2024 US Elections: Inflation’s Possible Paths

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 Aug 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 Aug 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 Aug 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 Aug 20243min

Recent market volatility has made headlines, but our Global Chief Economist explains why the numbers aren’t as dire as they seem.----- 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 be talking about central banks, the Bank of Japan, Federal Reserve, data and how it drove market volatility.It's Monday, August 12th at 10am in New York.You know, if life were a Greek tragedy, we might call it foreshadowing. But in reality, it was probably just an unfortunate coincidence. The BOJ's website temporarily went down when the policy announcement came out. As it turns out, expectations for the BOJ and the Fed drove the market last week. Going into the BOJ meeting consensus was for a September hike, but July was clearly in play.The market's initial reaction to the decision itself was relatively calm; but in the press conference following the decision, Governor Ueda surprised the markets by talking about future hikes. Some hiking was already priced in, and Ueda san's comments pushed the amount priced in up by another, call it 8 basis points, and it increased volatility.In the aftermath of that market volatility, Deputy Governor Yoshida shifted the narrative again, by stressing that the BOJ was attuned to market conditions and that there was no fundamental change in the BOJ's strategy. But this heightened attention on the BOJ's hiking cycle was a critical backdrop for the US non farm payrolls two days later.The market knew the BOJ would hike, and knew the Fed would cut, but Ueda san's tone and the downside surprise to payrolls ignited two separate but related market risks: A US growth slowdown and the yen carry trade.The Fed's July meeting was the same day as the BOJ decision, and Chair Powell guided markets to a September rate cut. Prior to July, the FOMC was much more focused on inflation after the upside surprises in the first quarter. But as inflation softened, the dual mandate came into a finer balance. The shift in focus to both growth and inflation was not missed by markets; and then payrolls at about 114, 000 in July. Well, that was far from disastrous; but because the print was a miss relative to expectations on the heel of a shift in that focus, the market reaction was outsized.Our baseline view remains a soft landing in the United States; and those details we discussed extensively in our monthly periodical. Now, markets usually trade inflections, but with this cycle, we have tried to stress that you have to look at not just changes, but also the level of the economy. Q2 GDP was at 2.6 per cent. Consumer spending grew at 2.3 per cent. And the three-month average for payrolls was at 170, 000 -- even after the disappointing July print.Those are not terribly frightening numbers. The unemployment rate at 4.3 per cent is still low for the United States. And 17 basis points of that two-tenths rise last month; well, that was an increase in labor force participation. That's hardly the stuff of a failing labor market.So, while these data are backward looking, they are far from recessionary. Markets will always be forward looking, of course; but the recent hard data cannot be ignored. We think the economy is on its way to a soft landing, but the market is on alert for any and all signs for more dramatic weakness.The data just don't indicate any accelerated deterioration in the economy, though. Our FX Strategy colleagues have long said that Fed cuts and BOJ hikes would lead to yen appreciation. But this recent move? It was rapid, to say the least. But if we think about it, the pair really has only come into rough alignment with the Morgan Stanley targets based on just interest rate differentials alone.We also want to stress the fundamentals here for the Bank of Japan as well. We retain our view for cautious rate hikes by the BOJ with the next one coming in January. That's not anything dramatic because over the whole forecast that means that real rates will stay negative all the way through the end of 2025.These themes -- the deterioration in the US growth situation and the appreciation of the yen -- they're not going away anytime soon. We're entering a few weeks of sparse US data, though, where second tier indicators like unemployment insurance claims, which are subject to lots of seasonality, and retail sales data, which tend to be volatile month to month and have had less correlation recently with aggregate spending, well, they're going to take center stage in the absence of other harder indicators.The normalization of inflation and rates in Japan will probably take years, not just months, to sort out. The pace of convergence between the Fed and the BOJ? It's going to continue to ebb and flow. But for now, and despite all the market volatility, we retain our outlook for both economies and both central banks. We see the economic fundamentals still in line with our baseline views.Thanks for listening. If you enjoy this show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

12 Aug 20245min

As markets adjust to global volatility, our Head of Corporate Credit Research considers when the Fed might choose to cut interest rates and how long the impacts may take to play out.----- 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 the market’s expectation for much larger rate cuts from the Federal Reserve, and how much that actually matters.It's Friday, August 9th at 2pm in London.Markets have been volatile of late. One of the drivers has been rising concern that the Fed may have left interest rates too high for too long, and now needs to more dramatically course-correct. From July 1st through August 2nd, the market’s expectation for where the Fed’s target interest rate will be in one year’s time has fallen by more than 1 percent. But…wait a second. We’re talking about interest rates here. Isn’t a shift towards expecting lower interest rates, you know, a good thing? And that seems especially relevant in the recent era, where strong markets often overlapped with fairly low interest rates. Zoom out over a longer span of history, however, and that’s not always the case.Interest rates, especially the rates from the Federal Reserve, are often a reflection of economic strength. And so high interest rates often overlap with strong growth, while a weak economy needs the support that lower rates provide. And so if interest rates are falling based on concern that the economy is weakening, which we think describes much of the last two weeks, it’s easier to argue why credit or equity markets wouldn’t like that outcome at all.That’s especially true because of the so-called lag in monetary policy. If the Fed lowered interest rates tomorrow, the full impact of that cut may not be felt in the economy for 6 to 12 months. And so if people are worried that conditions are weakening right now, they’re going to worry that the help from lower rates won’t arrive in time.The upshot is that for Credit, and I would say for other asset classes as well, rate cuts have only tended to be helpful if growth remained solid. Rate cuts and weaker growth were bad, and that was more true the larger those rate cuts were. In 2001, 2008 and February of 2020, large rate cuts as the economy weakened led to significant credit losses. Concern about what those lower rates signalled outweighed the direct benefit that a lower rate provided.We think that dynamic remains in play today, with the market over the last two weeks suggesting that a combination of weaker growth and lower rates may be taken poorly, not taken well.But there’s also some good news: Our economists think that the market's views on growth, and interest rates, may both be a little overstated. They think the US economy is still on track for a soft-landing, and that last week’s jobs report wasn’t quite as weak as it was made out to be.Because of all that, they also don’t think that the Fed will reduce interest rates as quickly as the market now expects. And so, if that’s now right, we think a stronger economy and somewhat higher rates is going to be a trade-off that credit is happy to take.Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

9 Aug 20243min

Our Head of Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.----- Transcript -----Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare? It’s Thursday, August the 8th, at 4pm in London. As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system. Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years, according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face. Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day. BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.Thanks for listening. If you enjoy the show, please do leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

8 Aug 20243min

Our Global Head of Thematic and Fixed Income Research joins our Chief Fixed Income Strategist to discuss the recent market volatility and how it impacts investor positioning within fixed income. ----- Transcript -----Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.Vishy: And I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist.Zezas: And on this episode of Thoughts on the Market, we'll talk about the recent market volatility and what it means for fixed income investors.It's Wednesday, August 7th at 10am in New York.Vishy, on yesterday's show, you discussed the recent growth of money market funds. But today I want to talk about a topic that's top of mind for investors trying to make sense of recent market volatility. For starters, what do you think tipped off these big moves across global markets?Vishy: Mike, a confluence of factors contributed to the volatility that we've seen in the last six or seven trading sessions. To be clear, in the last few weeks, there have been some downside surprises in incoming data. They were capped off by last Friday's US employment report that came in soft across the board. In combination, that raised questions on the soft-landing thesis that had been baked into market prices, where valuations were already pretty stretched. And this one came after a hawkish hike by Bank of Japan just two days prior.While Morgan Stanley economists were expecting it, this hike was far from consensus going in. So, what this means is that this could lead to a greater divergence of monetary policy between the Fed and the Bank of Japan. That is, investors perceiving that the Fed may need to cut more and sooner, and that Bank of Japan may need to hike more; in both cases, more than expected.As you know, when negative surprises show up together, volatility follows.Zezas: Got it. And so last week's soft US employment data raises the question of whether the Fed's overtightened and the US economy might be weaker than expected. So, from where you sit, how does this concern impact fixed income assets?Vishy: To be clear, this is really not our base case. Our economists expect US economy to slow, but not fall off the cliff. Last Friday's data do point to some slowing, on the margin more slowing than market consensus as well as our economists expected. And really what this means is the markets are likely to challenge our soft-landing hypothesis until some good data emerge. And that could take some time. This means recent weakness in spread products is warranted, and especially given tight starting levels.Zezas: So, it seems in the coming days and maybe even weeks, the path for total fixed income market returns is likely to be lower as the market adjusts to a weaker growth outlook. What areas of fixed income do you think are best positioned to weather this transition and why?Vishy: We really need more data to confirm or push back on the soft-landing hypothesis. That said, fears of growth challenges will likely build in expectations for more Fed cuts. And that is good for duration through government bonds.Zezas: And conversely, what segments of fixed income are most exposed to risk?Vishy: In one way or the other, all spread products are exposed. In my mind, the US corporate credit market recession risks are least priced into high yield single B bonds, where valuations are rich, and positioning is stretched.Zezas: So clearly the recent market volatility has affected global markets, not just the US and Japan. So, what are you seeing in other markets? And are there any surprises there?Vishy: Emerging market credit. In emerging market credit, investment grade sovereign bonds will likely outperform high yield bonds, causing us to close our preference for high yield versus investment grade. It is too soon to completely flip our view and turn bearish on the overall emerging market credit index.We do see a combination of emerging market single name CDSs as an attractive hedge. South Africa, Colombia, Mexico, for example.Zezas: So finally, where do we go from here? Do you think it's worth buying the dip?Vishy: Our message overall is that while there have been significant moves, it is not yet the time to buy on dips.Zezas: Well, Vishy, thanks for taking the time to talk.Vishy: Great speaking with you, Mike.Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. And share Thoughts on the Market with a friend or colleague today.

7 Aug 20244min