Europe in the Global AI Race

Generative AI could transform the nature of work and boost productivity, but companies and governments will need to invest in reskilling.----- Transcript -----Stephen Byrd: Welcome to Thoughts in the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research. Seth Carpenter: And I'm Seth Carpenter, the Global Chief Economist. Stephen Byrd: And on the special episode of the podcast, we'll discuss how generative A.I. could reshape the US economy and the labor market. It's Thursday, November 2nd at 10 a.m. in New York. Stephen Byrd: If we think back to the early 90's, few could have predicted just how revolutionary the Internet would become. Creating entirely new professions and industries with a wide ranging impact on labor and global economies. And yet with generative A.I. here we are again on the cusp of a revolution. So, Seth, as our global chief economist, you've been assessing the overarching macro implications of the Gen A.I. phenomenon. And while it's still early days, I know you've been thinking about the range of impacts Gen A.I could have on the global economy. I wondered if you could walk us through the broad parameters of your thinking around macro impacts and maybe starting with the productivity and the labor market side of things? Seth Carpenter: Absolutely, Stephen. And I agree with you, the possibilities here are immense. The hardest part of all of this is trying to gauge just how big the effects might be, when they might happen and how soon anyone is going to be able to pick up on the true changes and things. But let's talk a little bit about those two components, productivity and the labor market. They are very closely connected to each other. So one of the key things about generative A.I is it could make lots of types of processes, lots of types of jobs, things that are very knowledge base intensive. You could do the same amount of work with fewer people or, and I think this is an important thing to keep in mind, you could do lots more work with the same number of people. And I think that distinction is really critical, lots of people and I'm sure you've heard this before, lots of people have a fear that generative A.I is going to come in and destroy lots of jobs and so we'll just have lots of people who are out of work. And I guess I'm at the margin a lot more optimistic than that. I really do think what we're going to end up seeing is more output with the same amount of workers, and indeed, as you alluded to before, more types of jobs than we've seen before. That doesn't exactly answer your question so let's jump into those broad parameters. If productivity goes up, what that means is we should see faster growth in the economy than we're used to seeing and I think that means things like GDP should be growing faster and that should have implications for equities. In addition, because more can get done with the same inputs, we should see some of the inflationary pressures that we're seeing now dissipate even more quickly. And what does that mean? Well, that means that at least in the short run, the central bank, the Fed in the U.S., can allow the economy to run a little bit hotter than you would have thought otherwise, because the inflationary pressures aren't there after all. Those are the two for me, the key things one, faster growth in the economy with the same amount of inputs and some lower inflationary pressures, which makes the central bank's job a little bit easier. Stephen Byrd: And Seth, as you think about specific sectors and regions of the global economy that might be most impacted by the adoption of Gen A.I., does anything stand out to you? Seth Carpenter: I mean, I really do think if we're focusing just on generative A.I, it really comes down, I think a lot to what can generative A.I do better. It's a lot of these large language models, a lot of that sort of knowledge based side of things. So the services sector of the economy seems more ripe for turnover than, say, the plain old fashion manufacturing sector. Now, I don't want to push that too far because there are clearly going to be lots of ways that people in all sectors will learn how to apply these technology. But I think the first place we see adoption is in some of the knowledge based sectors. So some of the prime candidates people like to point to are things like the legal profession where review of documents can be done much more quickly and efficiently with Gen A.I. In our industry, Stephen in the financial services industry, I have spoken with clients who are working to find ways to consume lots more information on lots of different types of firms so that as they're assessing equity market investments, they have better information, faster information and can invest in a broader set of firms than they had before. I really look to the knowledge based sectors of the economy as the first target. You know, so that Stephen is mostly how I'm thinking about it, but one of the things I love about these conversations with you is that I get to start asking questions and so here it is right back at you. I said that I thought generative A.I is not going to leave large swaths of the population unemployed, but I've heard you say that generative A.I is really going to set the stage for an unprecedented demand in reskilling workers. What kind of private sector support from corporations and what sort of public sector support from governments do you expect to see? Stephen Byrd: Yeah Seth, I mean, that point about reskilling, I think, is one of the most important elements of the work that we've been doing together. This could be the biggest reskilling initiative that we'll ever see, given how broad generative A.I really is and how many different professions generative A.I could impact. Now, when we think about the job impacts, we do see potential benefits from private public partnerships. They would be really focused on reskilling and upskilling workers and respond to the changes to the very nature of work that's going to be driven by Gen A.I. And an example of some real promising efforts in that regard was the White House industry joint efforts in this regard to think about ways to reskill the workforce. That said, there really are multiple unknowns with respect to the pace and the depth of the employment impacts from A.I. So it's very challenging to really scope out the magnitude and cadence a nd that makes joint planning for reskilling and upskilling highly challenging. Seth Carpenter: I hear what you're saying, Stephen, and it is always hard looking into the future to try to suss out what's going on but when we think about the future of work, you talked about the possibility that Gen A.I could change the nature of work. Speculate here a little bit for me. What do you think? What could be those changes in terms of the actual nature of work? Stephen Byrd: Yeah, you know, that's what's really fascinating about Gen A.I and also potentially in terms of the nature of work and the need to be flexible. You know, I think job gains and losses will heavily depend on whether skills can be really transferred, whether new skills can be picked up. For those with skills that are easy to transfer to other tasks in occupations, you know, disruptions could be short lived. To this point the tech sector recently experienced heavy layoffs, but employees were quickly absorbed by the rest of the economy because of overall tight labor market, something you've written a lot about Seth. And in fact, the number of tech layoffs was around 170,000 in the first quarter of 2023. That's a 17 fold increase over the previous year. While most of these folks did find a new job within three months of being laid off, so we do see this potential for movements, reskilling, etc., to be significant. But it certainly depends a lot on the skill set and how transferable that skill set really is. Seth Carpenter: How do you start to hire people at the beginning of this sort of revolution? And so when you think about those changes in the labor market, do you think there are going to be changes in the way people hire folks? Once Gen A.I becomes more widespread. Do you think workers end up getting hired based on the skill set that they can demonstrate on some sort of credentials? Are we going to see somehow in either diplomas or other sorts of certificates, things that are labeled A.I? Stephen Byrd: You know, I think there is going to be a big shift away from credentials and more heavily towards skills, specific skill sets. Especially skills that involve creativity and also skills involving just complex human interactions, human negotiations as well. And it's going to be critical to prioritize skills over credentials going forward as, especially as we think about reskilling and retraining a number of workers, that's going to be such a broad effort. I think the future work will require hiring managers to prioritize these skills, especially these soft skills that I think are going to be more difficult for A.I models to replace. We highlight a number of skills that really will be more challenging to automate versus those that are less challenging. And I think that essentially is a guidepost to think about where reskilling should really be focused. Seth Carpenter: Well, Stephen, I have to say I'd be able to talk with you about these sorts of things all day long, but I think we've run out of time. So let me just say, thank you for taking some time to talk to me today. Stephen Byrd: It was great speaking with you, Seth. Seth Carpenter: And thanks to the listeners for listening. If you enjoyed Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

2 Nov 20238min

Investors are questioning whether a new U.S. Speaker in the House of Representatives will push for fresh legislation, and whether a potential government shutdown is on the horizon.----- 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 to markets from Congress's agenda. It's Wednesday, November 1st at 10 a.m. in New York. Last week in D.C., following a few weeks of Republicans failing to coalesce around a nominee, the House of Representatives chose a speaker, Republican Mike Johnson. So, with a new speaker in place, does that mean investors need to rethink their expectations about legislation that could impact markets? Not exactly. At least not before the next presidential election. Here's three takeaways from us to keep in mind. First, a new speaker doesn't mean new momentum for most of the legislation that investors tell us they care about. For example, fresh regulations for social media or cryptocurrency are no closer as a result of having a new speaker. Those are issues both parties are keen to tackle but are still working out exactly how they'd like to tackle them. Second, a government shutdown still remains a possibility. Speaker Johnson has said avoiding a shutdown is a priority for him, stating he would allow a vote on another stopgap spending measure to give Congress more time to agree on longer term funding levels. But such a stopgap measure could also reflect that House Republicans haven't yet solved for their own internal disagreement on key funding measures, such as aid for Ukraine. If that's the case, then a shutdown later this year or early next year remains a possibility. And, while on its own, a brief shutdown wouldn’t meaningfully affect the economy, markets will reflect a higher probability of weaker growth on the horizon, particularly as failure to agree on longer term funding would put in play an automatic government spending cut under current law. Third and finally, military aid and funding is likely to be a source of intense debate in Congress but we still expect defense spending to rise, supporting the aerospace and defense sectors in the equity market. Two factors give us comfort here. First, the Fiscal Responsibility Act, which was the bill that was passed to raise the debt ceiling, also laid out multi-year government spending targets that include an increase in defense spending. Being already passed by Congress, we expect this is the template they'll work within. Second, while a sufficient minority of the House Republican caucus is skeptical of further aid to Ukraine, such aid enjoys broader bipartisan support across all of Congress. So we expect any spending bill that makes its way through Congress is likely to have that aid. 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.

1 Nov 20232min

With mortgage rates at their highest level in 20 years, housing affordability may deteriorate to levels not seen in decades.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-Head of Securitized Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing U.S. home prices. It's Tuesday, October 31st at 11 a.m. in New York. Happy Halloween. Jay Bacow: Jim. Mortgage rates are close to 8%. They haven't been this high since the year 2000. Now, you've pointed out in this podcast before, home prices have been incredibly resilient. So what is this combination of mortgage rates being at the highs over the last 20 years versus resilient home prices mean for housing affordability? Jim Egan: Well, not good. Now, one of the statements that you and I have made on prior episodes of this podcast is that affordability remains incredibly challenged. But at least throughout the first half of 2023, it really wasn't getting any worse. If mortgage rates stay at these levels, we can no longer make the second half of that statement. In fact, affordability deterioration would return to the most severe that we've seen in decades, 2022 experience notwithstanding. Jay Bacow: Okay. But what does that mean for the housing market? You know, at first blush, it doesn't sound great, but we've done a lot of these podcasts, and the story that you're talking about sounds kind of similar to what we saw last year in 2022. Home sales and housing starts could fall, but home prices would remain protected as homeowners are effectively locked in to their current low mortgage rate and there's not a lot of for sellers. Jim Egan: Those dynamics certainly continue to play a role in our thinking. But in our view, with mortgage rates at these levels, that requires us to think about both the short term impacts but also the longer term impacts if we were to stay here. Jay Bacow: All right, Jim, you said shorter term first. So what do we think happens in the near future? Jim Egan: Basically, what you just described, look, the immediate reaction to the recent climb in mortgage rates has been on the supply side. Existing listings have begun falling again, as of August we can now say that we have the fewest listings on record, controlling for time of year, the housing market is very seasonal and homebuilder confidence has also retreated. Now it increased in every single month of 2023 from January through July. In the past three months, it's down over 30% from that peak, and the NAHB attributes a lot of this u-turn to higher mortgage rates. At least when it comes to home prices, we think that the impact from these renewed decreases in the supply of homes is going to have a greater impact on prices than any decrease in demand. In fact, that did cause us to move our home price forecast a couple of months ago. We were flat at the end of this year and again, we're saying short term, this is October, the end of this year is pretty close. Our bull case was plus five. We're not moving all the way to that plus five, but we're moving towards that plus five from our 0% base case. Jay Bacow: All right. So over the next few months, you're a little bit more constructive on home prices, but people own homes for many years. So longer term, what do you expect the outlook to be? Jim Egan: Well, the answer there is, you know, more predicated on how long mortgage rates stay at these levels. We do think that a higher for a longer environment requires a different outlook today than it did in late 2021 and early 2022, and there are a number of reasons for that, but I think one of the bigger ones, Jay, is kind of the distribution of outstanding mortgage rates today. What does that look like? Jay Bacow: The average outstanding mortgage rate today is roughly three and 5/8%. But if you look at the distribution of homeowners, because we spent basically all of 2020 and 2021 at really low mortgage rates and many homeowners were stuck in their house, they spent a lot of time refinancing. And so there isn't that many mortgages that have a much higher rate than that. And so if we look at, for instance, the universe of mortgages between 7% and 8%, that's less than 2% of the outstanding mortgages. Jim Egan: And this is an important point, because not that many borrowers are falling out of the money with this move, we don't think that supply is going to see the sharp, sharp drops that we experienced throughout 2022. There's also some level of transaction volumes that need to take place regardless of economic incentive. If we look at home sales versus the stock of own homes is one example here. We're already at the lows from the great financial crisis. So instead of sharp declines in home sales moving forward, we think it's more accurate to describe a higher for a longer rate environment as more preventing sales from increasing going forward. Jay Bacow: All right. So the sales outlook, I guess, feels a little better than the sharp drops that we saw last year. But what about home prices? Jim Egan: If home sales were to remain at these levels, then we become even more reliant on the supply of for sale housing, staying at historic lows, or at least the lowest levels we have on record going back over 40 years, to prevent home prices from falling. As a scenario analysis, let's just say that inventory were to grow just 5% next year. For context, inventory was growing for May of 2022 through the middle of this year. If we just get 5% growth and that comes alongside zero increase in sales because of the affordability challenge, our model says that would lead to a drop in home prices by the end of 2024, that rounds to about 5%. But Jay, that's all predicated on where mortgage rates go from here. So are we staying at these levels? Jay Bacow: The biggest driver of where mortgage rates go is where treasury rates are going to be. However, there's certainly a secondary component which has to do with the spread between where Treasury rates are and the spread where the originators can sell their mortgage exposure to investors. And that spread looks way too wide to us over the longer term. Now, you talked about short term versus long term. Short term, we're not really sure what happens to spread, longer term we do think that spreads will compress, which would bring mortgage rates lower. Jim Egan: Surely at some point these levels become attractive? Jay Bacow: Absolutely. And we think longer term, that point is now we're talking about owning a government guaranteed asset at about 6.75% yield that picks roughly 180 basis points the Treasury curve. That's not a level that things normally trade at. We think next year as the Fed cuts rates, vol comes down, the curve steepened and mortgages would tighten under that scenario. But near-term over the next couple of months, as you're talking through the end of the year, it's hard to have much conviction and there's risks certainly to further liquidity pressures and spread widening. Jay Bacow: All right, Jim, it's always great talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcast app and share the podcast with a friend or colleague today.

31 Okt 20236min

As we head into the end of the year, investors are again worrying about the impact that higher interest rates will have on growth.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 30th at 10 a.m. in New York. So let's get after it. 2023 has been a year of big swings for stock investors. Coming into the year, the consensus agreed that domestic growth is going to disappoint as recession risk appeared much higher than normal. The primary culprit was the record setting pace of tightening from the Federal Reserve and other central banks in 2022. In addition to this concern, earnings for the mega-cap leaders had disappointed expectations during the second half of 2022. As a result, sentiment was low and expectations about a recovery were pessimistic. Stocks had reflected some of that pessimism, even though they had rallied about 10% from the October '22 lows.The other distinguishing feature of the consensus view at the beginning of the year is that the bullish pitch was predicated on a Fed pivot and China's long awaited reopening from its lengthy pandemic lockdowns. This meant that many investors were overweight banks, industrials and commodity oriented stocks like energy and materials and longer duration bonds rather than mega-cap growth stocks. Such positioning could not have been worse for what has transpired this year. Domestic economic growth and interest rates have surprised on the upside, keeping the Fed more hawkish on its rate policy while commodity prices have been weak due to disappointing global economic growth despite China's reopening. The regional bank failures in March spurred a different kind of pivot from the Fed, as they decided to reverse a good portion of its balance sheet reduction when it bailed out the uninsured deposits of these failing institutions. That liquidity injection spurred a big rally in companies with the highest quality balance sheets. Newfound excitement then around artificial intelligence provided another reason for mega-cap growth stocks to trade so well since the March lows. This summer, that rally tried to broaden out as investors began to think artificial intelligence may save us from the margin squeeze being felt across the economy, especially smaller cap companies that don't have the scale or access to capital to thrive in such a challenging environment to grow profits. But now, even the higher quality mega-cap growth stocks are suffering. Since reporting second quarter earnings, these stocks are lower by 12% on average. Third quarter earnings were supposed to reverse these new down trends, but last week that didn't happen. Instead, most of these company stocks traded lower, even though several of them posted very strong earnings results. In our experience, this is a bearish signal for what the market thinks about the business and earnings trends going into 2024. In other words, the market is suggesting earnings expectations are too high next year, even for the best companies. Our take is that given the significant weaknesses already apparent in the average company earnings and the average household finances, we think it will be very difficult for these mega-cap companies to avoid these headwinds too, given these small companies and households are their customers. Finally, with interest rates so much higher than almost anyone predicted six months ago, the market is starting to call into question the big valuations at which these large cap winners trade. From our perspective, it appears that 2023 is coming full circle, with markets worrying again about the impact that higher interest rates will have on growth rather than just valuations. The delayed impact and reaction on the economy is normal, but once it starts, it's hard to reverse. While we were early and wrong in calling for this outcome in the spring, we think it's now upon us. For equity investors, what that really means is that this year is unlikely to see the typical fourth quarter rally. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

30 Okt 20233min

Corporate credit continues to outperform other class assets, due in part to U.S. economic growth in the third quarter.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Corporate Credit Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, October 27, at 2 p.m. in London. Credit has a reputation of being the scouts of financial markets, sniffing out and detecting danger well ahead of others. In 2000, 2007 and 2011, to name a few, credit markets started to weaken well before other asset classes in flagging danger. The Federal Reserve used credit spreads as one of their most important measures of financial stress. While we’d like to think that this is because credit investors are smarter than their peers, a more realistic answer lies in the nature of the asset class. Because credit offers a generally limited premium if things go right, relative to larger losses if things go wrong, credit investors are often incentivized to price in a rising probability of danger early. And so it's notable that amidst the current market weakness, credit is pretty well behaved, with benchmark spreads on U.S. investment grade credit roughly unchanged since October 3rd. Credit is very much a passenger, not a driver, of the proverbial financial market bus that in recent weeks has been swaying back and forth. We think credit continues to be a relative outperformer across assets, and for that to be true, two things need to continue. First, credit is very sensitive to the likelihood of a deep recession. Recent data has been good, with the U.S. economy growing a whopping 4.9% in the third quarter. While our US economists expect slower growth in the fourth quarter, we think a generally stronger than expected U.S. economic story has, and should continue to be, helpful to corporate credit. Second, credit has managed to avoid some of the bigger headaches surrounding other asset classes. Credit valuations are less expensive and closer to average than U.S. equity markets. Credit is less sensitive to volatile interest rates and enjoys a more stable base of demand than U.S. mortgages. And the outlook for future supply in corporate bonds looks lower than, say, U.S. Treasury bonds, as companies are starting to react to higher rates by borrowing less. Credit has a well-deserved history as an early warning signal for markets. But for now, we think it is better to view it as a financial markets passenger. Government bond yields and earnings are in the driver's seat and are much more likely to be important for driving overall direction. For now, we think this can suit credit just fine and continue to expect it to be a relative outperformer. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen and leave us a review. We'd love to hear from you.

27 Okt 20232min

With China at risk of falling into a debt deflation loop, lessons from Japan's deflation journey could provide some insight.----- Transcript -----Daniel Blake: Welcome to Thoughts on the Market. I'm Daniel Blake from the Morgan Stanley Asia and Emerging Market Equity Strategy Team. Laura Wang: And I'm Laura Wang, Chief China Equity Strategist. Daniel Blake: And on this special episode of the podcast, we'll discuss what lessons Japan's deflation journey can offer for China. It's Thursday, October 26th at 10 a.m. in Singapore and Hong Kong. Daniel Blake: So in the period from 1991 to 2001, known as Japan's lost decade, Japan suffered through a prolonged economic stagnation and price deflation. While the corporate sector stopped deleveraging in the early 2000’s. It wasn't until the Abenomics program, introduced under Prime Minister Shinzo Abe in 2013, that Japan emerged from deflation and started the process of a gradual recovery in corporate profitability. China's economic trajectory has been very different from Japan's over the last 30 years, but we now see some parallels emerging. Indeed, the risk of falling into a Japanese style stagnation is becoming more acute over the past year as a deep cyclical downturn in the property sector combines with the structural challenge that our economists call the 3D journey of debt, demographics and deflation. So, Laura, before we dig into the comparison between China and Japan's respective journeys to set the stage, can you give us a quick snapshot of where China's equity market is right now and what you expect for the rest of the year? Laura Wang: Sure, Daniel. China market has been through a quite volatile ten months so far this year with a very exciting start given the post COVID reopening. However, the strong macro momentum didn't sustain. Property sales is still falling somewhere between 30 to 50% each month on a year over year basis. And challenges from local government debt issue and early signs of deflationary pressure suggest that turn around for corporate earnings growth could still take longer to happen. We had downgraded China within the global emerging market context at the beginning of August, mainly out of these concerns, and we think more patience is needed at this point. We would like to see more meaningful easing measures to stimulate the demand and help reflate the economy, as well as clear a road map to address some of the structural issues, particularly around the local government debt problem. In contrast to China, Japan's equity market is very strong right now, and Morgan Stanley's outlook continues to be bullish from here. So, Daniel, why is it valuable to compare Japan's deflationary journey since the 1990s and China's recent challenges? What are some of the bigger similarities? Daniel Blake: I think we'll come back to the 3D's. So on the first to them, on debt we do have China's aggregate total debt around 290% of GDP. So that compares with Japan, which was about 265% of GDP back in 1990. So this is similar in the sense that we do have this aggregate debt burden sitting and needs to be managed. Secondly, on demographics, we've got a long expected but now very evident downturn in the share of the labor force that is in working age and an outright decline in working age population in China. And this is going to be a factor for many years ahead. China's birth rate or total number of births is looking to come down to around 8 million this year, compared with 28 million in 1990. And then a third would be deflation. And so we are seeing this broaden out in China, particularly the aggregate GDP level. So in Japan's case, that deflation was mainly around asset price bubbles. In China's case, we're seeing this more broadly with excess capacity in a number of industrial sectors, including new economy sectors. And then this one 4th D which is similar in both Japan's case and China now, and that's the globalization or de-risking of supply chains, as you prefer. When we're looking at this in Japan's case, Japan did face a more hostile trade environment in the late 1980s, particularly with protectionism coming through from the US. And we've seen that play out in the multipolar world for China. So a number of similarities which we can group under 4D's here. Laura Wang: And what are some of the key differences between Japan/China? Daniel Blake: So the first key difference is we think the asset price bubble was more extreme in Japan. Secondly, in China, most of the debt is held by local governments and state owned enterprises rather than the private corporate sector. And thirdly, China is at a lower stage of development than Japan in terms of per capita incomes and the potential for underlying growth. So, Laura, when you're looking ahead, what would you like to see from Chinese policymakers here, both in the near term as well as the longer term? Laura Wang: As far as what we can observe, Chinese policymakers has already started to roll out a suite of measures on the fronts of capital markets, monetary and fiscal policy side over the past 12 months. And we do expect more to come. Particularly on the capital market reform side, there are additional efforts that we think policymakers can help enforce. In our view, those actions could include capital market restructuring, funds flow and liquidity support, as well as further efforts encouraging enhancement of shareholder returns. To be more specific, for example, introducing more benchmark indices with a focus on corporate governance and shareholder returns, further tightening and enforcing the listing rules for public companies, m ore incentives for long term institutional participation, improving capital flow management for foreign investors, and implementing incentives to encourage dividend payouts and share buybacks. Those could all work quite well. Regulatory and even legislative support to help implement these measures would be extremely crucial. Daniel Blake: And what is your outlook for China's medium to long term return on equity path from here? And what are the key catalysts you're watching for that? Laura Wang: Given some of the structure challenges we discussed earlier, we do see a much wider forked path for China's long term growth ROE trajectory. We see MSCI China's long term ROE stabilizing at around 11% in the next 5 to 7 years in our base case. This means there should still be up to around two percentage point of recovery upside from the current levels, thanks to a combination of corporate self-help, the product cycle, policy support from the top and the low base effect. However, further upside above 11% will require a significant reflationary effort from the policymakers, both short term cyclical and long term structural, in combination with a more favorable geopolitical environment. Therefore, we believe prompt and forceful actions from policymakers to stabilize the economy to avoid more permanent negative impact on corporate and consumer behaviors are absolutely needed at this point. Now, let me turn this back to you, Daniel. What is your outlook for Japan's return on equity journey from here, and are there any risks to your bullish view? Daniel Blake: So we have seen Japan looking back from 2013 to now move from below book value in terms of aggregate valuations and a return on equity of just 4%, so much lower than even your bear case. So it's moved up from that level to 9% currently and we're seeing valuations moving up accordingly. We think that's further to go and we think Japan can actually reach 12% sustainable return on equity by 2025 and that's helped by return of nominal GDP growth in Japan and further implementation of governance improvements at the corporate level. So in terms of the risks, I think they are primarily external. We do see Japan's domestic economy in a pretty good place. We think BOJ can exit yield curve control and negative rates without a major shock. So externally we are watching China's risks of moving into a debt deflation loop, as we're discussing here, but also the potential impacts if the US or a global recession were to play out. So clearly we're watching very closely the Fed's efforts and global central bank efforts to achieve a soft landing here. Daniel Blake: So, Laura, thanks for taking the time to talk. Laura Wang: Sure. It's been great speaking with you, Daniel. Daniel Blake: 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.

26 Okt 20237min

The rise in Treasury yields, among other factors, has caused significantly tighter financial conditions. If these conditions slow growth in the fourth quarter, another rate hike this year seems unlikely.----- 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 will be talking about the implications of the continued selloff in the Treasury market. It's Wednesday, October 25th at 10 a.m. in New York. The grueling selloff in U.S. treasuries that began in the summer continues, most notably in the longer end of the yield curve. The ten year Treasury yield breached 5% on Monday, a level not seen since 2007 and an increase of about 125 basis points since the trough in July. Almost all of this move higher in the ten year yield has occurred in real yields. In our view, the Treasury market has honed its reaction to incoming data on the hawkish reaction function that the FOMC communicated in its September meeting, which was subsequently reiterated by multiple Fed speakers. Over the last several weeks, the asymmetry in the market's reaction to incoming data has been noteworthy. Upside surprises growth have brought up sharp increases in long end yields, while downside surprises inflation have met with muted rallies. To us, this means that for market participants, upside surprises to growth fuel doubts whether the pace of deceleration inflation is sustainable. In this context, it is no surprise that upside growth surprises have mattered more to long in yields than downside inflation surprises. We've indeed seen a spate of upside surprises. The 336,000 new jobs in the September employment report were nearly double the Bloomberg survey of economists. Month over month changes in retail sales at 0.7% were more than double the consensus expectation of about 0.3%, and triple if you exclude auto sales. We saw similar upside surprises in industrial production, factory orders, building permits as well. The rise in Treasury yields has further implications. The spike has contributed significantly to tighter financial conditions. As measured by Morgan Stanley Financial Conditions Index, conditions have tightened by the equivalent of about three 25 basis point hikes in the policy rate since the September FOMC meeting. As Morgan Stanley's Chief Global Economist Seth Carpenter highlighted, the implications of tighter financial conditions for growth and inflation depend critically on whether the tightening is caused by exogenous or endogenous factors. A persistent exogenous rise in rates should slow the economy, requiring the Fed to adjust the path of policy rates lower over time to offset the drag from higher rates. If instead, the higher rates on an endogenous reaction, reflecting a persistently stronger economy driven by more fiscal support, higher productivity or both, the Fed may not see the need to adjust its policy path lower. We lean towards the formal explanation, than the latter. In our view, it is unlikely that the third quarter strength in growth will persist. In fact, third quarter consumer spending benefited from large one off expenditures. Combine that with the expiration of student loan moratorium, we think will weigh heavily on real personal consumption in the fourth quarter and by extension, on economic growth. Tighter financial conditions driven by higher long end yields will only add to this drag. Therefore, we expect incoming data in the fourth quarter to show decelerating growth, which we expect will lead to a reversal of the recent yield spikes driven by term premiums moving lower. The subtle shift in the tone of Fed speak over the past two weeks suggests a similar interpretation, indicating a waning appetite for an additional hike this year in the wake of tighter financial conditions while retaining the optionality for future hikes. They think that the yield curve is doing the job of the Fed. This jibes with our view that there will be no further rate hikes this year. While our conviction on fourth quarter growth slowdown is strong, it will take time to become evident in the incoming data. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

25 Okt 20234min

As the U.S. Federal Reserve keeps rates elevated, investors are selling off bonds in anticipation of new issues with higher yields, triggering a historic rout in the world's biggest bond markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Matthew Hornbach, Morgan Stanley's Global Head of Macro Strategy. Along with my colleagues, bringing you a variety of perspectives, today, I'll discuss the ongoing U.S. Treasury bond market route. It's Tuesday, October 24th, at 10 a.m. in New York. The world's biggest bond markets are in the midst of a historic route, and an increasing number of experts are referring to this as the deepest bond bear market of all time. Simply put, it works like this. When the central bank policy rate increases, investors' expectations for yields on bonds go up. This prompts investors to sell the bonds they currently own in order to buy newly issued ones that promise higher yields. So in this higher for longer interest rate environment, investors have been selling bonds, resulting in serious declines in bond prices and simultaneous surges in bond yields. In the U.S. Treasury market, which is considered the bedrock of the global financial system, the yield on the 30 year U.S. government bond recently hit 5% for the first time since 2007. German and Japanese bond yields are also reaching significantly elevated levels. Why does the turmoil in the bond market matter so much for consumers? For one thing, the yields on local government bonds impacts how banks priced mortgages. In the U.S. Specifically, mortgage rates tend to track the yield on ten year treasuries. Government backed mortgage provider Freddie Mac recently announced that the average interest rate on the 30 year fixed rate mortgage hit 7.3% in the week ending September 28th. That's the highest level since 2000. The ripple effects from the bond market route stretch further than mortgages. For instance, higher U.S. yields also means an even stronger U.S. dollar, which puts downward pressure on other currencies. The equity markets also can't escape the impact of higher bond yields. Those higher yields compete for money that might otherwise get invested in the stock market. As yields surged in September, the S&P 500 fell about 4.5%, despite relatively positive economic data. Against this backdrop, consensus explanations for the bond market sell off have been focusing on technical drivers, like U.S. Treasury market supply and investor positioning adjustments, as well as fundamental drivers, like fiscal sustainability concerns, Bank of Japan policy changes and stronger than expected growth. What surprises us is that the Fed rarely enters the discussion, specifically its reactions to data and its subsequent forward guidance. But we do believe the Fed's involvement is one of the major drivers behind the current bond market rout. Without the Fed's more hawkish reaction to recent growth and inflation data, other technical and fundamental drivers would not have contributed as much to higher Treasury yields, in our view. As things stand, markets will need to continue to come to grips with interest rates staying high. The U.S. economy remains resilient, despite still elevated inflation. Our U.S. economist now thinks the Fed's December Federal Open Market Committee meeting is a live meeting. The September U.S. Consumer Price Index and payrolls data met our economists' bar for a potential additional hike later this year. And so these most recent data releases make the next round of monthly data even more important, as policymakers deliberate what to do in December. And these decisions by the Fed will continue to have a significant impact on the bond market. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.

24 Okt 20233min