Europe in the Global AI Race

As new weight management medications are being developed, might the obesity market parallel the likes of hypertension or high blood pressure to become the next blockbuster Pharma category?----- Transcript -----Welcome to Thoughts on the Market. I'm Terence Flynn, Head of the U.S. Pharma Sector for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, today I'll talk about the global obesity challenge and some of the key developments we expect in 2023. It's Tuesday, January 3rd, at 4 p.m. in New York. If you're like most people, you're probably seeing a lot of post-holiday ads for gym memberships, diet apps and nutrition services. So this seems like a relevant time to provide an update on obesity. A few months ago, we hosted an episode on this show discussing the global obesity epidemic and how it's now reached an inflection point because of new weight management drugs that show a lot of promise and benefits. We continue to believe that obesity is the "new hypertension or high blood pressure", and that it looks set to become the next blockbuster pharma category. Obesity has been classified by the American Medical Association, and more recently the European Commission, as a chronic disease, and its treatment is on the cusp of moving into mainstream primary care management. Essentially, the obesity market is where the treatment of high blood pressure was in the mid to late 80's, before it transformed into a $30 Billion market by the end of the 90's. One of the main reasons the narrative around obesity is inflecting is because the focus is shifting to the upstream cause, as opposed to the downstream consequences of diabetes and cardiovascular disease. Now, given this change in focus, we expect excess weight to become a treatment target. The World Health Organization estimates that about 650 million people are living with obesity, and the associated personal, social and economic costs are significant. Over time, we're expecting about a quarter of obese individuals will engage with physicians, up from about 7% currently. Now, this compares to approximately 80% for high blood pressure and diabetes. Furthermore, well over 300 million of these people could potentially receive a new anti-obesity medicine. Looking back historically, previous medicines for obesity had minimal efficacy and were plagued by safety issues, which also contributed to limited reimbursement coverage. In our view, this is all poised to change as the more efficacious GLP-1 drugs are adopted and utilized and the companies begin to generate outcomes data to support the derivative benefits of these drugs beyond weight loss. Of course, as with biopharma, there are many de-risking clinical, regulatory and commercial steps in the development of the obesity market. This year, we're most focused on a key phase three outcomes trial called "SELECT", which we expect to read out this summer to conclude that "weight management saves lives". Furthermore, we think the innovation wave should continue as companies are working on a next generation of injectable combo drugs that could come to the market later this decade for obesity and Type two diabetes. And beyond the possibility of turning the tide on the obesity epidemic, it's also exciting to see room in the markets for multiple players and investment opportunities in a market that could reach over $50 billion by 2030. 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.

3 Jan 20233min

Original Release on November 15th, 2022: As we look ahead to 2023, we see a divergence away from the trends of 2022 in key areas across growth, inflation, and central bank policy. Chief Cross Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's chief cross-asset strategist. Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's global chief economist. Andrew Sheets: And on the special two-part episode of the podcast, we'll be discussing Morgan Stanley's Global Year Ahead outlook for 2023. Today, we'll focus on economics, and tomorrow we'll turn our attention to strategy. It's Tuesday, November 15th at 3 p.m. in London. Seth Carpenter: And it's 10 a.m. in New York. Andrew Sheets: So, Seth I think the place to start is if we look ahead into 2023, the backdrop that you and your team are forecasting looks different in a number of important ways. You know, 2022 was a year of surprisingly resilient growth, stubbornly high inflation and aggressively tightening policy. And yet as we look ahead, all three of those elements are changing. I was hoping you could comment on that shift broadly and also dig deeper into what's changing the growth outlook for the global economy into next year. Seth Carpenter: You're right, Andrew, this year, in 2022, we've seen growth sort of hang in there. We came off of last year in 2021, a super strong year for growth recovering from COVID. But the theme this year really has been a great deal of inflation around the world, especially in developed markets. And with that, we've seen a lot of central banks everywhere start to raise interest rates a great deal. So what does that mean as we end this year and go into next year? Well, we think we'll start to see a bit of a divergence. In the developed market world where we've seen both a lot of inflation and a lot of central bank hiking, we think we get a great deal of slowing and in fact a bit of contraction. For the euro area and for the U.K, we're writing down a recession starting in the fourth quarter of this year and going into the beginning of next year. And then after that, any sort of recovery from the recession is going to be muted by still tight monetary policy. For the US, you know, we're writing down a forecast that just barely skirts a recession for next year with growth that's only slightly positive. That much slower growth is also the reflection of the Federal Reserve tightening policy, trying to wrench out of the system all the inflation we've seen so far. In sharp contrast, a lot of EM is going to outperform, especially EM Asia, where the inflationary pressures have been less so far this year, and central banks, instead of tightening aggressively to get restrictive and squeeze inflation out, they're actually just normalizing policy. And as a result, we think they'll be able to outperform. Andrew Sheets: And Seth, you know, you mentioned inflation coming in hot throughout a lot of 2022 being one of the big stories of the year that we've been in. You and your team are forecasting it to moderate across a number of major economies. What drives a change in this really important theme from 2022? Seth Carpenter: Absolutely. We do realize that inflation is going to continue to be a very central theme for all sorts of markets everywhere. And the fact that we have a forecast with inflation coming down across the world is a really important part of our thesis. So, how can we get any comfort on the idea that inflation is going to come down? I think if you break up inflation into different parts, it makes it easier to understand when we're thinking about headline inflation, clearly, we have food, commodity prices and we've got energy prices that have been really high in part of the story this year. Oil prices have generally peaked, but the main point is we're not going to see the massive month on month and year on year increases that we were seeing for a lot of this year. Now, when we think about core inflation, I like to separate things out between goods and services inflation. For goods, the story over the past year and a half has been global supply chains and we know looking at all sorts of data that global supply chains are not fixed yet, but they are getting better. The key exception there that remains to be seen is automobiles, where we have still seen supply chain issues. But by and large, we think consumer goods are going to come down in price and with it pull inflation down overall. I think the key then is what goes on in services and here the story is just different across different economies because it is very domestic. But the key here is if we see the kind of slowing down in economies, especially in developed market economies where monetary policy will be restrictive, we should see less aggregate demand, weaker labor markets and with it lower services inflation. Andrew Sheets: How do you think central banks respond to this backdrop? The Fed is going to have to balance what we see is some moderation of inflation and the ECB as well, with obvious concerns that because forecasting inflation was so hard this year and because central banks underestimated inflation, they don't want to back off too soon and usher in maybe more inflationary pressure down the road. So, how do you think central banks will think about that risk balance and managing that? Seth Carpenter: Absolutely. We have seen some surprises, the upside in terms of commodity market prices, but we've also been surprised at just the persistence of some of the components of inflation. And so central banks are very well advised to be super cautious with what's going on. As a result. What we think is going to happen is a few things. Policy rates are going to go into restrictive territory. We will see economies slowing down and then we think in general. Central banks are going to keep their policy in that restrictive territory basically over the balance of 2023, making sure that that deceleration in the real side of the economy goes along with a continued decline in inflation over the course of next year. If we get that, then that will give them scope at the end of next year to start to think about normalizing policy back down to something a little bit more, more neutral. But they really will be paying lots of attention to make sure that the forecast plays out as anticipated. However, where I want to stress things is in the euro area, for example, where we see a recession already starting about now, we don't think the ECB is going to start to cut rates just because they see the first indications of a recession. All of the indications from the ECB have been that they think some form of recession is probably necessary and they will wait for that to happen. They'll stay in restrictive territory while the economy's in recession to see how inflation evolves over time. Andrew Sheets: So I think one of the questions at the top of a lot of people's minds is something you alluded to earlier, this question of whether or not the US sees a recession next year. So why do you think a recession being avoided is a plausible scenario indeed might be more likely than a recession, in contrast maybe to some of that recent history? Seth Carpenter: Absolutely. Let's talk about this in a few parts. First, in the U.S. relative to, say, the euro area, most of the slowing that we are seeing now in the economy and that we expect to see over time is coming from monetary policy tightening in the euro area. A lot of the slowing in consumer spending is coming because food prices have gone up, energy prices have gone up and confidence has fallen and so it's an externally imposed constraint on the economy. What that means for the U.S. is because the Fed is causing the slowdown, they've at least got a fighting chance of backing off in time before they cause a recession. So that's one component. I think the other part to be made that's perhaps even more important is the difference between a recession or not at this point is almost semantic. We're looking at growth that's very, very close to zero. And if you're in the equity market, in fact, it's going to feel like a recession, even if it's not technically one for the economy. The U.S. economy is not the S&P 500. And so what does that mean? That means that the parts of the U.S. economy that are likely to be weakest, that are likely to be in contraction, are actually the ones that are most exposed to the equity market and so for the equity market, whether it's a recession or not, I think is a bit of a moot point. So where does that leave us? I think we can avoid a recession. From an economist perspective, I think we can end up with growth that's still positive, but it's not going to feel like we've completely escaped from this whole episode unscathed. Andrew Sheets: Thanks, Seth. So I maybe want to close with talking about risks around that outlook. I want to talk about maybe one risk to the upside and then two risks that might be more serious to the downside. So, one of the risks to the upside that investors are talking about is whether or not China relaxes zero COVID policy, while two risks to the downside would be that quantitative tightening continues to have much greater negative effects on market liquidity and market functioning. We're going through a much faster shrinking of central bank balance sheets than you know, at any point in history, and then also that maybe a divided US government leads to a more challenging fiscal situation next year. So, you know, as you think about these risks that you hear investors citing China, quantitative tightening, divided government, how do you think about those? How do you think they might change the base case view? Seth Carpenter: Absolutely. I think there are two-way risks as usual. I do think in the current circumstances, the upside risks are probably a little bit smaller than the downside risks, not to sound too pessimistic. So what would happen when China lifts those restrictions? I think aggregate demand will pick back up, and our baseline forecast that happens in the second quarter, but we can easily imagine that happening in the first quarter or maybe even sometime this year. But remember, most of the pent-up demand is on domestic spending, especially on services and so what that means is the benefit to the rest of the global economy is probably going to be smaller than you might otherwise think because it will be a lot of domestic spending. Now, there hasn't been as much constraint on exports, but there has been some, and so we could easily see supply chains heal even more quickly than we assume in the baseline. I think all of these phenomena could lead to a rosier outlook, could lead to a faster growth for the global economy. But I think it's measured just in a couple of tenths. It's not a substantial upside. In contrast, you mentioned some downside risks to the outlook. Quantitative tightening, central banks are shrinking their balance sheets. We recently published on the fact that the Fed, the Bank of England and the European Central Bank will all be shrinking their balance sheet over the next several months. That's never been seen, at least at the pace that we're going to see now. Could it cause market disruptions? Absolutely. So the downside risk there is very hard to gauge. If we see a disruption of the flow of credit, if we see a generalized pullback in spending because of risk, it's very hard to gauge just how big that downside is. I will say, however, that I suspect, as we saw with the Bank of England when we had the turmoil in the gilt market, if there is a market disruption, I think central banks will at least temporarily pause their quantitative tightening if the disruption is severe enough and give markets a chance to settle down. The other risk you mentioned is the United States has just had a mid-term election. It looks like we're going to have divided government. Where are the risks there? I want to take you back with me in time to the mid-term elections in 2010, where we ended up with split government. And eventually what came out of that was the Budget Control Act of 2011. We had split government, we had a debt limit. We ended up having budget debates and ultimately, we ended up with contractionary fiscal policy. I think that's a very realistic scenario. It's not at all our baseline, but it's a very realistic risk that people need to pay attention to. Andrew Sheets: Seth, thanks for taking the time to talk. Seth Carpenter: Andrew, I always like getting a chance to talk to you. Andrew Sheets: And thanks for listening. Be sure to tune in for part two of this episode where Seth and I will discuss Morgan Stanley's year ahead. Strategy Outlook. If you enjoy thoughts of the market, please leave us a review on Apple Podcasts and share this podcast with a friend or colleague today.

30 Dec 202211min

Original Release on December 7th, 2022: As India enters a new era of growth, investors will want to know what’s driving this growth and how it may create once-in-a-generation opportunities. Head of Global Thematic and Public Policy Research Michael Zezas and Chief India Equity Strategist Ridham Desai discuss.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research. Ridham Desai: And I'm Ridham Desai, Morgan Stanley's Chief India Equity Strategist. Michael Zezas: And on this special episode of Thoughts on the Market, we'll discuss India's growth story over the next decade and some key investment themes that global investors should pay attention to. It's Wednesday, December 7th, at 7 a.m. in New York. Michael Zezas: Our listeners are likely well aware that over the past 25 years or so, India's growth has lagged only China's among the world's largest economies. And here at Morgan Stanley, we believe India will continue to outperform. In fact, India is now entering a new era of growth, which creates a once in a generation shift in opportunities for investors. We estimate that India's GDP is poised to more than doubled to $7.5 trillion by 2031, and its market capitalization could grow 11% annually to reach $10 trillion. Essentially, we expect India to drive about a fifth of global growth in the coming decade. So Ridham, what in your view are the main drivers behind India's growth story? Ridham Desai: Mike, the full global trends of demographics, digitalization, decarbonization and deglobalization that we keep discussing about in our research files are favoring this new India. The new India, we argue, is benefiting from three idiosyncratic factors. The first one is India is likely to increase its share of global exports thanks to a surge in offshoring. Second, India is pursuing a distinct model for digitalization of its economy, supported by a public utility called India Stack. Operating at population scale India stack is a transaction led, low cost, high volume, small ticket size system with embedded lending. The digital revolution has already changed the way India handles documents, the way it invests and makes payments and it is now set to transform the way it lends, spends and ensures. With private credit to GDP at just 57%, a credit boom is in the offing, in our view. The third driver is India's energy consumption and energy sources, which are changing in a disruptive fashion with broad economic benefits. On the back of greater access to energy, we estimate per capita energy consumption is likely to rise by 60% to 1450 watts per day over the next decade. And with two thirds of this incremental supply coming from renewable sources, well in short, with this self-help story in play as you said, India could continue to outperform the world on GDP growth in the coming decade. Michael Zezas: So let's dig into some of the specifics here. You mentioned the big surge in offshoring, which has resulted in India's becoming "the office of the world". Will this continue long term? Ridham Desai: Yes, Mike. In the post-COVID environment, global CEOs appear more comfortable with work from home and also work from India. So the emergence of distributed delivery models, along with tighter labor markets globally, has accelerated outsourcing to India. In fact, the number of global in-house captive centers that opened in India over the past two years was double of that in the prior four years. During the pandemic years, the number of people employed in this industry in India rose by almost 800,000 to 5.1 million. And India's share in global services trade rose by 60 basis points to 4.3%. In the coming decade we think the number of people employed in India for jobs outside the country is likely to at least double to 11 million. And we think that global spending on outsourcing could rise from its current level of U.S. dollar 180 billion per year to about 1/2 trillion U.S. dollars by 2030. Michael Zezas: In addition to being "the office of the world", you see India as a "factory to the world" with manufacturing going up. What evidence are we seeing of India benefiting from China moving away from the global supply chain and shifting business activity away from China? Ridham Desai: We are anticipating a wave of manufacturing CapEx owing to government policies aimed at lifting corporate profits share and GDP via tax cuts, and some hard dollars on the table for investing in specific sectors. Multinationals are more optimistic than ever before about investing in India, and that's evident in the all-time high that our MNC sentiment index shows, and the government is encouraging investments by building both infrastructure as well as supplying land for factories. The trends outlined in Morgan Stanley's Multipolar World Thesis, a document that you have co authored, Mike, and the cheap labor that India is now able to offer relative to, say, China are adding to the mix. Indeed, the fact is that India is likely to also be a big consumption market, a hard thing for a lot of multinational corporations to ignore. We are forecasting India's per capita GDP to rise from $2,300 USD to about $5,200 USD in the next ten years. This implies that India's income pyramid offers a wide breadth of consumption, with the number of rich households likely to quintuple from 5 million to 25 million, and the middle class households more than doubling to 165 million. So all these are essentially aiding the story on India becoming a factory to the world. And the evidence is in the sharp jump in FDI that we are already seeing, the daily news flows of how companies are ramping up manufacturing in India, to both gain access to its market and to export to other countries. Michael Zezas: So given all these macro trends we've been discussing, what sectors within India's economy do you think are particularly well-positioned to benefit both short term and longer term? Ridham Desai: Three sectors are worth highlighting here. The coming credit boom favors financial services firms. The rise in per capita income and discretionary income implies that consumer discretionary companies should do well. And finally, a large CapEx cycle could lead to a boom for industrial businesses. So financials, consumer discretionary and industrials. Michael Zezas: Finally, what are the biggest potential impediments and risks to India's success? Ridham Desai: Of course, things could always go wrong. We would include a prolonged global recession or sluggish growth, adverse outcomes in geopolitics and/or domestic politics. India goes to the polls in 2024, so another election for the country to decide upon. Policy errors, shortages of skilled labor, I would note that as a key risk. And steep rises in energy and commodity prices in the interim as India tries to change its energy sources. So all these are risk factors that investors should pay attention to. That said, we think that the pieces are in place to make this India's decade.Michael Zezas: Ridham, thanks for taking the time to talk. Ridham Desai: Great speaking with you, Mike. Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.

29 Dec 20227min

Original Release on December 2nd, 2022: While 2022 saw the fastest pace of policy tightening on record, has the Fed’s hiking cycle properly set the U.S. economy up for a soft landing in 2023?----- Transcript -----Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss our 2023 outlook for the U.S. economy. It's Friday, December 2nd, at 10 a.m. in New York. Let's start with the Fed and the role higher interest rates play in the overall growth outlook. The Fed has delivered the fastest pace of policy tightening on record and now feels comfortable to begin slowing the pace of interest rate increases. We expect it to step down the pace to 50 basis points at its meeting later this month and then deliver a final hike in January to a peak rate of between 4.5 and 4.75%. But in order to keep inflation on a downward trajectory, the Fed will likely keep rates at that peak level for most of next year. This shift to a more cautious stance from the Fed we think will help the U.S. economy narrowly miss recession in 2023. And we think only in the back half of 2024 will the pace of growth pick back up as the Fed gradually reduces the policy rate back toward neutral, which is around 2.5%. Altogether, we forecast 2023 GDP growth of just 0.3% before rebounding modestly to 1.4% in 2024. One bright spot in the outlook is that inflation seems to have reached a turning point. Mounting evidence points to a slowing in housing prices and rents, though they continue to drive above target inflation. Core goods inflation should turn to disinflation as supply chains normalize and demand shifts to services and away from goods. Used vehicle prices are a big contributor to lower overall inflation in our forecast, as our motor vehicle analysts believe that used car prices could be down as much as 10 to 20% next year. So overall, we expect core PCE - or personal consumption expenditures inflation - to slow from 5% this year, to 2.9% in 2023, and further to 2.4% in 2024. Throughout 2022, rising interest rates have raised borrowing costs, which has weighed on consumption. And we expect that to continue into 2023 as the cumulative effects of past policy hikes continue to flow through to households. On the income side, we expect a rebound in real disposable income growth in 23, because inflation pressures abate while job growth continues to be positive. So if I put those together, slower consumption and rising incomes should lift the savings rate from 3.2% this year, to 5.1% in 2023, and 6.2% in 2024. So households will start to rebuild that cushion. Now we're in the midst of a sharp housing correction, and we expect a double digit decline in residential investment to continue. But we don't expect a commensurate drop in home valuations. Our housing strategies predict just a 4% drop in national home prices in 2023, and further price declines are likely in the years ahead, but that's a much milder drop in home valuations compared with the magnitude of the drop off in housing activity. So we think that residential wealth, real estate wealth will continue to be a strong backdrop for household balance sheets. Now going forward, mortgage rates will start to fall again after reaching these peaks around 7%. And with healthy job gains, and that increase in real disposable income growth affordability should begin to ease somewhat, we think starting in the back half of 2024. Turning to the labor market, while signs of falling inflation is important to the Fed, so are signs that the labor market is softening and we expect softer demand for labor and further labor supply gains to create the slack in the labor market the Fed is looking for. So we expect job growth will likely fall below the replacement rate by the second quarter of 2023, pushing up the unemployment rate to 4.3% by the end of next year and 4.4% by the end of 2024. In sum, we think the U.S. economy is at a turning point, but not a turning point toward recession, a turning point toward what is likely to prove to be two sluggish years of growth in the economy. The Fed's hiking cycle is working as it should. The labor market is softening. The inflation rate is coming down. And we think that puts the U.S. economy on track for a soft landing in 2023. 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.

28 Dec 20224min

Original Release on November 22nd, 2022: The year ahead outlook is a process of collaboration between strategists and economists from across the firm, so what were analysts debating when thinking about 2023, and how were those debates resolved? Chief Cross-Asset Strategist Andrew Sheets and Head of Fixed Income Research Vishy Tirupattur discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross Asset Strategist. Vishy Tirupattur: And I am Vishy Tirupattur, Morgan Stanley's Head of Fixed Income Research. Andrew Sheets: And on this special episode of the podcast, we'll be discussing some of the key debates underpinning Morgan Stanley's 2023 year ahead outlook. It's Tuesday, November 22nd at 3 p.m. in London. Vishy Tirupattur: And 10 a.m. in New York. Andrew Sheets: So Vishy, within Morgan Stanley research we collaborate a lot, but I think it's not an exaggeration to say that when we sit down to write our year ahead outlooks for strategy and economics, it's probably one of the most collaborative exercises that we do. Part of that is some pretty intense debate. So that's what I was hoping to talk to you about, kind of give listeners some insight into what are the types of things that Morgan Stanley research analysts were debating when thinking about 2023 and how we resolved some of those issues. And I think maybe the best place to start is just this question of inflation, right? Inflation was the big surprise of 2022. We underestimated it. A lot of forecasters underestimated inflation. As we look into 2023, Morgan Stanley's economists are forecasting inflation to come down. So, how did that debate go? Why do we have conviction that this time inflation really is going to moderate? Vishy Tirupattur: Thanks, Andrew. And it is absolutely the case that challenging each other's view is critically important and not a surprise that we spent a lot of time on inflation. Given that we have many upside surprises to inflation throughout the year, you know, there was understandable skepticism about the forecasts that US inflation will show a steady decline over the course of 2023. Our economists, clearly, acknowledge the uncertainty associated with it, but they took some comfort in a few things. One in the base effect. Two, normalizing supply chains and weaker labor markets. They also saw that in certain goods, certain core goods, such as autos, for example, they expect to see deflation, not just disinflation. And there's also a factor of medical services, which has a reset in prices that will exert a steady drag on the core inflation. So all said and done, there is significant uncertainty, but there are still clearly some reasons why our economists expect to see inflation decline. Andrew Sheets: I think that's so interesting because even after we published this outlook, it's fair to say that a lot of investor skepticism has related to this idea that inflation can moderate. And another area where I think when we've been talking to investors there's some disagreement is around the growth outlook, especially for the U.S. economy. You know, we're forecasting what I would describe as a soft landing, i.e., U.S. growth slows but you do not see a U.S. recession next year. A lot of investors do expect a U.S. recession. So why did we take a different view? Why do we think the U.S. economy can kind of avoid this recessionary path? Vishy Tirupattur: I think the key point here is the U.S. economy slows down quite substantially. It barely skirts recession. So a 0.5% growth expectation for 2023 for the U.S. is not exactly robust growth. I think basically our economists think that the tighter monetary policy will stop tightening incrementally early in 2023, and that will play out in slowing the economy substantially without outright jumping into contraction mode. Although we all agree that there is a considerable uncertainty associated with it. Andrew Sheets: We've talked a bit about U.S. inflation and U.S. growth. These things have major implications for the U.S. dollar. Again, I think an area that was subject to a lot of debate was our forecast that the dollar's going to decline next year. And so, given that the U.S. is still this outperforming economy, that's avoiding a recession, given that it still offers higher interest rates, why don't we think the dollar does well in that environment? Vishy Tirupattur: I think the key to this out-of-consensus view on dollar is that the decline in inflation, as our economists forecast and as we just discussed, we think will limit the potential for US rates going much higher. And furthermore, given that the monetary policy is in restrictive territory, we think there is a greater chance that we will see more downside surprises in individual data points. And while this is happening, the outlook for China, right, even though it is still challenging, appears to be shifting in the positive direction. There's a decent chance that the authorities will take steps towards ending the the "zero covid" policy. This would help bring greater balance to the global economy, and that should put less upward pressure on the dollar. Andrew Sheets: So Vishy, another question that generated quite a bit of debate is that next year you continue to see quantitative tightening from the Fed, the balance sheet of the Federal Reserve is shrinking, it's owning fewer bonds and yet we're also forecasting U.S. bond yields to fall. So how do you square those things? How do you think it's consistent to be forecasting lower bond yields and yet less Federal Reserve support for the bond market? Vishy Tirupattur: Andrew, there are two important points here. The first one is that when QT ends, really, history is really not much of a guide here. You know, we really have one data point when QT ended, before rate cuts started happening. And the thinking behind our thoughts on QT is that the Fed sees these two policy tools as being independent. And stopping QT depends really on the money market conditions and the bank demand for reserves. And therefore, QT could end either before or after December 2023 when we anticipate normalization of interest rate policy to come into effect. So, the second point is that why we think that the interest rates are going to rally is really related to the expectation of significant slowing in the economic growth. Even though the U.S. economy does not go into a contraction mode, we expect a significant slowing of the U.S. economy to 0.5% GDP growth and the economy growing below potential even into 2024 as the effects of the tighter monetary policy conditions begin to play out in the real economy. So we think the rally in U.S. rates, especially in the longer end, is really a function of this. So I think we need to keep the two policy tools a bit separate as we think about this. Andrew Sheets: So Vishy, I wanted us to put our credit hats on and talk a little bit about our expectations for default rates. And I think here, ironically, when we've been talking to investors, there's been disagreement on both sides. So, you know, we're forecasting a default rate for the U.S. of around 4-4.5% Next year for high yield, which is about the historical average. And you get some investors who say, that expectation is too cautious and other investors who say, that's too benign. So why is 4-4.5% reasonable and why is it reasonable in the context of those, you know, investor concerns? Vishy Tirupattur: It's interesting, Andrew, when you expect that some some people will think that the our expectations are too tight and others think that they are too wide and we end up somewhat in the middle of the pack, I think we are getting it right. The key point here is that the the maturity walls really are pretty modest over the next two years. The fundamentals, in terms of coverage ratios, leverage ratio, cash on balance sheets, are certainly pretty decent, which will mitigate near-term default pressures. However, as the economy begins to slow down and the earnings pressures come into play, we will expect to see the market beginning to think about maturity walls in 2025 onwards. All that means is that we will see defaults rise from the extremely low levels that we are at right now to long-term average levels without spiking to the kinds of default rates we have seen in previous economic slowdowns or recessions. Andrew Sheets: You know, we've had this historic rise in mortgage rates and we're forecasting a really dramatic drop in housing activity. And yet we're not forecasting nearly as a dramatic drop in U.S. home prices. So Vishy, I wanted to put this question to you in two ways. First, how do we justify a much larger decrease in housing activity relative to a more modest decrease in housing prices? And then second, would you consider our housing forecast for prices bullish or bearish relative to the consensus? Vishy Tirupattur: So, Andrew, the first point is pretty straightforward. You know, as mortgage rates have risen in response to higher interest rates, affordability metrics have dramatically deteriorated. The consequence of this, we think, is a very significant slowing of housing activity in terms of new home sales, housing starts, housing permits, building permits and so on. The decline in those housing activity metrics would be comparable to the kind of decline we saw after the financial crisis. However, to get the prices down anywhere close to the levels we saw in the wake of the financial crisis, we need to see forced sales. Forced sales through foreclosures, etc. that we simply don't expect to see happen in the next few years because the mortgage lending standards after the financial crisis had been significantly tighter. There exists a substantial equity in many homes today. And there's also this lock-in effect, where a large number of current mortgage holders have low mortgage rates locked in. And remember, US mortgages are predominantly fixed rate mortgages. So the takeaway here is that housing activity will drop dramatically, but home prices will drop only modestly. So relative to the rest of the street, our home price forecast is less negative, but I think the key point is that we clearly distinguish between what drives home pricing activity and what drives housing activity in terms of builds and starts and sales, etc.. And that key distinction is the reason why I feel pretty confident about our housing activity forecast and home price forecast. Andrew Sheets: Vishy, thanks for taking the time to talk. Vishy Tirupattur: Always a pleasure talking to you, Andrew. Andrew Sheets: Happy Thanksgiving from all of us at Thoughts on the Market. We have passed yet another exciting milestone: over 1 million downloads in a single month. I wanted to say thank you for continuing to tune in and share the show with your friends and colleagues. It wouldn't be possible without you, our listeners. SummaryThe year ahead outlook is a process of collaboration between strategists and economists from across the firm, so what were analysts debating when thinking about 2023, and how were those debates resolved? Chief Cross-Asset Strategist Andrew Sheets and Head of Fixed Income Research Vishy Tirupattur discuss.

27 Dec 202210min

Original Release on November 17th, 2022: With risks to both home sales and home prices continuing to challenge the housing market, investors will want to know what is keeping the U.S. housing market from a sharp fall mirroring the great financial crisis? Co-heads of U.S. Securitized Products Research Jim Egan and Jay Bacow discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-head of U.S. Securities Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing our year ahead outlook for the U.S. housing market for 2023. It's Thursday, November 17th, at 1 p.m. in New York. Jay Bacow: So Jim, it's outlook season. And when we think about the outlook for the housing market, we’re not just looking in 2023, people live in their houses for their whole lives.Jim Egan: Exactly. We are contemplating what's going to happen to the housing market, not just in 23, but beyond in this year's version of the outlook. But just to remind the listeners, we have talked about this on this podcast in the past, but our view for 2023 hasn't changed all that much. What we think we're going to see is a bifurcation narrative in the housing market between activity, so home sales and housing starts, and home prices. The biggest driver of that bifurcation, affordability. Because of the increase in prices, because of the incredible increase in mortgage rates that we've seen this year, affordability has been deteriorating faster than we've ever seen it. That's going to bring sales down. But the affordability for current homeowners really hasn't changed all that much. We're talking about deterioration for first time homebuyers, for prospective homebuyers. Current homeowners in a lot of instances have locked in very low 30 year fixed rate mortgages. We think they're just incentivized to keep their homes off the market, they're locked into their current mortgage, if you will. That keeps supply down, that also means they're not buying a home on the follow, so it means that sales fall even faster. Sales have outpaced the drop during the great financial crisis. We think that continues through the middle of next year. We think sales ultimately fall 11% next year from an already double digit decrease in 2022 on a year over year basis. But we do think home prices are more protected. We think they only fall 4% year over year next year, but when we look out to 2024, it's that same affordability metric that we really want to be focused on. And, home prices plays a role, but so do mortgage rates. Jay, how are we thinking about the path for mortgage rates into 2024? Jay Bacow: Right. So obviously the biggest driver of mortgage rates are first where Treasury rates are and then the risk premium between Treasury rates and mortgages. The drive for Treasury rates, among other things, is expectations for Fed policy. And our economists are expecting the Fed to cut rates by 25 basis points in every single meeting in 2024, bringing the Fed rate 200 basis points lower. When you overlay the fact that the yield curve is inverted and our interest rate strategists are expecting the ten year note to fall further in 2023, and risk premia on mortgages is already pretty wide and we think that spread can narrow. We think the mortgage rate to the homeowner can go from a peak of a little over 7% this year to perhaps below 6% by 2024. Jim, that should help affordability right, at least on the margins. Jim Egan: It should. And that is already playing a role in our sales forecasts and our price forecasts. I mentioned that sales are falling faster than they did during the great financial crisis. We think that that pace of change really inflects in the second half of next year. Not that home sales will increase, we think they'll still fall, they're just going to fall on a more mild or more modest pace. Home prices, the trajectory there also could potentially be more protected in this improved affordability environment because I don't get the sense that inventories are really going to increase with that drop in mortgage rates. Jay Bacow: Right. And when we look at the distribution of mortgage rates in America right now, it's not uniformly distributed. The average mortgage rate is 3.5%, but right now when we think how many homeowners have at least 25 basis points of incentive to refinance, which is generally the minimum threshold, it rounds to 0.0%. If mortgage rates go down to 4%, about 2.5 points below where they are right now, we're still only at about 10% of the universe has incentive to refinance. So while rates coming down will help, you're not going to get a flood of supply. Jim Egan: We think that’s important when it comes to just how far home prices can fall here. The lock in effect will still be very prevalent. And we do think that that continues to support home prices, even if they are falling on a year over year basis as we look out beyond 2023 into 2024 and further than that. Now, the biggest pushback we get to this outlook when we talk to market participants is that we're too constructive. People think that home prices can fall further, they think that home prices can fall faster. And one of the reasons that tends to come up in these conversations is some anchoring to the great financial crisis. Home prices fell about 30% from peak to trough, but we think it's important to note that that took over five years to go from that peak to that trough. In this cycle home prices peaked in June 2022, so December of next year is only 18 months forward. The fastest home prices ever fell, or the furthest they ever fell over a 12 month period, 12.7% during the great financial crisis. And that took a lot of distress, forced sellers, defaults and foreclosures to get to that -12.7%. We think that without that distress, because of how robust lending standards have been, the down 4% is a lot more realistic for what we could be over the course of next year. Going further out the narrative that we'll hear pretty frequently is, well, home prices climbed 40% during the pandemic, they can reverse out the entirety of that 40%. And we think that that relies on kind of a faulty premise that in the absence of COVID, if we never had to deal with this pandemic for the past roughly three years, that home prices would have just been flat. If we had this conversation in 2019, we were talking about a lot of demand for shelter, we were talking about a lack of supply of shelter. Not clearly the imbalance that we saw in the aftermath of the pandemic, but those ingredients were still in place for home prices to climb. If we pull trend home price growth from 2015 to 2019, forward to the end of 2023, and compare that to where we expect home prices to be with the decrease that we're already forecasting, the gap between home prices and where that trend price growth implies they should have been, 9%. Till the end of 2024 that gap is only 5%. While home prices can certainly overcorrect to the other side of that trend line, we think that the lack of supply that we're talking about because of the lock in effect, we think that the lack of defaults and foreclosures because of how robust lending standards have been, we do think that that leaves home prices much more protected, doesn't allow for those very big year over year decreases. And we think peak to trough is a lot more control probably in the mid-teens in this cycle. Jay Bacow: So when we think about the outlook for the U.S. housing market in 2023 and beyond, home sale activity is going to fall. Home prices will come down some, but are protected from the types of falls that we saw during the great financial crisis by the lock in effect and the better outlook for the credit standards in the U.S. housing market now than they were beforehand. Jay Bacow: Jim, always greatv talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you all for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app, and share the podcast with a friend or colleague today.

23 Dec 20227min

When attempting to determine what the global economy looks like, some economic indicators at an investors disposal may be more useful, while others lag behind.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist 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 Thursday, December 22nd at 2 p.m. in London. At the heart of investment strategy is trying to determine what the global economy will look like and what that could mean to markets. But this question has a catch. Market prices often move well ahead of the economic data, partly because markets are anticipatory and partly because it takes time to collect that economic data, creating lags. When thinking about all the economic indicators that an investor can look at, a consistent question is which of these are most and least useful in divining the future? One early indicator we think has relatively powerful forecasting properties is the yield curve, specifically the difference between short term and long term government borrowing costs. These differences can tell us quite a bit about what the bond market thinks the economy and monetary policy is going to do in the future, and can move before broader market pricing. One example of this, as we discussed on the program last week, is that an inverted yield curve like we see today tends to mean that the end of Fed rate hikes are less helpful to global stock markets than they would be otherwise. But at the other end of the spectrum is data on the labor market, which tends to be much more lagging. At first glance, that seems odd. After all, jobs and wages are very important to the economy, why aren't they more effective in forecasting cross-asset returns? But drill deeper and we think the logic becomes a little bit more clear. As the economy initially weakens, most businesses try to hang on to their workers for as long as possible, since firing people is expensive and disruptive. As such, labor markets often respond later as growth begins to slow down. And the reverse is also true, coming out of a recession corporate confidence is quite low, making companies hesitant to add new workers even as conditions are recovering. Indeed, with hindsight, one of the ironies of market strategy is it's often been best to sell stocks when the labor market is at its strongest, and buy them when the labor market is weakest. And then there's wages. Wage growth is currently quite high, and there's significant concern that high wage growth will lead to excess inflation, forcing the Federal Reserve to keep raising interest rates aggressively. While that's possible, history actually points in a different direction. In 2001, 2007, and 2019, the peak in U.S. wage growth occurred about the same time that the Federal Reserve was starting to cut interest rates. In other words, by the time that wage growth on a year over year basis hit its zenith, other parts of the economy were already showing signs of slowing, driving a shift towards easier central bank policy. Investors face a host of economic indicators to follow. Among all of these, we think the yield curve is one of the most useful leading indicators, and labor market data is often some of the most lagging. Happy holidays from all of us here at Thoughts on the Market. We'll be back in the new year with more new episodes. And thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.

22 Dec 20223min

As congress wraps up for 2022, and we look towards a divided government in 2023, there are a few possible legislative moves on the horizon that investors will want to be prepared for.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Wednesday, December 21st at 11 a.m. in New York. As Congress wraps up its business for the year, it's a good time to level-set on what investors should watch out for out of D.C. in 2023. While it's not an election year, and a divided government means legislative achievements will be tough to come by, it's always a good idea to be prepared. So here's three things to watch for. First, cryptocurrency regulations. Turmoil in the crypto market seems to have accelerated lawmaker interest in tackling the thorny issue. And even if Democrats and Republicans can't come together on regulation, the Biden administration has been studying how regulators could use existing laws to roll out new rules. For investors, the most tangible takeaway from our colleagues is that crypto regulation could support large cap financials by evening the regulatory playing field with the crypto firms. Second, watch for permitting reform on oil and gas exploration. While a late year effort led by Democratic Senator Joe Manchin didn't muster enough votes for passage. It's possible Republicans may be willing to revisit the issue in 2023 when they control the House of Representatives. If this were to pass, watch the oil markets, which might be sensitive to perceptions of future increased supply, supporting the recent downtrend in prices. Lastly, keep an eye out for the U.S. to raise more non-tariff barriers with regard to China. While we're not aware of any specific deadlines in play, many of the laws passed in recent years that augment potential actions like export controls put the U.S. government on a sustained path toward drawing up more tariff barriers. Hence the continued momentum toward restricting many types of trade around semiconductors. We'll be particularly interested in 2023 if the U.S. takes actions that start to relate to other industries, which would reflect a broadening scope of U.S. intentions and the US-China trade conflict. That is potentially a challenge to our strategists' currently constructive view on China equities. Of course, these aren't the only three things out of D.C. that investors should watch for, and history tells us to expect the unexpected. We'll do just that and keep you in the loop here. In the meantime, happy holidays and have a safe and blessed new year. 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.

21 Dec 20222min