volatility, we retain our outlook for both economies and both central banks. We see the economic fundamentals still in line with our baseline views.

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

As markets adjust to global volatility, our Head of Corporate Credit Research considers when the Fed might choose to cut interest rates and how long the impacts may take to play out.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the market’s expectation for much larger rate cuts from the Federal Reserve, and how much that actually matters.

It's Friday, August 9th at 2pm in London.

Markets have been volatile of late. One of the drivers has been rising concern that the Fed may have left interest rates too high for too long, and now needs to more dramatically course-correct. From July 1st through August 2nd, the market’s expectation for where the Fed’s target interest rate will be in one year’s time has fallen by more than 1 percent. 

But…wait a second. We’re talking about interest rates here. Isn’t a shift towards expecting lower interest rates, you know, a good thing? And that seems especially relevant in the recent era, where strong markets often overlapped with fairly low interest rates. 

Zoom out over a longer span of history, however, and that’s not always the case.

Interest rates, especially the rates from the Federal Reserve, are often a reflection of economic strength. And so high interest rates often overlap with strong growth, while a weak economy needs the support that lower rates provide. And so if interest rates are falling based on concern that the economy is weakening, which we think describes much of the last two weeks, it’s easier to argue why credit or equity markets wouldn’t like that outcome at all.

That’s especially true because of the so-called lag in monetary policy. If the Fed lowered interest rates tomorrow, the full impact of that cut may not be felt in the economy for 6 to 12 months. And so if people are worried that conditions are weakening right now, they’re going to worry that the help from lower rates won’t arrive in time.

The upshot is that for Credit, and I would say for other asset classes as well, rate cuts have only tended to be helpful if growth remained solid. Rate cuts and weaker growth were bad, and that was more true the larger those rate cuts were. In 2001, 2008 and February of 2020, large rate cuts as the economy weakened led to significant credit losses. Concern about what those lower rates signalled outweighed the direct benefit that a lower rate provided.

We think that dynamic remains in play today, with the market over the last two weeks suggesting that a combination of weaker growth and lower rates may be taken poorly, not taken well.

But there’s also some good news: Our economists think that the market's views on growth, and interest rates, may both be a little overstated. They think the US economy is still on track for a soft-landing, and that last week’s jobs report wasn’t quite as weak as it was made out to be.

Because of all that, they also don’t think that the Fed will reduce interest rates as quickly as the market now expects. And so, if that’s now right, we think a stronger economy and somewhat higher rates is going to be a trade-off that credit is happy to take.

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 Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.

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Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare? 

It’s Thursday, August the 8th, at 4pm in London.   

As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system. 

Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years, according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.

The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face. 

Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day. 

BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.

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