2026 Midterm Elections: What’s at Stake for Markets

As markets contend with the recent volatility in the banking sector, global central banks face the challenge of continuing to combat inflation against this updated backdrop. Chief Cross-Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Seth Carpenter: And I'm Seth Carpenter, Global Chief Economist. Andrew Sheets: And today on the podcast we'll be talking about Global Central Bank policy and what's next amidst significant market volatility. It's Friday, March 24th at 4 p.m. in London. Seth Carpenter: And it's noon here in New York. Andrew Sheets: So Seth I know that both of us have been running around over the last week speaking with clients, but it's really great to catch up with you because we're coming to the end of the first quarter and yet I feel like a year's worth of things have happened in global central banks and the economic narrative. Maybe just take a step back and help us understand how you're thinking about the global economy right now. Seth Carpenter: You're absolutely right, Andrew. There is so much going on this year, so it's worth taking a step back. Coming into this year, we were looking for the economy to slow down. And I think it's just critical to remember why, central banks everywhere that are fighting inflation are raising interest rates intentionally to tighten financial conditions in order to slow their economies down and thereby bring down inflationary pressures. The trick, of course, is not slowing things down so much that they actively cause a recession. So the Fed having hiked interest rates already, we came into the year expecting a few more hikes, but then the data got stronger and Chair Powell opened the door to maybe going back to 50 basis point hikes. And now we've got this development in the banking sector. But it's not as if so far the central banks have seen evidence that things have gone so far that they're going to cause a recession. So all of this sounds a little bit simple maybe, but the key thing here is how can they calibrate whether or not they've done enough in terms of tightening financial conditions or if they've gone too far. Andrew Sheets: That's a really important point, because if you look at what the market is now pricing from the Federal Reserve, it's expecting significant rate cuts through the end of the year. And it's pricing in a scenario where the Fed has effectively gone far enough or maybe they've even gone too far and has to reverse their policy pretty quickly. How do you think about the path forward from here and how likely is it that central banks will ease as much as markets are currently pricing? Seth Carpenter: I mean, I do think there is a path for central banks to ease, but that is not and let me just start off with that is not our baseline scenario for this year. You led off with inflation and I think that's an appropriate place to start because what we heard clearly from central bankers in all of the developed markets was they are still hyper focused on inflation being too high and the need to bring it down. So one way of thinking about what's going on is that there's just a continuation of the normal tightening of monetary policy, so bank funding costs have gone up. If you read the the publications that our colleague Betsy Graseck, who runs Bank Equity Research in North America, she's pointed out that there's been a clear increase in bank funding costs that compresses net interest margins and that should, as a result, have an effect on what's going on with credit extension. In that version of the world, the Fed is in this fine tuning version of the world where they have to feel their way to the right degree of tightness and maybe they overdo it a little bit and then eventually pull back. I think the other version of the world that's very hard to get your mind around it is absolutely not our best case scenario right now, is that there's just a wholesale pulling back in terms of the availability and willingness of banks to make credit, either because of what's going on with their own funding or because of risk in the economy. And if there's an immediate cessation of lending, well, then I think you're talking about small and medium sized businesses that rely on bank loans not being able to say cover payrolls, or not being able to cover working capital. I think that version of the world is very, very different and that would lead to a much sharper slowdown in the economy and I think, again, would elicit some reaction from the Fed. Andrew Sheets: So Seth, I'm really glad you brought the banking sector and its uncertain impact on the economy, because it goes to this broader question of lags and how that impacts some of the big debates that investors are having in the market. You have central banks that are looking at inflation and labor market data, that's arguably some of the more lagging economic data we have, by which I mean it historically tends to show weakness later than other economic indicators. So how do you think about those lags in inflation, in monetary policy and in bank credit when you're thinking about both Morgan Stanley's forecasts, but also how central banks navigate the picture here? Seth Carpenter: Very key part of what's going on is to try to understand that lag structure. I would say the best estimates are changes in monetary policy that tighten financial conditions, probably affect the real economy with a lag of two, three, maybe four quarters. And then from the real side of the economy to inflation, there's probably another lag of two or three or maybe four quarters. So we're talking about at least a year from policy to inflation and maybe as much as two years. One thing to keep in mind though, about those lags is we can look at the Fed and what they tell us about their own projections for how the economy would evolve under what they consider appropriate policy. And the answer is the median member of the Federal Open Market Committee sees core inflation at about 2.1%, so almost, but not quite back to target at the end of 2025. So if you think about when they started hiking rates until the end of 2025, they're thinking it's an appropriate time horizon for it to take well over three years. I think that's the kind of time horizon we should be thinking about in general, when everything goes, shall we say, roughly according to plan. Now, the banking system developments throw a big monkey wrench into everything. And to be clear, confounding all of this, even before we had any of the volatility in the banking sector, we were already seeing slowing, that always happens when interest rates rise. Deposits were coming down in the United States, even before any of the recent developments, the rate of growth of loans was coming down. We had on a three month basis, C&I loan growth slowed to about zero. So we were already seeing the slowing happening in the banking sector. I think the real question is, are we going to see just incrementally more or is there something more discontinuous? Our baseline view relies on this being sort of an incremental additional tightness in conditions, but we have to keep monitoring to make sure we know what happens. Andrew Sheets: Seth maybe my last question would be, given everything that's been going on, what do you think is something that is most misunderstood by the market or least understood by the market? Seth Carpenter: I definitely hear in conversations with clients and others this idea that there might be a dichotomy. Are central banks going to give up their concern about inflation and instead turn their focus to financial stability? And I always try to push back on that and say that that's a bit of a bit of a false dichotomy. Why do I say that? Because, remember, fundamentally, central banks are trying to tighten financial conditions in order to slow the economy, in order to bring inflation down. And so if what we're seeing now is just further tightening of financial conditions, that will help them slow the economy down, there's no trade off to be made. And in fact, Chair Powell, at the last press conference said what's going on in banking system is something like the equivalent of one or two interest rate hikes. So in that sense, there's clearly no dichotomy to be had. So I would say that's for me, the biggest misunderstanding in the way the debate is going on is whether central banks have to focus either on financial stability or on inflation. But if I can, let me turn the tables and ask a question of you. We came into this year with our outlook called the year of Yield, but now the world is very different. You've talked about how much volatility there is. So when you're talking to clients, how are they supposed to navigate these very turbulent waters with lots of cross-currents going in different directions? Andrew Sheets: One thing that I hope listeners understand is that when we set our views from the strategy side at Morgan Stanley, we work very closely with you and the Global Economics Team. And I think one of the core themes this year is that even though we've seen a lot of volatility in the narrative and in the data, the core message is that 2023 is a year where growth is decelerating meaningfully in the U.S and Europe and the 2023 is a year where growth is decelerating meaningfully in the U.S and Europe, and that's the case if you have a recession, which is not our base case, or if you avoid a recession, which is. And I think we've seen developments in the banking sector since we've and I think the developments that we've seen in the banking sector only reinforce this view, only reinforce the idea that growth is going to slow, given how hot it was coming in, given the effect of higher rates and now given the additional impact of a more conservative bank of a more conservative banking sector. I think you make a great point that there's a lot we don't know about how banks will react or how consumers will react to tighter credit conditions. Regardless, I still think at the core we should be investing for a decelerating growth environment. And I think that's an environment that argues for more conservatism in portfolios, owning less equities than normal and owning more bonds than normal. And that's very much premised on the idea that growth will decelerate from here and strategies will and that investing will follow a pattern similar to other periods of significant deceleration. Well, Seth, it was great talking with you. Seth Carpenter: It's great speaking with you Andrew. Andrew Sheets: And thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

25 Maalis 20239min

Original Release on February 6th, 2023: As new gene therapies are researched, developed and begin clinical trials, what hurdles must genetic medicine overcome before these therapies are commonly available? Head of U.S. Pharmaceuticals Terence Flynn and Head of U.S. Biotech Matthew Harrison discuss. ----- Transcript -----Terence Flynn: Welcome to Thoughts on the Market. I'm Terence Flynn, Head of U.S. Pharma for Morgan Stanley Research. Matthew Harrison: And I'm Matthew Harrison, Head of U.S. Biotech. Terence Flynn: And on this special episode of Thoughts on the Market, we'll be discussing the bold promise of genetic medicine. It's Monday, February 6th, at 10 a.m. in New York. Terence Flynn: 2023 marks 20 years since the completion of the Human Genome Project. The unprecedented global scientific collaboration that generated the first sequence of the human genome. The pace of research in molecular biology and human genetics has not relented since 2003, and today we're at the start of a real revolution in the practice of medicine. Matthew what exactly is genetic medicine and what's the difference between gene therapy and gene editing? Matthew Harrison: As I think about this, I think it's important to talk about context. And so as we've thought about medical developments and drug development over the last many decades, you started with pills. And then we moved into drugs from living cells. These are more complicated drugs. And now we're moving on to editing actual pieces of our genome to deliver potentially long lasting cures. And so this opens up a huge range of new treatments and new opportunities. And so in general, as we think about it, they're basically two approaches to genetic medicine. The first is called gene therapy, and the second is called gene editing. The major difference here is that in gene therapy you just deliver a snippet of a gene or pre-programmed message to the body that then allows the body to make the protein that's missing, With gene editing, instead what you do is you go in and you directly edit the genes in the person's body, potentially giving a long lasting cure to that person. So obviously two different approaches, but both could be very effective. And so, Terence, as you think about what's happening in research and development right now, you know, how long do you think it's going to be before some of these new therapies make it to market? Terence Flynn: As we think about some of the other technologies you mentioned, Matthew, those took, you know, decades in some cases to really refine them and broaden their applicability to a number of diseases. So we think the same is likely to play out here with genetic medicine, where you're likely to see an iterative approach over time as companies work to optimize different features of these technologies. So as we think about where it's focused right now, it's being primarily on the rare genetic disease side. So diseases such as hemophilia, spinal muscular atrophy and Duchenne muscular dystrophy, which affect a very small percentage of the population, but the risk benefit is very favorable for these new medicines. Now, there are currently five gene therapies approved in the U.S. and several more on the horizon in later stage development. No gene editing therapies have been approved yet, but there is one for sickle cell disease that could actually be approved next year, which would be a pretty big milestone. And the majority of the other gene editing therapies are actually in earlier stages of development. So it's likely going to be several years before those reach the market. As, again as we've seen happen time and time again in biopharma as these new therapies and new platforms are rolled out they have very broad potential. And obviously there's a lot of excitement here around these genetic medicines and thinking about where these could be applied. But I think before we go there, Matthew, obviously there are still some hurdles that needs to be addressed before we see a broader rollout here. So maybe you could touch on that for us. Matthew Harrison: You're right, there are some issues that we're still working through as we think about applying these technologies. The first one is really delivery. You obviously can't just inject some genes into the body and they'll know what to do. So you have to package them somehow. And there are a variety of techniques that are in development, whether using particles of fat to shield them or using inert viruses to send them into the body. But right now, we can't deliver to every tissue in every organ, and so that limits where you can send these medicines and how they can be effective. So there's still a lot of work to be done on delivery. And the second is when you go in and you edit a gene, even if you're very precise about where you want to edit, you might cause some what we call off target effects on the edges of where you've edited. And so there's concern about could those off target effects lead to safety issues. And then the third thing which we've touched on previously is durability. There's potentially a difference between gene therapy and gene editing, where gene editing may lead to a very long lasting cure, where different kinds of gene therapies may have longer term potential, but some may need to be redosed. Terence, as we turn back to thinking about the progress of the pipeline here, you know, what are the key catalysts you're watching over 23 and 24? Terence Flynn: You know, as everyone probably knows, biopharma is a highly regulated industry. We have the FDA, the Food and Drug Administration here in the U.S., and we have the EMA in Europe. Those are the bodies that, you know, evaluate risk benefit of every therapy that's entering clinical trials and ultimately will reach the market. So this year we're expecting much of the focus for the gene editing companies to be broadly on regulatory progress. So again, this includes completion of regulatory filings here in the U.S. and Europe for the sickle cell disease drug that I mentioned before. And then something that's known as an IND filing. So essentially what companies are required to do is file that before they conduct clinical trials in humans in the U.S. There are companies that are pursuing this for hereditary angioedema and TTR amyloidosis. Those, if successful, would allow clinical trials to be conducted here in the U.S. and include U.S. patients. The other big thing we're watching is additional clinical data related to durability of efficacy. So, I think we've seen already with some of the gene therapies for hemophilia that we have durable efficacy out to five years, which is very exciting and promising. But the question is, will that last even longer? And how to think about gene therapy relative to gene editing on the durability side. And then lastly, I'd say safety. Obviously that's important for any therapy, but given some of the hurdles still that you mentioned, Matthew, that's obviously an important focus here as we look out over the longer term and something that the companies and the regulators are going to be following pretty closely. So again, as we think about the development of the field, one of the other key questions is access to patients. And so pricing reimbursement plays a key role here for any new therapy. There are some differences here, obviously, because we're talking about cures versus traditional chronic therapies. So maybe Matthew you could elaborate on that topic. Matthew Harrison: So as you think about these genetic medicines, the ones that we've seen approved have pretty broad price ranges, anywhere from a million to a few million dollars per patient, but you're talking about a potential cure here. And as I think about many of the chronic therapies, especially the more sophisticated ones that patients take, they can cost anywhere between tens of thousands and hundreds of thousands of dollars a year. So you can see over a decade or more of use how they can actually eclipse what seems like a very high upfront price of these genetic medicines. Now, one of the issues obviously, is that the way the payers are set up is different in different parts of the world. So in Europe, for example, there are single payer systems for the patient never switches between health insurance carriers. And so therefore you can capture that value very easily. In the U.S., obviously it's a much more complicated system, many people move between payers as they switch jobs, as you change from, you know, commercial payers when you're younger to a government payer as you move into Medicare. And so there needs to be a mechanism worked out on how to spread that value out. And so I think that's one of the things that will need to evolve. But, you know, it's a very exciting time here in genetic medicine. There's significant opportunity and I think we're on the cusp of really seeing a robust expansion of this field and leading to many potential therapies in the years to come. Terence Flynn: That's great, Matthew. Thanks so much for taking the time to talk today. Matthew Harrison: Great speaking with you, Terrence. Terence Flynn: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on Apple Podcasts app. It helps more people to find the show.

23 Maalis 20238min

As investors focus on the risks of debt, can Emerging Markets combat pressure from wide fiscal deficits? Global Head of Fixed Income and Thematic Research Michael Zezas, Global Head of EM Sovereign Credit Strategy Simon Waever and Global Economics Analyst Diego Anzoategui discuss.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Simon Waever: I'm Simon Waever, Morgan Stanley's Global Head of EM Sovereign Credit Strategy. Diego Anzoategui: And I'm Diego Anzoategui from the Global Economics Team. Michael Zezas: And on this special episode of Thoughts on the Market, we'll discuss how emerging markets are facing the pressures from rising debt levels and tougher external financing conditions. It's Wednesday, March 22nd at 10 a.m. in New York. Michael Zezas: The bank backdrop that's been unfolding over the last couple of weeks has led investors in the U.S. and globally to focus on the risks of debt right now. Emerging markets, which have seen sovereign debt levels rise in part due to the COVID pandemic, is one place where debt concerns are intensifying. But our economists and strategists here at Morgan Stanley Research believe this concern is overdone and that there might be opportunities in EM. Diego, can you maybe start by giving us a sense of where debt levels are in emerging markets, post-COVID, especially amidst rising interest rates globally? Diego Anzoategui: The overall EM debt to GDP ratio increased 11% from 2019, reaching levels above the 60% mark in 2022. Just a level, leveled by some economists, that's a warning sign because of its potential effects on the growth outlook. But without entering the debate on where this threshold is relevant or not, there is no doubt that the increase is meaningful and widespread because nearly every team has higher debt levels now. And broadly speaking, there are two factors explaining the rise in EM debt. The first one is a COVID, which was a hit on fiscal expenditure and revenues, overall. Many economies implemented expansionary fiscal policies and lockdowns caused depressed economic activity and lower fiscal revenues. The second one is the war in Ukraine, that caused a rise in oil and food commodity prices, hitting fiscals in economies with government subsidies to energy or food. Michael Zezas: And, Simon, while most emerging markets continue to have fiscal deficits wider than their pre-COVID trends, you argue that there's still a viable path to normalization against the backdrop of global economic conditions. What are some risks to this outlook and what catalysts and signposts are you watching closely? Simon Waever: Sure. I'm looking at three key points. First, the degree of fiscal adjustment. I think markets will reward those countries with a clear plan to return to pre-pandemic fiscal balances. That's, of course, easier said than done, but at least for energy exporters, it is easier. Second market focus will also be on the broader policy response. Again, I think markets will reward reforms that help boost growth, and inbound investment. It's also important as central banks respond to the inflation concerns, which for the most part they have done. And then I think having a strong sustainability plan also increasingly plays a role in achieving both more and cheaper financing. Third and lastly, we can't avoid talking about the global financial conditions. While, of course that's not something individual countries can control, it does impact the availability and cost of financing. In 2022, that was very difficult, but we do expect 2023 to be more supportive for EM sovereigns. Michael Zezas: And with all that said, you believe there may be some opportunities in emerging markets. Can you walk us through your thinking there? Simon Waever: Right. So building on all the work Diego and his team did, we think solvency is actually okay for the majority of the asset class, even if it has worsened compared to pre-COVID. Liquidity is instead the weak spot. So, for instance, some countries have lost access to the market and that's been a key driver of why sovereign defaults have picked up already. But looking ahead, three points are worth keeping in mind. One, 73% of the asset class is investment grade or double B rated, and they do have adequate liquidity. Two, for the lower rated countries valuations have already adjusted. For instance, if I look at the probability of default price for single B's, it's around double historical levels already. And then three, positioning to EM is very light. It actually has been for the last three years. So these are all reasons why we're more upbeat on EM longer term, even if near-term, it'll be driven more by a broader risk appetite. Michael Zezas: And Simon, what happens to emerging markets if, say, developed market interest rates move far beyond current expectations and what we in Morgan Stanley research are currently forecasting? Simon Waever: In short, it would be very difficult for EM and I would say especially high yield to handle another significant move higher in either U.S. yields or the U.S. dollar. As I mentioned earlier, market access for single B's needs to return at some point in 2023 as countries already drew down on alternative funding sources. And even within the IG universe, it would make debt servicing costs much higher. Michael Zezas: And Diego, when you look beyond 2023, what are you focused on from an economics perspective? Diego Anzoategui: Beyond 2023, we're going to focus on fiscal balances mainly. The expenditure side of the equation has broadly normalized after COVID. So it's currently at pre-COVID levels. But the revenue side of the economy is lagging, so its revenues are below pre-COVID trends. So we're going to be focused on the economic cycle to check where revenue picks up again to pre-COVID levels. Michael Zezas: And, last question Simon, which countries within emerging markets are you watching particularly closely? Simon Waever: So overall, the investment grade and double B rated countries are largely priced for a more benign outlook already, which we agree with. But I would highlight Brazil as an exception, as one place that's not pricing the fiscal risks ahead. For the lower rated credits, I would highlight Egypt, Nigeria and Kenya as key countries to watch. They are large index constituents, still have relatively high prices and they all have upcoming maturities. Pakistan and Tunisia are at even higher risk of being the next countries to see a missed payment, but the difference here is that they're also priced much more conservatively. Michael Zezas: Well, Simon, Diego, thanks for taking the time to talk. Simon Waever: Great speaking with you, Mike. Diego Anzoategui: Great talking to you, Mike. Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

22 Maalis 20236min

Against the backdrop of volatility in the banking sector, tightening in consumer and commercial credit may have far-reaching impacts for economic growth.----- Transcript -----Welcome to Thoughts on the Market. I'm Vishy Tirupattur, Chief Fixed Income Strategist here at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the impact of the current volatility in the banking sector on credit. It's Tuesday, March 21st at 11 a.m. in New York. On the back of the developments over the last two weeks, our banking analysts see a meaningful increase in funding costs ahead, which should lead to tighter lending standards, lower loan growth and wider loan spreads. Our economists were already expecting a meaningful slowdown in growth and job gains over the coming months, and the prospect of incremental tightening of credit conditions raises the risk that a soft landing turns into a harder one. According to the U.S. Small Business Administration, small businesses are those that employ fewer than 500 workers, and between 1995 and 2021, they accounted for nearly 63% of the net new job creation. Today, nearly 47% of all private sector employees work at small businesses. In the banking sector, small banks account for 38% of total loans in the U.S. and 30% of commercial and industrial loans. Businesses rely on C&I loans for short term funding of activities such as hiring, paying workers, purchasing supplies, equipment and building inventories. We now expect this C&I lending to slow down the most based on our prior experience. We also expect that lending to commercial real estate sector to decline given the stresses that are building over there. On the other hand, we are looking for lending to consumer to grow, but more slowly than what we thought before. Beyond their normal lending activity, banks enable credit formation in the economy by being buyers of senior tranches of securitized credit, providing senior leverage to securitization vehicles, which is a major source of credit formation. Well, we don't exactly know how bank regulations will change in response to the developments of last two weeks, there is the potential for bank sponsorship of securitized credit to diminish and thus indirectly affect credit formation. From a corporate bond investor perspective, the view has been that the banking sector fundamentals have been in a good place, and last year's underperformance versus non financials was largely a technical story. The developments of the last two weeks have undermined this thesis. Looking beyond the near-term uncertainty, we believe that the supply risks in bank credit are now skewed to the upside. The emphasis on funding diversity shifting away from deposits to wholesale funding is likely to keep regional bank issuance elevated for much longer. While the Bank Term Funding Program (BTFP) may alleviate the urgency to issue these bonds, it by no means provides a permanent solution. So looking beyond the near-term uncertainty, new assurance from banks, regional banks in particular, is likely to persist. Given that the sector was a consensus overweight and is also likely to see more supply when markets normalize, we see continued volatility and increased tiering within bank credit. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

21 Maalis 20233min

As markets look to recent bank failures, how are valuations for both stocks and bonds likely to change with this risk to growth?----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, March 20th at 11 a.m. in New York. So let's get after it. Over the past few weeks, the markets have fixated on the rapid failure of two major banks that, up until very recently, have been viewed as safe depository institutions. The reason for their demise is crystal clear in hindsight, and not that surprising when you see the interest rate risk these banks were taking with their deposits, and the fact that the Fed has raised rates by five percentage points in the past year. The uninsured deposit backstop put in place by the Fed and FDIC will help to alleviate further major bank runs, but it won't stop the already tight lending standards across the banking industry from getting even tighter. It also won't prevent the cost of deposits from rising, thereby pressuring net interest margins. In short, the risk of a credit crunch has increased materially. Bond markets have exhibited volatility around these developments as market participants realize the ramifications of tighter credit. The yield curve has steepened by 60 basis points in a matter of days, something seen only a few times in history and usually the bond market's way of saying recession risk is now more elevated. An inversion of the curve typically signals a recession within 12 months, but the real risk starts when it re-steepens from the trough. Meanwhile, the European Central Bank decided to raise rates by 50 basis points last week, despite Europe's own banking issues and sluggish economy. The German bund curve seemed to disagree with that decision and steepened by 50 basis points, signaling greater recession risk like in the U.S. If growth is likely to slow further from the incremental tightening in the U.S. banking system and the bond market seems to be supporting that conclusion, why on earth did U.S. stocks rally last week? We think it had to do with the growing view that the Fed and FDIC bail out of depositors is a form of quantitative easing and provides a catalyst for stocks to go higher. While the $300 billion increase in Fed balance sheet reserves last week does re liquefy the banking system, it does little in terms of creating new money that can flow into the economy or markets, at least beyond a brief period of, say, a day or a few weeks. Secondarily, the fact that the Fed is lending, not buying, also matters. If a bank borrows from the Fed, it's expanding its own balance sheet, making leverage ratios more binding. When the Fed buys a security outright, the seller of that security has more balance sheet space for renewed expansion. That is not the case in this situation, in our view. As of Wednesday last week, the Fed was lending depository institutions $300 billion more than it was the prior week. Half was primary credit through the discount window, which is often viewed as temporary borrowing and unlikely to translate into new credit creation for the economy. The other half was a loan to the bridge the FDIC created for the failed banks. It's unlikely that any of these reserves will transmit to the economy as bank deposits normally do. Instead, we believe the overall velocity of money in the banking system is likely to fall sharply and more than offset any increase in reserves, especially given the temporary emergency nature of these funds. Over the past month, the correlation between stocks and bonds has reversed and is now negative. In other words, stocks go down when rates fall now and vice versa. This is in sharp contrast to most of the past year when stocks are more worried about inflation, the Fed's reaction to it and rates going higher. Instead, the path of stocks is now about growth and our belief that earnings forecasts are 15 to 20% too high has increased. From an equity market perspective, the events of the past week mean that credit availability is decreasing for a wide swath of the economy, which may be the catalyst that finally convinces market participants that valuations are way too high. We've been waiting patiently for this acknowledgment because with it comes the real buying opportunity, which remains several months away. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

20 Maalis 20233min

As Europe commits to net-zero carbon emissions by 2050, one hurdle will be the energy emissions caused by buildings’ operations. What investment opportunities might come from energy renovation? European Building and Construction Equity Analyst Ceder Ekblom and European Property Analyst Sebastian Isola discuss. ----- Transcript -----Cedar Ekblom: Welcome to Thoughts on the Market. I'm Cedar Ekblom, Equity Analyst covering European Building and Construction for Morgan Stanley research. Sebastian Isola: And I'm Sebastian Isola from the European Property Team. Cedar Ekblom: On this special episode of Thoughts on the Market, we'll discuss Europe's commitment to building energy efficiency. Cedar Ekblom: Sebastian when I talk to investors and talk about energy emissions, most people immediately think of cars and transportation. But according to the International Energy Agency, in 2021 the operation of buildings accounted for 30% of global final energy consumption and 27% of total energy sector emissions. That's a huge number. A lot of people don't realize that. So it's clear that decarbonizing building stock is essential to achieving a net zero by 2050 scenario. Sebastian, we recently wrote about this and with this big goal in mind, can you give us an overview of where Europe is right now and what the biggest opportunities are that you see? Sebastian Isola: I think to start, Europe's building stock is old and inefficient. More than 40% was built before 1970 when the first energy efficiency standards were introduced, and we're currently renovating just 1% of building stock a year. The European Commission thinks that this needs to at least double to meet its 2030 target for a 55% cut in emissions. If we successfully lift innovation spend, there is a big opportunity for makers of solar, heating and ventilation equipment, building automation, energy efficient lighting, and any product linked to the building envelope from insulation to roofing and windows. Cedar Ekblom: So it sounds like there's great opportunity here, but investors often push back with the argument that energy renovation is a 'hope' rather than a reality. What are your views on the economics of investment? Sebastian Isola: I think firstly, I'd say that our alphawise survey gives us a proprietary insight into what's really happening on the ground. It confirms renovation spend is on the rise, there was a 10% increase in the number of people that renovated their homes to save energy in 2022 versus 2021. Secondly, for commercial property landlords, the economics of investment is clear. Green buildings are attracting higher rents, and in some markets, office buildings with sustainability ratings are being awarded materially higher valuations, sometimes more than a 20% premium. And Cedar, what are the key renovation categories and what is the driving motivation behind them? Cedar Ekblom: Well, if you talk to anyone in the industry, they'll tell you that fabric first is where we need to start. So what does that actually mean? We have to look at improving the insulation of the walls, the roofs, and looking at new windows and doors. And the reason why we need to prioritize this is ultimately space heating accounts for about two thirds of total energy consumption. The good thing is that our survey told us that in the nonresidential market, these types of investments are the ones being prioritized. Installation is expected to be one of the key renovation categories for 2023. Building managers told us that they plan to boost spend on installation by 8%. After upgrading the building envelope, you need to think about tackling HVAC equipment and rolling out building automation. And finally solar continues to rank as the most attractive for residential energy renovation upgrades. In terms of the motivations, 59% of consumers and building managers say that lowering energy costs was the biggest driver for investment. I think that ultimately makes sense when we think about the landscape of the energy market in Europe over the last 12 months with the big increases in gas and electricity prices. Sebastian Isola: And with that in mind Cedar, what's your near-term and longer term outlook for renovation spend? Cedar Ekblom: Well, look, the runway for investment is huge. The European Commission estimates that an additional €275 billion of investment in building energy efficiency is required annually to 2030. And that's only an interim goal. If we really want to reach a 2050 net zero ambition, the optionality for investment means that we could be looking at more than €5.9 trillion of spend. If we deliver that total construction spend in real terms would run at 3% annually. That's a big increase from the less than 1% average growth over the last 10 years. Now, Sebastian, we've obviously spoken about the potential for fantastic investment, but there's obviously some big barriers around actually driving this uplift. How is the region trying to tackle these types of hurdles? Sebastian Isola: I think the biggest barriers are funding and skills and there's a 'carrot and stick' approach to funding. Government subsidies are coming through, although maybe slightly slower than we'd like. The good news is that private investment really is ramping up, and that's partly driven by better economics, but also new penalties which make letting inefficient buildings less profitable. In the UK, if we use that as an example, you need to achieve an EPC rating of B or higher by 2030 to be able to let your building. To put that in context, 75% of commercial properties in the UK currently don't meet that EPC standard. So there's going to be a huge scale of renovation required for commercial property in the UK to be brought up to that standard by 2030. And that really is going to drive investment in commercial property and in energy renovation. The second challenge is skills. It's not an easy problem to fix, especially when the construction industry is already challenged by a lack of skilled labor. The EU is taking an important step to address these hurdles by introducing the Energy Performance of Buildings Directive. This sets a region wide energy efficiency standard and harmonizes how buildings are ranked. It was passed into law in February of this year and we think it sets the framework for a multi-decade investment runway. Cedar Ekblom: Sebastian, thanks for taking the time to talk. Sebastian Isola: Great speaking to you Cedar. Cedar Ekblom: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app, it helps more people find the show.

17 Maalis 20235min

Investors’ renewed concerns around the banking system should have a variety of impacts on fixed-income investment.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Thursday, March 16th at 11 a.m. in New York. It's a volatile moment in markets, with investors grappling with complicated questions around the failure of Silicon Valley Bank. That event has naturally led to concerns about broader challenges to the banking system and potential impacts to the path for monetary policy. Here's what we think fixed income investors need to know in the near-term. Our banking analysts and economists have concluded that the U.S. banking system is more constrained. The causes of the Silicon Valley Bank situation will likely cause banks and their regulators to think differently about capital, causing lending growth to decline more than expected this year. That, in turn, should put pressure on the labor market and therefore the general U.S. economic outlook. We expect this dynamic will influence the U.S. bond market in the following ways in the near-term. For treasuries, we believe yields will be biased lower, because while the data still shows inflation pressures have persisted, that may take a backseat to financial stability concerns in the minds of investors. For corporate credit, there may be some near-term underperformance, given the market features a heavy weighting towards bonds issued by U.S. banks. In MUNI's, our team doesn't expect them to outperform in the near-term as the kind of interest rate volatility caused by recent events historically has been a headwind to the asset class. But a bright spot might be agency mortgage bonds, where our colleagues see room for compression in yields relative to treasuries. Those levels, which are near COVID crisis levels, perhaps overcompensate for fears that banks may have to sell their portfolios of similar bonds. So that's what's going on in the near-term, but my colleagues and I will be back here frequently to give you some longer term perspective. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

16 Maalis 20232min

As cryptocurrency has seen some of its major players topple, policy makers have set their sights on regulation. So what are some of the possible scenarios for crypto policy? U.S. Public Policy Researcher Ariana Salvatore and Head of Cryptocurrency Research Sheena Shah discuss.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.----- Transcript -----Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore from Morgan Stanley's U.S. Public Policy Research Team. Sheena Shah: And I'm Sheena Shah, Head of the Cryptocurrency Research Team. Ariana Salvatore: And on this special episode of the podcast, we'll focus on the issue of cryptocurrency regulation. It's Wednesday, March 15 at 10 a.m. in New York. Sheena Shah: And 2 p.m. in London. Ariana Salvatore: The recent news about the U.S. banking system has brought even more focus on the cryptocurrency markets. Our listeners may have heard about a series of insolvencies and collapses of major crypto players last year, with the most notable being the FTX exchange. These events have raised concerns among policymakers and are signaling a need to regulate cryptocurrencies as a means of protecting investors. Sheena, before we dig into any potential regulatory path for crypto from here, I think it's important to try to get a grip on a question that might seem basic, but in fact is one that policymakers have actually been grappling with for quite some time. And that is, what is a cryptocurrency from a regulatory perspective. Is it a security or is it a commodity? How should it be classified from a regulatory perspective? Sheena Shah: So cryptos could be classified as many things: securities, commodities, currencies, or even something else. But the U.S. regulators are making their view very clear. The SEC is saying every crypto apart from Bitcoin is a security. The definition will determine what products can be offered, which companies can offer them, which regulator will be in charge and maybe even how transactions are taxed. There is agreement that Bitcoin should be classified as a commodity, partly due to its decentralized nature, and no regulator is classifying Bitcoin as a currency as this would admit that it's a direct competitor with the U.S. dollar. Ariana Salvatore: Got it. So taking a step back for a second, cryptocurrencies up until this point have been largely unregulated and volatility is obviously nothing new in the space. What has been happening in crypto markets lately that's just now suggesting a need for regulation? Sheena Shah: Well, last year crypto prices were in a bear market and the collapse of the FTX exchange just increased the politician interest in this area. Trading data tell us that the average U.S. retail investor purchased crypto when Bitcoin was trading above $40,000, around double the current price. So regulators want to make sure that retail investors understand the risks and to limit the volatility spillover from crypto to the traditional financial system. Now that we know why there's a need for regulation, what do you think the core principles would be behind a potential regulatory framework? Ariana Salvatore: So when we think about the way that Congress approaches the crypto space, there are really two key principles. The first is restrictiveness, or how much lawmakers want to rein in the space. And this we kind of see as a spectrum, so ranging from status quo or continuation of regulation by enforcement, to a scenario that we're calling comprehensive crypto crackdown. And that would be probably the most severe outcome from our perspective. The second principle is pretty binary. So whether or not Congress is able to delegate authority or control over the crypto space to one agency or another. One thing I'll just mention back on that Restrictiveness idea, it's not necessarily a question of just how much Congress wants to reign in the space, it's arguably even more so a function of what's possible in the legislative sense. Remember, the Republican Party controls the House of Representatives, so there are some structural constraints here that might make any regulatory efforts a little bit lighter touch than what you could expect in a unified government scenario or single party control. Sheena Shah: So there are lots of opinions on crypto regulation. What do you think is a viable eventual scenario for some regulatory framework? Ariana Salvatore: When we think about what's possible, like you said, there's a range of outcomes, but our base case is what we're calling scoping in Stablecoins. So in this scenario, Congress does in fact deliver a clear delegation of authority to either the FDIC or the CFTC, effectively answering that question of mapping out control. And it also puts into place some baseline consumer focused protections. So, for example, requiring Stablecoin issuers to be FDIC insured and imposing federal risk management standards, primarily things like reserve requirements. Now, why do we think they're going to target Stablecoins first? Besides the fact that that's pretty much all lawmakers can agree on for right now, we think there are two pressing reasons. First, most stablecoins are U.S. dollar based, and the services that some crypto companies have been offering are quite similar to what banks offer, which provides pretty direct competition with the U.S. banking system. And secondly, a large portion of crypto trading is also done via stablecoins, which means that regulating this area first could have a significant impact on the broader market without having to necessarily stretch those regulations further. So Sheena, turning it back to you, how do we think other governments around the world are looking at crypto regulation? Are they focused as the U.S. is, or are we kind of leading the way in this area? Sheena Shah: Most countries are looking at crypto regulation right now, and many are applying the similar rules, such as requiring exchanges to register with the regulators. I would say that the European Union is further ahead than the U.S. in terms of a crypto specific framework, with their MiCA regulation due to be put into law soon. In the U.S., they've gone down a route of enforcing current financial rules on crypto products. At first glance, the actions are thought to be pushing crypto innovations to other parts of the world. We think it's a bit too early to tell whether that will occur in the long run. Ariana Salvatore: Now, one specific area I'd like to touch on also, because it's become a global debate, is Central Banks Digital Currencies or CBDCs. Given the role of the U.S. dollar in the global economy, do you think the U.S. needs a CBDC? And if it does, what form do you think it could take? Sheena Shah: The U.S. only started investigating a CBDC because everyone else was doing it too. Most notably China and the Eurozone. The U.S. doesn't actually necessarily need a CBDC for domestic payments as instantaneous bank settlements are going to be possible through FedNow being introduced later this year. We don't know what form a CBDC could take as that's still being researched, but some forms could have dramatic implications for the banking sector should banks not be required to create the currency. This year we're paying more attention to the developments of the digital euro as that may be available within 2 to 3 years. Now, Ariana, if we bear in mind everything we've discussed so far, realistically how much do you expect to be accomplished in terms of crypto regulation by the next election? Ariana Salvatore: So in the note, we rank our scenarios in terms of likelihood. And as I mentioned before, scoping and stablecoins is our base case. So we do think that something gets done in this area ahead of the 2024 election, although obviously it's a very complex space and there's quite a ramp time associated with lawmakers learning about crypto and all the different nuances and working out those details. I think this question also brings up a really interesting point, though, in particular on timing and how that could relate to potential market impact. So back to your Civics 101 class, when Congress passes a law it technically goes into effect immediately, but the rules themselves can take some time to come to fruition. If the legislation directs federal agencies to come up with regulatory parameters within a certain time frame, that time frame can vary. It can be years, but sometimes it can be months following the legislation. So that is to say that although right now we're seeing significant legislative discussion underway, it's possible that markets have some time to digest the impact as these rules are introduced and developed and fine tuned to then eventually come into effect. We think that delay could create a ramp period for companies to make adjustments to become compliant with some of the new rules which we think could, overall in the longer term, soften the blow of regulation and mitigate the shock to markets. So, Sheena, last question for you. Given all of this, what key events or catalysts should investors be paying particular attention to in the coming months? Sheena Shah: Broad investor focus is clearly on the traditional banking sector. For crypto, we watch to see if there are any further announcements related to these recent coordinated actions from regulators aiming to define crypto products and any that could reduce the on-ramps between the fiat world and the crypto world. Ariana Salvatore: Got it, that makes sense. So this is a continuously evolving space with a lot of potential new developments along the way, and we'll be sure to keep an eye on it as it evolves. Sheena, thanks so much for taking the time to talk. Sheena Shah: Great speaking with you, Ariana. Ariana Salvatore: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

15 Maalis 20238min