2026 Global Outlook: Slower Growth and Inflation

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.----- Transcript -----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.

22 Elo 20249min

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.----- Transcript -----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.

21 Elo 20242min

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.----- Transcript -----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.

20 Elo 20243min

Our Global Chief Economist explains what stricter immigration policy in key markets around the world could mean for economic growth and inflation.----- Transcript -----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.

19 Elo 20244min

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.----- Transcript -----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.

16 Elo 20243min

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.----- Transcript -----Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore from Morgan Stanley's U.S. Public Policy Research Team. And I'mAndrew 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.

15 Elo 20247min

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.----- Transcript -----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.

14 Elo 20244min

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. ----- Transcript -----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.

13 Elo 20243min