2026 Midterm Elections: What’s at Stake for Markets

On the heels of a midsummer spike, long-end treasury yields have picked up further momentum, which has created complex implications for the Fed, the corporate credit market, and emerging market bonds.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about our views on the back of moves higher in Treasury yields. It's Friday, October 13th at 3 pm. in New York. The midsummer move higher in long-end treasury yields picked up further momentum in September, spiking to levels last seen over 15 years ago. Market narratives explaining these moves have revolved largely around upside surprises to growth and concerns about large federal fiscal deficits. The September employment report was unequivocally strong, perhaps too strong for policymakers to relax their tightening bias. While inflation has been decelerating faster than the Fed forecasts, continued strength in job gains could fuel doubts about the sustainability of the pace of deceleration. On the other hand, the rise in long-end yields have led financial conditions tighter. By our economists’ measure, since the September FOMC meeting, financial conditions have tightened to the equivalent of about two 25 basis point hikes, bringing the degree of tightness more in line with the Fed's intent. Thus, our economists see no need for further hikes in the Fed's policy rates this year. In effect, the move higher in Treasury yields is doing the job of additional hikes. It's worth highlighting that there has been a subtle shift in the tone of Fed speak in the past two weeks, indicating that the appetite for additional hike this year is waning. Given the moves in Treasury yields, we felt the need to reassess our Treasury yield forecasts and move them higher relative to our previous forecasts. Our interest rate strategists now expect ten-year Treasury yields to end year 2023 at 4.3% and mid-2024 at 3.9%. The effects of higher treasury yields are different in the corporate credit market. Unlike the Treasury market, the concentration of yield buyers in investment grade corporate credit bonds is much higher, especially at the back end of the curve. These yield buyers offer an important counterbalance. In fact, for longer duration buyers, there are not that many competing alternatives to IG corporate credit. While spreads look low relative to Treasury yields, growth optimism is likely to keep demand skewed towards credit over government bonds. Insurance companies and pension funds may have room to add corporate credit exposure, although stability in yields is certainly important. Higher treasury yields have implications to other markets as well, notably on emerging market bonds. Considering the move in U.S. Treasury yields, we think EM credit bonds cannot absorb any further move higher. In a higher for longer scenario, we expect EM high yield bonds to struggle. Therefore, we no longer think that EM high-yield credit will outperform EM investment grade 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.

13 Okt 20232min

Although inflation is largely under control in Asian economies, central banks could be pushed to respond if high U.S. yields meet rising oil prices.----- Transcript -----Welcome to Thoughts on the Market. Chetan Ahya, Morgan Stanley's Chief Economist. Along with my colleagues bringing you a variety of perspectives, today, I'll discuss how higher U.S. rates environment could affect Asia. It's Thursday, October 12th, at 9 a.m. in Hong Kong. Real rates in the U.S. have risen rapidly since mid-May and remain at elevated levels. Against this backdrop, investors are asking if Asian central banks will have to restart their rate hiking cycles. We think Asia should be less affected this time around, mainly because of the difference in inflation dynamics. As we've highlighted before on this show when compared to the U.S., Asia's inflation challenge is not as intense. In fact, for 80% of the economies in the region inflation is already back in the respective central bank's comfort zone. Real policy rates are already high and so against this backdrop, we believe central banks will not have to hike. However, we do think that the central banks will delay cutting rates. Previously, we had expected that the first rate cut in the region could come in the fourth quarter of 2023, but now we believe that cuts will be delayed and only start in first quarter of 2024. So what can trigger renewed rate hikes across Asia? We think that central banks will respond if high U.S. yields are accompanied by Brent crude oil prices rising in a sustained manner, above $110 per barrels versus $85 today. Under this scenario, the region's macro stability indicators of inflation and current account balances could become stretched and currencies may face further weakness. In thinking about which central banks might face more pressures to hike, we consider three key factors, economies with lower yields at the starting point, economies running a current account deficit or just about a mile surplus and the oil trade deficit. This suggests that economies like India, Korea, Philippines and Thailand, may be more exposed and so this means that the central banks in these countries may be prompted to begin raising rates. In contrast, the economies of China and Taiwan are less exposed, and so their central banks would be able to stay put. Thanks for listening, and 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.

12 Okt 20232min

With Congress still without a Speaker of the House, investors should keep an eye on the impact that another potential government shutdown would have on the markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of Congress on financial markets. It's Wednesday, October 11th, at 10 a.m. in New York. As of this recording, the U.S. House of Representatives still does not have a speaker following Representative McCarthy's ouster a little over a week ago. Republicans are scheduled to meet today to attempt to nominate the speaker, but until one is chosen, it's unclear that Congress can do any other business. But does that actually matter for investors? Here's two signals from these events that we think are important. First, it signals that Congress is unlikely to deliver any substantial legislation between now and the 2024 election outside of funding bills. Republicans' difficulty choosing a speaker reflects their lack of consensus on many policy issues, including regulation, social spending and more. That further impedes the government's ability to legislate, which was already hampered by different parties controlling the White House and Congress. So for investors who have credited the rise in bond yields and stock prices to expanded fiscal support from the federal government in recent years, you shouldn't expect there to be more on the horizon. The exception to this could be an economic crisis that prompts a fiscal response. But for investors, that means you'd likely see bonds rally and stocks sell off before fiscal support would again become a stock market positive. The second signal, which also cuts against the narrative of government policy support for markets, is that a government shutdown is still a distinct possibility. Congress recently avoided the government shutdown at the beginning of the month by passing a temporary extension of funding into November. But that move only delayed the resolution of key policy disagreements within the House Republican caucus that nearly led to the shutdown in the first place. With the clock ticking toward another shutdown deadline, Republicans are spending precious time selecting a new speaker, and it's not clear they're any closer to resolving their disagreements on key issues such as funding aid to Ukraine. Without that resolution, the risk remains that the House could fail to consider funding bills in time to avoid another shutdown. Now, to put it in context, our economists expect that downward growth pressures from a shutdown event should be modest, and so there are more meaningful factors to consider for markets out there, but certainly this condition doesn't help investors' confidence in the U.S. growth trajectory. And generally speaking, a Congress stunted in its ability to legislate has the potential to become a bigger challenge, particularly if geopolitical events create greater global growth risks. So bottom line, this situation is worth keeping tabs on, but isn't yet something we think should principally drive investors decision making. 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.

11 Okt 20233min

As companies integrate generative AI into enterprise software, a wide variety of jobs that depend on requesting or distributing data could be automated.----- Transcript -----Welcome to Thoughts on the Market. I'm Keith Weiss, Head of Morgan Stanley's U.S. Software Team. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the significant potential impact from generative A.I on enterprises. It's Tuesday, October 10th, at 10 a.m. in New York. You may remember the generative A.I powered chat app that reached 1 million users in only five days after its launch late last year. While much of the early discussion on the use of generative A.I focused on the consumer opportunity, we see perhaps an even bigger opportunity in enterprise software. The advantages from traditional A.I to generative A.I are rapidly broadening the scope of the types of work and business processes that enterprise software can automate, and this could ultimately have an impact on industries across the entire economy. Of course, one of the biggest questions everyone seems to have is how will generative A.I impact jobs? We forecast 25% of labor could be impacted by generative A.I capabilities available today, likely rising to 44% of labor in three years. Further, by looking at the wages associated with those jobs, our analysis suggests generative and A.I technologies can impact the $2.1 trillion of labor costs attached to those jobs today, expanding to $4.1 trillion in three years in the U.S. alone. This drives an approximately $150 billion revenue opportunity for software companies in our view. An important caveat here, we believe it's too early to make any definitive claims on the number of jobs that will be replaced by generative A.I. So we used the term impact to denote the potential for either an augmentation or further automation of these jobs on a go forward basis. So what are the jobs we think are most likely to be impacted? Based on the current capabilities of generative A.I technologies like large language models, we believe the common characteristics are skills amongst the jobs most impacted are the need to retrieve or distribute information. For example, billing clerks, proofreaders, switchboard operators, general office workers and brokerage clerks. On the other side of the equation, jobs that are least impacted today are those that require some aspect of physical labor, including ophthalmologists, extraction workers, choreographers, firefighters and manufactured building and mobile home installers. Over the next three years, as this more generalized A.I. technology focuses in on more specific use cases, we believe the impact of generative A.I will shift into more specialized jobs, such as general and operations managers, as well as registered nurses, software developers, accountants and auditors, and customer service reps. Of these, the General and Operations Manager jobs could experience the highest potential cumulative wage impact. In fact, our analysis suggests a $83 billion impact amongst general and operations managers today. The magnitude of the enterprise impact marks only one side of the equation, as the timing of the realizable opportunity becomes increasingly important for investors to navigate this evolving technology cycle. To be clear, the rapid adoption of these consumer technologies are not going to be indicative of the pace of adoption we're likely to see amongst the enterprise. There are several notable frictions to enterprise adoption related to items such as finding a good return on investment, enabling good data protection, the skill sets necessary to run and operate these new technologies and legal and regulatory considerations, all which necessitate significantly longer adoption cycles for the enterprise. For this reason, we think generative A.I remains in the early stages of the opportunity. Thank you 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.

10 Okt 20233min

While U.S. consumer sentiment is on the decline, there are some categories that have remained stable as purse strings tighten.----- Transcript -----Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S. Equity Strategy Team. Along with my colleagues bringing you a variety of perspectives, today I'll give you an update on the U.S. consumer. It's Monday, October 9th at 10 a.m. in New York. As we get into the fall season and close out the third quarter of this year, investors are paying attention to the state of the U.S. consumer. Our recent survey work reveals that inflation continues to be a primary concern for consumers and that the U.S. political environment is the second most significant concern. Furthermore, consumers continue to worry about their payment obligations, and 30% of people we surveyed expressed concern over their potential inability to repay debts. Low income consumers are generally more worried about their inability to pay rent, while upper income consumers are concerned about their investments, U.S. politics and geopolitics. Overall, consumer confidence in the U.S. economy and household finances worsened modestly in September. More than half of U.S. consumers are expecting the economy to get worse in the next six months, while less than a quarter of consumers are expecting the economy to get better. This worsening sentiment is also consistent across different income cohorts. Additionally, savings rates continue to trend lower versus earlier this year. Consumers report having an average savings reserve of 4.2 months, the average over the past few months has been trending lower compared to earlier in the year. Of course, savings reserves vary significantly by income though, with upper income consumers having on average around 6 to 7 months worth of expenses in savings compared to about 3 months for low income cohorts. Positively fewer consumers reported missing or being late on a loan or bill payment, with 34% missing a payment last month versus 38% in August. Low income consumers are more likely to have missed or been late on payments versus middle and high income consumers. Consumer spending intentions across income cohorts for the next month are similar to last month, with 31% of consumers expecting to spend more next month and 19% expecting to spend less. Consumers continue to prioritize essential categories like groceries and household items, but plan to spend less on more discretionary products like electronics, leisure and entertainment, small appliances and food away from home. Interesting to note, cell phone bills continue to be a clear priority for consumers. Travel intentions have also remained relatively stable. Over half of consumers are planning to travel over the next six months, mostly to visit friends and family, which is slightly up from last year. Not surprisingly, travel spending is higher for high income consumers than for low and middle income ones. However, we have seen plans for international travel start to decline. Thank you 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.

9 Okt 20232min

As bond yields continue to rise, credit has been more of a passenger than the driver of recent market volatility.-----Transcript -----Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Morgan Stanley's Head of Corporate Credit Research. Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross-Asset Strategist. Andrew Sheets: And on the special episode of the podcast, we'll discuss Morgan Stanley's updated cross-asset and corporate credit views. It's Friday, October 6th at 3 p.m. in London. Serena Tang: And 10 a.m. in New York. Andrew Sheets: Before we get into our discussion, let me introduce Serena Tang as Morgan Stanley's new Global Cross-Asset Strategist. Serena has been working with me for the last 15 years and together we initiated our cross-asset effort nearly a decade ago. Serena was responsible for building the team's investment framework, specializing in multi asset allocation, portfolio optimization, and long run capital market assumptions. So I can confidently say that Morgan Stanley's cross-asset effort is in very capable hands. As for me, I'm now Morgan Stanley's Head of Corporate Credit Research, but I'll continue to host my colleagues as we look forward to bringing you key debates from across asset classes and regions. So, Serena, welcome and let's jump right into what's going on in markets. Over the last several weeks, as everybody in the U.S. has returned from summer, the debate among Morgan Stanley's economists and strategists is centered on two main issues, the outperformance of the U.S. economy and the underperformance of China's economy, as well as the spike of government bond yields, especially at the longer end of the curve. So where has this left our views across asset classes? Serena Tang: Yeah, yields and real yields have indeed moved a lot higher in a very short amount of time, you know, on that narrative that rates will stay higher for longer. And I would say that, you know, while the market has been going against our current call for government bond yields to fall over the next 6 to 9 months or so, we’re steadfast on our preference for high quality fixed income over risk assets like global equities, like high yield corporate bonds. And the reason really comes down to how higher real yields mean the discount rate for equities is also higher, leading to lower stock prices. And we've kind of seen this over the past few weeks or so. I think this is especially true in today's environment where the rise in yields and the rise in real yields isn't really driven by a rise in growth expectations, which you know traditionally have been great for equities thinking about future growth. But rather today's move in yields is really much a function of what the markets think the Fed would do over the coming few months. And all this largely explains the nearly 9% selloff we've seen in global equities since the start of August. But Andrew, you know, such dynamics must also be very similar in the credit world. In your view, how do rising government bond yields affect your outlook for global credit? Andrew Sheets: So I think credit finds itself in a pretty interesting place as bond yields have risen. You know, I would safely say that I think credit as a passenger in recent market volatility, it's not the driver. And, you know, if I think very simply about why bond yields have been selling off and there are a lot of different theories of why that's been happening, maybe a simple explanation would be that bond yields offer pretty poor so-called carry, a government bond, a ten year government bond yields less than just holding cash. They offer poor momentum, they're moving in the wrong direction and they have difficult technicals, i.e., there's a lot of supply of government bonds forecast over the coming years. And across a lot of those metrics, I do think credit looks somewhat better. Credit yields are higher, that carry is better. Credit compensates you more for taking on a longer maturity corporate bond, which is the opposite of what you see in the government bond market. And as yields have risen, companies have looked at those higher yields and done, I think, a very understandable thing, they are borrowing less money because it's more expensive to borrow that money. So we've seen less supply of corporate bonds into the market, which means there's less supply that needs to be absorbed and bought by investors. So credit can't ignore what's going on in this environment and we're broadly forecasting this to be worse for weaker companies, as the effect of potentially slower growth and higher rates we think will weigh more heavily on the more levered type of capital structure. But overall, I think within this kind of challenging environment, I think credit has been an outperformer and I think it can remain an outperformer given it has some advantages on these key metrics. Serena Tang: So you touched on lower quality companies. One of the very interesting forecasts from your team is that we still think default rates can go higher over the next 12 months. Now, how do I square this with everything that you just said, but also our U.S. economics team’s continued forecast for a soft landing? Andrew Sheets: It's a great question. I'd say our default forecast, which is that US default rates rise to a little bit under 5% over the next 12 months, is quite divisive. I’d say there's a group of investors who say, well, it doesn't make a lot of sense that default rates would rise given that our base case does call for a soft landing of the US economy, no recession. And another group that says, well, that seems like too low of a default rate because interest rates have just risen at one of the fastest paces we've seen in 150 years. Of course, that's going to put stress on weaker companies. And I guess we see the markets splitting the difference a little bit between that. I think the fact that you are seeing a clearly outperforming US economy, I think that does really reduce the risk of an above average default rate. It would be very unusual to see an above average default rate with anything like what we're forecasting in our base case economically. And then at the same time, you do have, thanks to the low rates we're coming from, an unusually large share of borrowers who borrowed a lot relative to the amount of income that they generate because they could do that at lower interest rates, and now that's going to be a struggle at higher interest rates. So I think the combination of those two factors gets you something that's in the middle. I think you do have a more robust than expected US economy, but you do have this tail of more heavily indebted issuers that is just, I think, going to struggle with the math of how do you pay for that debt when the interest rate is effectively doubled from where it was just 18 months ago? Serena Tang: And you described just now our credit being in the middle, so to speak. And, you know, being in the middle is much better than what we're projecting for equity returns, and hence one of the reasons we like high quality credit and we like high quality bonds. But then my question to you is, what might the market be missing right now? But also importantly, what do you think we might be wrong? Andrew Sheets: So I think there are a couple of important things to follow. I think there has been over the last several years an advent of alternative forms of capital, some of this is kind of rolled up into the general classification of private credit. But, you know, there have been a lot of new entrants, new investors who are willing to lend to companies under nontraditional terms. And I think it's a big open question around, does that presence of additional investors actually make defaults a lot less likely because there's a new outlet for companies that need to raise funds from this new investor pool, or does that pool not have that effect? And if anything, maybe it is a source of some additional risk. It's a group of lending that's hard to observe by design, by its nature. I think another important thing to watch will be what do companies do? Part of our thinking on the research side is that companies will view current yields as expensive and they will react like any actor would act. When it's more expensive to borrow, they will borrow less. They will try to improve their balance sheet and maybe in the process they'll buy back less stock or do other types of things. That might be wrong. You know, we might see a different reaction from companies. Companies might view that debt cost as different. Maybe they view it as more reasonable than we think they will. So at the moment, we're thinking that companies will view that debt is expensive and respond accordingly and do more bondholder friendly things, so to speak. But we'll have to see. And we could be wrong about how corporate treasurers and management are thinking about those trade offs. Andrew Sheets: Serena, thanks for taking the time to talk. Serena Tang: As always, great. Speaking of you, Andrew. Andrew Sheets: 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.

6 Okt 20238min

Here’s why convertible bonds, an often overlooked asset class, are becoming more attractive as an alternative to common stock.----- Transcript -----Welcome to Thoughts on the Market. I'm Todd Castagno, head of Morgan Stanley's Global Valuation Accounting Research Team. Along with my colleagues bringing you a variety of perspectives, today I'll be discussing the increasing attractiveness of the convertible debt market. It's Thursday, October 5th at 10 a.m. in New York. Rising interest rates have increased borrowing costs for everybody, and that includes companies looking to raise or refinance debt. And that generates a renewed appetite for an oft overlooked asset class called convertible bonds. But what are convertible bonds? To start, convertible bonds are what we call a hybrid instrument, combining the features of a traditional corporate debt and common equity. Similar to corporate bonds, convertibles offer guaranteed income via interest of the initial investment. The reason they are called "convertible" is because they offer investors the option to convert that bond to common stock when a company's share price hits a certain threshold. These hybrid features provide investors with downside protection and upside equity appreciation. There are many reasons why companies choose to issue convertible debt. First, they offer a strategic financial flexibility for high growth in early stage companies, a quick time to market execution time. Second, convertible debt provides an alternative path for companies that would find it difficult to access straight debt in the market. Third, they offer a way to raise equity without issuing more stock directly through secondary offerings. And this is a big plus for corporates because investors often perceive a secondary offering as a negative signal. And finally, a lower cash coupon and lower interest expense is very attractive in a high-rate environment. Why is that? Convertible bonds have lost market share from traditional corporate debt over the last 15 years. The convertibles market size has remained largely unchanged, while the traditional corporate debt market in the U.S. has roughly doubled. Convertibles are relatively less attractive at lower interest rates and accommodating capital markets for traditional alternatives. As it stands, 2023 is on track to double last year's issuance, as likely to be the highest post global financial crisis issuance outside of COVID. Important to note, the nature of issuance this year is different from recent history. In the last decade or so, issuance has been led by smaller market cap and growth companies, who don't have established debt markets or ratings and thus don't have easy access to straight debt capital. However, this year, 65% of issuers have had a credit rating and thus have had easy access to the straight debt market. They're coming to the convertibles market, not as a necessity, but are instead actively choosing to issue converts because of the favorable economics, through interest expense savings, and a last wrinkle, new favorable accounting. Accounting rules recently changed that reduce complexity for both issuers and investors. While accounting typically does not drive economics, on the margin, the recent change improves transparency and reduces cost to issue. Utilities have been especially large convertible issuers this year in the market. 75% of convertible offerings in 2023 year-to-date have been refinancing, which are likely to be one of the areas primed for growth in the capital markets. Looking ahead, we believe the convertibles market is poised for growth. We will likely see more convertible issuances, given a higher interest rate environment, tighter capital markets and a wall maturities, that is coming due in the next 2 to 3 years. Convertibles are a particularly suitable instrument in this context as they offer defensive income enhanced alternative to investing in the underlying common stock. 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.

5 Okt 20233min

Fundamentals for investment-grade credit remain resilient and steady, while below-grade credit continues to deteriorate. ----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about our views on corporate credit markets. It's Wednesday, October 4th at 10 a.m. in New York. With the second quarter earnings now in the rearview mirror, we look at how credit fundamentals have evolved and what that means for credit investors. Quality based divergence in credit fundamental performance continues to bear out, reinforcing our preference for higher quality within the credit universe. Investment grade credit fundamentals remain resilient. Overall, issuers have held up reasonably well despite moving past the peak in the strength of balance sheet metrics. While certain metrics have started to deteriorate, most notably interest coverage as a result of higher interest rates, leverage ratios have stayed well-contained despite the uptick in debt levels. We are calling for wider spreads in investment grade credit, as the market might be overly discounting the odds of a recession, and we had already priced for a smooth soft landing. While current spread levels do not leave much room for further compression, current yield levels remain attractive at multi year highs. These levels present both a source of attractive income and potential price upside as growth and inflation cool, particularly heading into a Fed pause and potential rate cutting cycle, which our economists expect will start in March 2024. While one could argue that with spreads at tight levels, the yield demand could simply shift to treasuries. However, with very low dollar prices on most investment grade bonds and the macro optimism around a soft landing, we think investment grade credit will remain well placed for some time to come. In-place fundamentals remain strong and thus far are not flashing signs of alarm to argue for long-duration buyers of credit to shift into treasuries. On the other end of the grade spectrum, in the below investment grade segment, fundamentals have continued to deteriorate. Earnings growth turned negative, coverage metrics fell, cash to debt ratios declined, and leverage rose. The weakness was widespread across sectors, with materials and consumer discretionary sectors seeing the largest year-over-year increase in leverage. Within our high yield fundamental sample, median interest coverage dropped for a third consecutive quarter, now more than a turn below its peak in 2022. The trend was similar for loans as well, while surging interest costs were the primary driver, weaker earnings were also at play. The concentration of "tail" cohorts is rising. In high yield, the vulnerable cohort, that is companies with low coverage and low cash debt ratios, reached 5% in size, which is record high post global financial crisis. In loans, the coverage tail inflected higher for the first time in two years. Clearly, quality based divergence continues to play out in credit fundamentals, which aligns with our recommendation to be defensive and stay invested in the higher quality segments of the credit markets. 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.

4 Okt 20233min