Episodes
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Our Global Head of Emerging Markets Sovereign Credit reviews key insights and strategies for investors following the recent elections in Mexico, South Africa and India.
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Welcome to Thoughts on the Market. I’m Simon Waever, Morgan Stanley’s Global Head of EM Sovereign Credit and Latin America Fixed Income Strategy. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the far-reaching impact of emerging market elections on global markets.
It’s Friday, June 7, at 10am in New York.
Elections in 2024 will impact roughly 4 billion people around the globe – that’s the most in history. And within emerging markets, elections this year will impact nearly half the market cap of both hard and local currency debt indices and 60 percent of equities. With a dozen elections in the emerging markets sovereign credit universe already behind us, there are still almost another twenty more to go.
We find that elections in emerging markets matter for both credit spreads and fiscal balances. And a frequent investor question is how to trade positive and negative election outcomes. This can be defined in many ways, of course, but we focus on whether credit spreads widen – which is a negative – or tighten – which is a positive – in the week post-elections. And history suggests that buying into negative election surprises has been a profitable strategy. But on the other hand, positive elections, they’re priced in beforehand and should not be chased post-outcome.
So why is that, exactly? Well, for positive elections, markets tend to rally nearly continuously into the elections; but after the initial week of tightening, spreads then revert and end up trading only slightly tight to the levels prior to the elections.
And then for negative elections, there’s actually no real trend ahead of the elections, with spreads largely flat. But then, after the initial sell-off, credit spreads end up reversing the initial move wider, and three months out the spreads are tighter than immediately post-elections.
So, with this in mind, let’s consider the three most recent election outcomes in Mexico, India, and South Africa. And actually, all three had an element of surprise.
In Mexico, they elected their first female president, Claudia Sheinbaum. That was expected – but the surprise was that she got a much larger majority than polls suggested, which means that it becomes easier to push through constitutional changes. So, I think it’s fair to say that uncertainty has increased, and markets are now in a wait-and-see mode looking for what policy she will prioritize.
And from my side, I’m paying particularly close attention to the many reforms submitted by the executive to the Congress back in February, and then any signs of fiscal consolidation, which is needed.
South Africa saw the ANC fall below 50 per cent for the first time, and they now need to form a coalition or at least agree on a confidence and supply model. Well, I would say that at this point, markets are already pricing a lot of that uncertainty.
Finally, in India, the BJP led New Democratic Alliance is set to form a government for the third term, and we think the most important aspect of this is policy predictability. And in particular we see a number of critical structural reforms made in this third term; and then importantly for fixed income, we see a reduction in the primary budget deficit.
We will continue to monitor closely the remaining emerging markets elections in this landmark election year, and we’ll come back with more investment updates.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our four-person panel explains Japan’s economic boom, from growing GDP to corporate sector vibrancy, and which upward trends will sustain.
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Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.
Japan is undergoing a once in a generation transformation. A country once associated with its lost decades is now seeing multi-decade highs for nominal GDP growth and equity indices.
On this special episode of the podcast, we will discuss why we are so optimistic on Japan's trajectory from here. I'm joined by our Chief Japan Economist Takeshi Yamaguchi, our Chief Asia and EM Strategist Jonathan Garner, and our Japan Equity Strategist Sho Nakazawa.
This episode was recorded last Friday, May 31st at 9 am in Hong Kong.
Jonathan Garner: And 9 am in Singapore.
Takeshi Yamaguchi: And 10 am in Tokyo.
Chetan Ahya: Japan's nominal GDP growth reached a 32 year high in 2023. Equity markets have reached multi decade highs, and ROE and productivity growth have been on an improving trend. Corporate sector vibrancy is returning, and animal spirits are reviving. A new, stronger equilibrium is one of robust nominal GDP growth and a sustainable moderate inflation.
This new equilibrium of stronger normal GDP growth and low real interest rates will also be supportive of Japan's capex trends. With that backdrop, let me now turn to Yamaguchi san.
Yamaguchi-san, what makes us confident that this virtuous cycle of rising wages and prices will continue to play out?
Takeshi Yamaguchi: We think Japan's social norm of no price hike, no wage hike is changing, and a good feedback loop between wages and prices is emerging. Workers demand higher wages with higher inflation expectations and the corporate management accept their demand, as they also expect higher inflation. Japan's labor market remains structurally tight and aggregated corporate profits are now at a record high level. In addition to the pass-through from prices to wages, we are beginning to see the pass-through in the other direction from wages to prices, especially in service prices.
The average wage hike in these spring wage negotiations was the highest in the last 33 years. So, we expect to see a gradual rise in service inflation going ahead with a rise in wages.
Chetan Ahya: Could you elaborate a bit on the details of the capex outlook?
Takeshi Yamaguchi: Yes. We expect Japan's private capex to exceed its previous 1991 peak this year. In the previous deflationary period, domestic nominal GDP remained in a flat range, and Japanese firms mainly invested abroad. That said, the trend of Japanese nominal GDP growth has shifted up, which will likely positively affect Japanese firms’ decision to increase domestic investment.
Also, there are various other factors supporting domestic capex, such as real interest rates remaining low, the weak yen, the government's new industrial policy supporting onshoring and semiconductor investment, and the need for digitalization and labor-saving investment on the back of structural labor shortage driven by demographic shifts.
Chetan Ahya: Thank you, Yamaguchi-san. And, you know, I can't let you go without answering this question, which is much of the focus of the markets right now. If yen depreciates to 160 again, how much upside risk to your rate path do you see?
Takeshi Yamaguchi: Our FX team expects the yen to gradually appreciate to 146 by the end of 2024, and under the assumption, we expect one hike this year in July and another one in January next year. However, if sustained yen depreciation raises domestic underlying inflation trend, we think the BOJ will respond by raising the policy rate further to 0.75 per cent in 2025.
Chetan Ahya: Thank you, Yamaguchi-san. Jonathan, let me come over to you now. You have led the debate on Japan's ROE improvement and have been bullish since 2018. How are we thinking about Japan equities from a broader Asia market allocation perspective now?
Jonathan Garner: Back in 2018, we highlighted Japan equities as what we called the most underappreciated turnaround story in global equities. And at the heart of our thesis was the idea that monetary and fiscal policy dials were now set to exit deflation, driving an improved top-down environment for corporations from an asset utilization perspective.
It's worth recalling that during the deflation era, Japan listed equities ROE averaged just 4.2 per cent for two decades, by far the lowest in global markets. That's now reached almost 10 per cent, and we're confident that by the end of next year we can be approaching 12 per cent, which would put Japan back in the middle of the pack in global equity markets.
And we think further re-rating in line with the improved ROE is likely, over the medium term.
Chetan Ahya: And how much upside do we see from here?
Jonathan Garner: Well, in terms of the target price that we published in our midyear outlook, that now stands at 3,200 for June 2025 for TOPIX. And the way that we derive that is through an earnings forecast for TOPIX, which is around 5 per cent above current consensus levels.
And in addition, a forward PE multiple assumption of 15 times, which is close to where the market is currently trading, and around about a 4 PE point discount to our target multiple for the S&P 500. So that gives us around 16 per cent upside versus current spot levels.
Chetan Ahya: Thank you, Jonathan. And you mentioned about corporate governance changes helping Japan equity markets. Sho, let me bring you in here. How will corporate governance changes drive further improvement in Japan's ROE?
Sho Nakazawa: I would say corporate governance reform, which is Tokyo Stock Exchange initiative will help fuel OE gains going forward. From the last year below 1x P/B has been a buzz word in the market, growing sense of shame and peer pressure to enhance capital efficiency for the corporate executives. And this is not just a psychological change. If we look at cumulative share buybacks amount, last fiscal year it hit a record high of ¥10 trillion, and we are seeing further record growth into this fiscal year as well.
Chetan Ahya: And what are the key alpha generation themes still to pay for within Japan equities space?
Sho Nakazawa: In terms of alpha generation, we explored three key themes within the Japanese equity landscape. So one, identifying companies with labor productivity and pricing power that can pay and absorb higher real wages; and two, finding the next cohort of corporate reform beneficiaries. Three, assessing the impact of NISA, Nippon Individual Saving Account, inflows.
I think this will drive large cap, high-liquidity value and high dividend stock. Still plenty to play for in Japan.
Chetan Ahya: Yamaguchi-san, Jonathan, Nakazawa-san, thank you all for taking the time to talk. And thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.
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Original Release on April 29, 2024: Our analysts find that despite the obvious differences between retail fashion and airlines, struggling brands in both industries can use a similar playbook for a turnaround.
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Ravi Shanker: Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's North American Freight Transportation and Airlines Analyst.
Alex Straton: And I'm Alex Straton, Morgan Stanley's North America Softlines, Retail and Brands Analyst.
Ravi Shanker: On this episode of the podcast, we'll discuss some really surprising parallels between fashion, retail, and airlines.
It's Monday, April 29th at 10am in New York.
Now, you're probably wondering why we're talking about airlines and fashion retail in the same sentence. And that's because even though they may seem worlds apart, they actually have a lot in common. They're both highly cyclical industries driven by consumer spending, inventory pressure, and brand attrition over time.
And so, we would argue that what applies to one industry actually has relevance to the other industry as well. So, Alex, you've been observing some remarkable turnaround stories in your space recently. Can you paint a picture of what some fashion retail businesses have done to engineer a successful turnaround? Maybe go over some of the fundamentals first?
Alex Straton: What I'll lead with here is that in my North America apparel retail coverage, turnarounds are incredibly hard to come by, to the point where I'd argue I'm skeptical when any business tries to architect one. And part of that difficulty directly pertains to your question, Ravi -- the fundamental backdrop of the industry.
So, what are we working with here? Apparel is a low single digit growing category here in North America, where the average retailer operates at a mid single digit plus margin level. This is super meager compared to other more profitable industries that Ravi and I don't necessarily have the joy of covering. But part of why my industry is characterized by such low operating performance is the fact that there are incredibly low barriers to entry in the space. And you can really see that in two dynamics.
The first being how fragmented the competitive landscape is. That means that there are many players as opposed to consolidation across a select few. Just think of how many options you have out there as you shop for clothing and then how much that has changed over time. And then second, and somewhat due to that fragmentation, the category has historically been deflationary, meaning prices have actually fallen over time as retailers compete mostly on price to garner consumer attention and market share.
So put differently, historically, retailers’ key tool for drawing in the consumer and driving sales has been based on being price competitive, often through promotions and discounting, which, along with other structural headwinds, like declining mall traffic, e-commerce growth and then rising wages, rent and product input costs has actually meant the average retailers’ margin was in a steady and unfortunately structural decline prior to the pandemic.
So, this reliance on promotions and discounting in tandem with those other pressures I just mentioned, not only hurt many retailers’ earnings power but in many cases also degraded consumer brand perception, creating a super tough cycle to break out of and thus turnarounds very tough to come by -- bringing it full circle.
So, in a nutshell, what you should hear is apparel is a low barrier to entry, fragmented market with subsequently thin margins and little to no precedent for successful turnarounds. That's not to say a retail turnaround isn't possible, though, Ravi.
Ravi Shanker: Got it. So that's great background. And you've identified some very specific key levers that these fashion retail companies can pull in order to boost their profitability. What are some of these levers?
Alex Straton: We do have a recent example in the space of a company that was able to break free of that rather vicious cycle I just went through, and it actually lifted its sales growth and profitability levels above industry average. From our standpoint, this super rare retail turnaround relied on five key levers, and the first was targeting a different customer demographic. Think going from a teens focused customer with limited brand loyalty to an older, wealthier and less fickle shopper; more reliable, but differently.
Second, you know, evolving the product assortment. So, think mixing the assortment into higher priced, less seasonal items that come with better margins. To bring this to life, imagine a jeans and tees business widening its offering to include things like tailored pants and dresses that are often higher margin.
Third, we saw that changing the pricing strategy was also key. You can retrain or reposition a brand as not only higher priced through the two levers I just mentioned, but also try and be less promotional overall. This is arguably, from my experience, one of the hardest things for a retailer to execute over time. So, this is the thing I would typically, you know, red flag if you hear it.
Fourth, and this is very, very key, reducing the store footprint, re-examining your costs. So, as I mentioned in my coverage, cost inflation across the P&L (profit and loss) historically, consumers moving online over time, and what it means is retailers are sitting on a cost base that might not necessarily be right for the new demand or the new structure of the business. So, finding cost savings on that front can really do wonders for the margins.
Fifth, and I list this last because it's a little bit more of a qualitative type of lever -- is that you can focus on digital. That really matters in this modern era. What we saw was a retailer use digital driven data to inform decision making across the business, aligning consumer experience across channels and doing this in a profitable way, which is no easy feat, to say the least.
So, look, we identified five broad enablers of a turnaround. But there were, of course, little changes along the way that were also done.
Ravi Shanker: Right.
Alex Straton: So, Ravi, given what we've discussed, how do you think this turnaround model from fashion retail can apply to airlines?
Ravi Shanker: Look, I mean, as we discussed, at the top here, we think there are significant similarities between the world of fashion retail and airlines; even though it may not seem obvious, at first glance. I mean, they're both very consumer discretionary type, demand environments. The vicious circle that you described, the price deflation, the competition, the brand attrition, all of that applies to retail and to airlines as well.
And so, I think when you look at the five enablers of the turnaround or levers that you pull to make it happen, I think those can apply from retail to airlines as well. For instance, you target a different customer, one that likes to travel, one that is a premium customer and, and wants to sit in the front of the plane and spend more money.
Second, you have a different product out there. Kind of you make your product better, and it's a better experience in the sky, and you give the customer an opportunity to subscribe to credit cards and loyalty program and have a full-service experience when they travel.
Third, you change your distribution method. You kind of go more digital, as you said. We don't have inventory here, so it'd be more of -- you don't fly everywhere all the time and be everything to everyone. You are a more focused airline and give your customer a better experience. So, all of those things can drive better outcomes and better financial performance, both in the world of fashion retail as well as in the world of airlines.
Alex Straton: So, Ravi, we've definitely identified some pretty startling similarities between fashion retail and airlines. Definitely more so than I appreciated when you called me a couple months ago to explore this topic. So, with that in mind, what are some of the differences and challenges to applying to airlines, a playbook taken from the world of fashion retail?
Ravi Shanker: Right, so, look, I mean, they are obviously very different industries, right? For instance, clothing is a basic human staple; air travel and going on vacations is not. It's a lot more discretionary. The industry is a lot more consolidated in the airline space compared to the world of retail. Air travel is also a lot more premium compared to the entire retail industry. But when you look at premium retail and what some of those brands have done where brands really make a difference, the product really makes a difference. I think there are a lot more similarities than differences between those premium retail brands on the airline industry.
So, Alex, going back to you, given the success of the turnaround model that you've discussed, do you think more retail businesses will adopt it? And are there any risks if that becomes a norm?
Alex Straton: The reality is Ravi, I breezed through those five key enablers in a super clear manner. But, first, you know, the enablers of a turnaround in my view are only super clear in hindsight. And then secondly, one thing I want to just re-emphasize again is that a turnaround of the nature I described isn't something that happens overnight. Shifting something like your consumer base or changing investor perception of discounting activity is a multi year, incredibly difficult task; meaning turnarounds are also often multi year affairs, if ever successful at all.
So, looking ahead, given how rare retail turnarounds have proven to be historically, I think while many businesses in my coverage area are super intrigued by some of this recent success; at the same time, I think they're eyes wide open that it's much easier said than done, with execution far from certain in any given turnaround.
Ravi Shanker: Got it. I think the good news from my perspective is that hindsight and time both the best teachers, especially when put together. And so, I think the learnings of some of the success stories in your sector can not only be lessons for other companies in your space; they can also be lessons in my space. And like I said, I think some airlines have already started embarking on this turnaround, others are looking to see what they can do here. And I'm sure again, best practices and lessons can be shared from one sector to another. So, Alex, thanks so much for taking the time to talk to us today.
Alex Straton: It was great to speak with you, Ravi.
Ravi Shanker: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
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Our Chief Fixed Income Strategist takes listeners behind the curtain on Morgan Stanley’s expectations for markets over the next 12 months.
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Welcome to Thoughts on the Market. I am Vishy Tirupathur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the key debates we engaged in during the mid-year outlook process.
It's Tuesday, June 4th at 1pm in New York.
Over the last few episodes, you've been hearing a lot about Morgan Stanley's midyear outlook, where our economists have forecasted a sunny macro environment of decelerating growth and inflation, and policy easing in most developed market economies, leading to a positive backdrop for risk assets in the base case, especially in the second half of the year.
But beyond the year end, many uncertainties -- uncertainties of outcomes and uncertainties of the consequences of those outcomes -- point to a wider range of outcomes, driving a wider than normal bull versus bear skew in our expectations for markets over the next 12 months.
As always, these outlooks are the culmination of a process involving much deliberation and spirited debate among economists and strategists across all the regions and asset classes we cover. I thought it might be useful to detail some of these debates that we've had during the process to shed a better light on the forecast in our outlook.
First, given the many changes to market pricing of Fed's rate cuts year to date, driven by higher-than-expected inflation, the path ahead for US inflation was heavily debated. Our economists argued that the acceleration in goods and financial services prices, which explains a substantial portion of the upside in the first quarter inflation data should decelerate from here. And also that leading indicators point to a weaker shelter inflation ahead. Their analysis also showed that residual seasonality contributed to the unexpected strength in first quarter [20]24 inflation data, suggesting a payback has to happen in the second half of 2024.
The outlook for China economy and our cautious stance on the market was another point of debate, mainly because China's growth has surprised to the upside relative to our 2024 year ahead outlook. Our economists argued that while there are a few policy positives on housing and green products mitigating the debt deflation spiral, growth remains unbalanced and subpar. So, we discussed our cautious stance on China equity markets against this backdrop and concluded that the equity market recovery is still very challenging in China.
Third, given the combination of favorable technicals, solid fundamentals, and a relatively benign economic outlook, we debated whether corporate credit, on which we are constructive, should we be even more constructive in our forecasts. After all, the setup for corporate credit has many elements similar to those during the mid 1990s, when, for example, US IG index spreads were about 30 basis points tighter versus the current spread targets.
Our strategist highlighted the significant differences in the market structure, the composition of the index, and the duration of the underlying bonds that make up this index today, versus 1990s -- all of which put a higher floor on spreads, which explains our spread targets.
The debates notwithstanding, we cannot argue with the benign macro backdrop and what that means for the second half of 2024. We turn overweight in global equities and overweight in a range of spread products within fixed income, most notably agency MBS, EM Sovereign credit, leveraged loans, securitized credit, especially CLO equity tranches.
Thanks for listening. If you enjoyed the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief Cross-Asset Strategist explains why the high correlation between stocks and bonds could work in investors’ favor throughout the second half of this year.
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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why we believe bonds and equities can both rally this year, with the still-elevated correlations between the two assets a boon rather than a bane to investors.
It’s Monday, June 3rd at 10am in New York.
In our mid-year outlook two weeks ago, we expressed our bullish view on both global equities and parts of fixed income space like agency mortgage-backed securities and leveraged loans, on the back of the benign economic backdrop our economists are forecasting for in the second half of 2024.
Now, this may be surprising to some. Received wisdom is that in an environment of rate cuts and falling yields, equities can't perform well because the former usually maps to growth slowdowns. When equities see double-digit upside – which is what we’re projecting for European equities – it’s unusual for bonds to also see strong and positive returns, which is what we’re projecting for German government bonds.
And I want to push back on this received wisdom that we can’t have an ‘everything rally’. When we look at the annual performance of global stocks and 10-year US Treasuries every year going back to 1988, in the 13 times when the Fed cut rates over the course of the year, bond yields were lower and equities were up 43 per cent of the time. And in those periods, stock returns averaged 18 per cent while yields fell over 1 percentage points. ‘Everything rallies’ happen often in this very macro backdrop of benign growth and Fed cuts we’re expecting, And when they do happen, everything indeed rallies – strongly.
Or to frame it another way – our expectations for both global equities and fixed income to see strong total returns this year is the flipside of what markets had experienced in 2022. Now back then, unlike in most other prior cycles, stock-bond return correlations were high because inflation was elevated even as growth was sluggish, meaning that bonds sold off on higher rates expectations, and equities on bad earnings. Today, with our view that global growth can be robust while disinflation continues, the opposite will likely be true; bonds should rally on lower rates expectations, and equities on strong earnings revisions. Stock-bond return correlations are still elevated, but it should work in an investor’s favor this year.
Lean into it. Good macro, fair fundamentals, pockets of attractive valuations all make for a strong environment for risk assets, a reason for us to get more bullish on European and Japanese equities, but also in fixed income products like leveraged loans and Collateralized Loan Obligations.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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In a generally positive environment for corporate credit, the recent performance of high-yield bonds in the telecom, media and technology (TMT) sector offers a market contrast. Our Lead Analyst for High-Yield TMT joins our Head of Corporate Credit Research to explain the divergence.
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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research for Morgan Stanley.
David Hamburger: And I'm David Hamburger, Head of US Sector Corporate Credit Research and Lead Analyst for the high yield telecom, media, and technology sectors.
Andrew Sheets: And today on the podcast we'll be discussing the contrast between strong overall markets in credit and a whole lot of volatility in the high yield TMT space.
It's Friday, May 31st at 10am in New York.
So, David, it's great to talk to you. You know, listeners have probably been hearing about our views on overall markets and credit markets for the 12 months ahead.
We have US growth at 2 percent. We have inflation coming down. We had the Fed lowering interest rates. But there’s needless to say; there's some pretty notable contrast between that sort of backdrop and the backdrop we've had for credit year to date, which has been pretty calm, pretty strong -- and what's been going on in your sector.
So maybe before we get into the why -- let's talk about the what and bring people up to speed on the saga that's been high yield TMT year.
David Hamburger: Yeah. I'm here today to disavow you of any notion that everything is fine and dandy in the market today. So, if you look at the high yield communications sector, it's trading about 325 basis points wide of the overall high yield index. And just to give you that magnitude of that -- the high yield index trading around 300 basis points -- we're talking about 625 basis points over. Now, the high yield communication sector as well is trading about 275 basis points, wider than the next widest sector in the index.
And so, it's pretty astounding today, given the market backdrop, how much underperformance we've seen in this sector.
Andrew Sheets: What's been causing this just large divergence between high yield TMT and what seems like a lot of other things?
David Hamburger: Yeah, I think there are two forces at work here. One's kind of a broader set of issues that I can outline for you. Really, I think it's a combination of one, the maturation of the communications marketplace. Coming out of COVID, we certainly had accelerated adoption of broadband and wireless services. That in and of itself has created a lot of intense competition.
And as such, we've seen a lot of technological advances that have created some secular pressures on the space. As well, when you pair that up with elevated financial leverage, all coming together at a time when the marginal cost of capital for companies has increased due to higher interest rates. Those are really some of the underlying forces at work that have driven underperformance in this sector.
But some companies have managed to navigate this environment. And I would say by and large, it's those with really strong balance sheets. But that has really cast a shadow on this sector -- is the fundamental and financing issues.
When you think about the bloated balance sheets that some of the other companies have had, they've been exploring a whole new set of transactions and, evaluating different options for their balance sheets. And that's probably the more sinister thing that we've seen in the market of late.
Andrew Sheets: So, so tell me a little bit more about this. You know, what are some of the types of things that companies can do that often leave the bond holder unhappy?
David Hamburger: We all became all too aware of what private equity sponsors might do back in the heyday of LBOs, and we still live in that world today, and it's really fairly well known.
You know, I've been in the credit markets for more than 20 years, but I can't recall a time we've seen so many management teams and controlling shareholders now that are at odds with their creditors because of elevated leverage and the business risks they face. So really, the prospect of real and expected liability management has created a lot of dislocation across companies’ capital structures.
So, what have they done? We look and see companies that have been exploring liability manage, taking advantage of weak protections in certain credit documentation in their structure at the expense of other creditors in the same capital structure. So, we have one company where you see this dislocation in their term loans. They have the same pool of collateral between two different term loans with two different maturities. The later dated maturity is trading higher than the nearer dated maturity, strictly or solely because of the better protections in that documentation. And the premise being, you can negotiate with that class of creditors, give them an advantaged position in the capital structure at the expense of other creditors -- in order to somehow manage the balance sheet and manage those liabilities.
Andrew Sheets: And David, is it fair to say that this is a direct outcrop of, you know -- a term some people might have heard of -- of covenant light debt, where, you know, usually debt has certain legal protections that mean that the bondholder is more assured of getting paid back or not being made a less well off than other lenders. But you know, we did see some of that change during different, stronger market conditions. Is that a partial explanation of what's going on?
David Hamburger: That's exactly right, Andrew. We are seeing the result, if I might say, the hangover from some of these covenant light deals that came to market over the last few years; almost to the point of speak to some clients and they will just want to know what is the vintage of that secured debt issue that you're talking about because there were certain years where they were far more flexible documentation and protections. And now, given where the equity markets are trading and the financing environment, you see a lot of those securities trading at severe discounts to par, which is unusual because, again, in my 20-year career, I've not often seen companies with billion-dollar equity market caps and bonds trading in the 20, 30, or 40 cents on the dollar.
You would think that if a company had a substantial market cap, that their bonds would be trading closer to par and would have value. But what really the market's, I think, pricing in is this transference of value from creditors to shareholders; and the opportunity cost associated with these shareholders; or controlling shareholders or management teams looking to capture those discounts that they now see in their bonds; or in their loans to the benefit of equity shareholders -- really puts all constituents in the company's balance sheet, if you will, at odds with one another.
Andrew Sheets: So, David, this is so interesting because again, I think, you know, for a lot of listeners, you can read the newspaper, you see the headlines, the market looks very strong and stable. And yet, there's definitely a tempest that's been brewing, you know, in your sector. For people who are investing in high yield TMT, what are you think the most important things that you're looking out for in your credit coverage?
David Hamburger: Well, look, we're forced to really dig in and scrutinize these credit docs and really understand what protections are there, understanding how companies might navigate through those protections in order to prolong or preserve their equity value or the equity options in their companies.
It's not like we're trying to be alarmists in saying this is a canary in the coal mine, but it is certainly a cautionary tale for any high yield investor to be well versed in those credit documentation, understanding the protections in those debt securities.
And we have seen bondholders and creditors, largely even in loans, you know, get together in co-op agreements to push back on some of these aggressive liability management transactions. And that, I think, is really important in an environment where yields have come back in and, you know, where people look at opportunities and maybe we could, once again, see two things. One, a reach for yield, where you're looking at sectors that have underperformed. And secondly, should we get back into an environment of covenant light docks once again? So, I don't want to be talking about this again in a few years’ time. And it's not something that the market has helped resolve rather than just perpetuate.
Andrew Sheets: David, it's fascinating as always. Thanks for taking the time to talk.
David Hamburger: Thank you Andrew. Glad to be here.
Andrew Sheets: And thanks for listening. If you enjoy the show, please leave us a review wherever you get your podcast and share Thoughts on the Market with a friend or colleague today.
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Our Chief Europe Economist explains why the region’s outlook over the next year is trending upward, including how higher growth will lead to lower interest rates this cycle.
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Welcome to Thoughts on the Market. I’m Jens Eisenschmidt, Morgan Stanley’s Chief Europe Economist. Along with my colleagues bringing you a variety of perspectives, today I will discuss our outlook for Europe’s economy in the second half of 2024 and into next year.
It’s Thursday, May 30 at 10am in Frankfurt.
So, over the last year, we have had a relatively downbeat outlook for Europe's economy, but as we head into the second half of this year our view is decidedly more optimistic. After bottoming last year, euro area growth should reach 0.7 per cent annualized terms in 2024 and 1.2 per cent in 2025 on the back of stronger consumption and exports. Inflation is on its way to the European Central Bank’s target, paving the way for the ECB to start cutting rates in June with three cuts in 2024, for a total of 75 basis points, and four more cuts in 2025, for a total of 100 basis points.
What’s particularly notable, though, is the set-up of this growth rebound is highly unusual for several reasons.
Let's start with inflation. In a normal environment, higher growth leads to higher inflation and vice versa. This time is different. The euro area needs to grow faster to get inflation down. The reason is that faster growth should lead to better resource utilization in sectors characterized by labor hoarding or keeping a surplus of employees. This should keep unit labor costs – or how much a business pays its workers to produce one unit of output – in check. We’re expecting further wage increases, mostly driven by the catch-up with past inflation, and so higher productivity is a way to cushion the pass-through to prices.
So again, just to repeat, we are in a cycle where we need higher growth to get inflation down and not as usual, we have higher growth and that gets us more inflation. Of course, there is a limit to that. If we get too much growth, that would be an issue potentially for the ECB. And if you get too little growth, that is another issue because then we won't get the productivity rebound.
In some sense, you could think of the growth we need as a landing strip and we need to come in at that landing strip precisely; and so far, the signs are there that is exactly the picture we are getting in 2024 and 2025 in Europe.
Now the monetary and fiscal policy mix is another area where this cycle stands out. So normally, monetary policy would tighten into an upswing and ease into a downturn, while fiscal policy would be expansionary in a downturn and contractionary in an upswing. Euro area monetary policy is currently restrictive – but it’s set to get less restrictive over time. The likelihood of rates coming down is hardly bad news for growth. But policymakers will need to take care to not reignite inflation in the process.
So all of that gives rise to the gradualism that the European Central Bank has been signaling it will use in its policy easing approach. And again, think about the landing strip metaphor. If we are not gradual enough and we reignite a growth too much, and with it inflation, we might be exiting the landing strip in one way or the other.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Head of Fixed Income and Thematic Research reflects on Japanese investors’ interest in the outcome of the upcoming presidential vote in the US.
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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the upcoming US elections.
It's Wednesday, May 29th at 10:30am in New York.
I recently returned from Tokyo, having attended and presented at Morgan Stanley's inaugural Japan summit. And while I was asked to present on topics ranging from our fixed income markets outlook to the role of Japan in an increasingly multipolar world, my one-on-one conversations always tracked back to the same client question: who will win the US election.
Of course this is a matter of great importance globally. But the investor in Japan is particularly interested in whether possible election outcomes could disrupt their rosy economic outlook – either through new tariffs or increased geopolitical tensions between the US and China, and also North Korea. To that end, many were focused on polls showing former President Trump with sufficient support to win the election, asking how predictive this would be of the ultimate outcome.
Here our view remains, for all investors, that polls aren't giving a reliable signal yet. The election is still several months away. And Trump doesn't have leads beyond a normal polling error in sufficient states to win the presidency.
So, investors still need to consider the potential impacts of a variety of US electoral outcomes. That's perhaps not the most settling answer for investors, who strive to limit uncertainties. But we think it's the most honest one. And as we've been doing in this space all year, we'll continue to walk you through the outcomes, policy impacts, and resulting market effects you need to be aware of.
Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief Europe Equity Strategist explains why she is forecasting a 23 percent total return for European equities over the next year.
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Welcome to Thoughts on the Market. I’m Marina Zavolock, Morgan Stanley’s Chief European Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why our mid-year outlook extends our bullish view on European equities.
It’s Tuesday, May 28, at 10am in London.
We have recently updated our outlook for the year ahead, maintaining our bullish view on European equities as we fully incorporate and roll forward our mid-1990s “soft landing” playbook. Like today, the mid-1990's was a period where markets focused on rates, inflation, and related data above anything else. The US and Europe saw soft and “softish” landings, the Fed’s cutting cycle was slower than investors initially expected, and there was an undercurrent of technological innovation. European equities, in particular, are following the mid-1990s path closely, and that means both a mid-cycle extension and a strong market set-up.
We have high conviction in our constructive European equities view and have recently raised our one year forward MSCI Europe Index target to 2,500 – 18 percent potential upside. This brings potential total return upside – if we incorporate dividends and buybacks – to 23 percent.
So why do we remain bullish? Over the second half of this year in particular we anticipate European equities ongoing re-rating is likely to combine with an emerging European equities earnings recovery. We’ve just come out of one of the strongest earnings seasons Europe has had in several quarters and we anticipate this is only the beginning. Our earnings model projects 7.5 percent earnings growth by year end for MSCI Europe, which is almost double consensus estimates. On top of this, we think the market underappreciates a number of significant thematic tailwinds that benefit European equities. These include rising corporate confidence, an M&A cycle recovery that is leading the global trend, an imminent start to rate cuts, high and rising capital distributions including buybacks, and underappreciated AI diffusion.
In terms of our sector preferences, structurally, we continue to prefer Europe’s quality growth sectors. These include Software, Aerospace & Defense, Pharma, and Semiconductors, along with the Banks sector.
Shorter-term, we also believe a recovery in bond yield-sensitive stocks has begun, which is expected at this stage in our mid-1990s playbook. We expect this rally to be tactical and bumpy but ultimately more powerful than a similar rotation that occurred around the Fed pivot late last year. We recently upgraded Building & Construction to overweight to play this rotation.
Although we believe European equities are in the sweet spot over the second half of 2024, we expect the bar for continued performance to become tougher by the time we get into first half of 2025. Also, our bear case incorporates rising geopolitical risks and lower-than-expected economic growth – the latter in line with our economists' bear case. A US election scenario that would bring a change in the status quo is also a risk for European equities, albeit it’s far more idiosyncratic than broad-based according to our in-depth analysis.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Head of Corporate Credit Research explains why moderate economic growth offers opportunities in credit markets – if investors choose carefully.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley, along with my colleagues, bring you a variety of perspectives Today, I'll be talking about our outlook for credit markets over the next 12 months.
It's Friday, May 24th, at 9 a. m. in New York. Morgan Stanley's global economic and strategy teams have recently published our mid year outlook. Twice a year, all of us get together to take a step back, debating what we think the outlook could look like over the 12 months ahead. For credit, we think that backdrop still looks pretty good.
Corporate credit, in representing lending to companies, is an asset class that loves moderation and hates extremes. An economy that's too weak raises the risk that companies fail, and has been consistently bad for returns. But an economy that's too strong also causes challenges, as companies take more risks, the rewards of which often go to stockholders, not their lenders.
The good news for credit is that Morgan Stanley's latest economic forecasts are absolutely full of moderation for economic growth. We see the U.S. growing at about 2 percent this year and next and Europe growing at about 1%. Right in that temperate zone, the credit usually finds optimal.
We see inflation falling, with core inflation back to 2 percent in the U. S. and Europe over the next 12 months. And monetary policy should also moderate, with the Federal Reserve, European Central Bank, and the Bank of England All lowering interest rates as this inflation comes down.
For credit, forecasts that expect moderate growth, moderating inflation, and moderating interest rates are exactly that down the fairway outcome that we think markets generally like. The challenge, of course, is that spreads have narrowed and lower risk premiums are discounting a lot of good news. So how do investors navigate richer valuations within what we think is still a very supportive economic backdrop?
One thing we continue to like is leveraged loans, where yields and spreads we think are more attractive. In the U. S., yields on loans are still north of 9%. We like short dated investment grade bonds, which we think offer a good mix of income and stability, and also happen to correspond to the maturity range that our interest rate colleagues expect yields to see the largest decline.
That should help total returns. And in Europe, we don't think spreads are particularly tight. And that should be further supported by relatively upbeat views on the European stock market from our equity strategies. Morgan Stanley's macroeconomic backdrop, which is full of moderation, is supportive for credit.
Tighter valuations are a challenge, but given this moderate backdrop, we think they can stay expensive. We still think there are good opportunities within credit, but investors will have to pick their spots. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen, and share thoughts on the market with a friend or colleague today.
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With cooling inflation and an expected drop for mortgage rates, will more affordable housing lead to a big spike in sales? Our Co-Heads of Securitized Product Research take stock of the US housing market.
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Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.
James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley.
Jay Bacow: And on this episode of the podcast, we'll discuss our outlook for mortgage rates and the housing market over the next 12 months.
It's Thursday, May 23rd, at 1pm in New York.
James Egan: Jay, I want to talk about mortgage rates. From November through January, mortgage rates decreased over 120 basis points. But then from February to May, they've given back more than half of that decline. Where are mortgage rates headed from here?
Jay Bacow: So, day to day, week to week, it's hard to have a lot of conviction, a lot of things can happen. But, over the next 12 months, we think mortgage rates are coming down. We estimate that by summer 2025, the 30-year fixed rate mortgage will be roughly 6.25 per cent.
James Egan: Alright, that is a significant amount lower than about 7 per cent where we are right now. And that's good news for affordability in the US housing market. What gets us there?
Jay Bacow: We think inflation is going to cool, and our economists are forecasting that the Fed is going to cut their policy rate by 75 basis points this year and 100 basis points next year. In fact, our economists are forecasting eight of the G10 central banks to cut rates next year.
Now, mortgage rates are 30 year fixed rate products, so they're based more on where the longer end of the treasury curve is than the front end. But our rate strategists think ten year notes are going to rally to 375 by next summer.
When you combine all of that with our expectation for secondary mortgage rates to tighten versus treasuries, that's how we end up with that forecast for the primary rate to rally.
James Egan: All right, I want to dig in there. I really like how you highlighted the secondary mortgage rates tightening versus treasuries. One thing I know that we've both gotten a lot of questions on over the course of the past year plus is how wide mortgages are trading versus treasuries right now. So, what do you think drives that tightening basis?
Jay Bacow: There’s a lot of factors -- but in end, two of them that are always going to drive things are supply and demand. One of the interesting things is that while housing activity has picked up, we're near the decade high in the percentage of homes that are bought with all cash, which means that the supply of mortgages to the market is actually not that high.
On the demand front, we think you're going to get demand from a broad spread of investors. We think there's been some money manager supported inflows into the mortgage market. We think that as the Fed cuts rates and you get the Basel III endgame resolution, domestic banks are going to come back to the market as they get more regulatory clarity.
And then also as the Fed cuts rates, that means that FX (foreign exchange) hedging costs for overseas investors will be improved and so you think Japanese life insurance companies can go back to the market and we think there's going to be continued demand from Chinese commercial banks. But, if you get all of this support, then as mortgage rates come down, that should be good news on the affordability front in the housing market, right Jim?
James Egan: Exactly. When we combine that decrease in mortgage rates with what our US economics team is saying will be about mid-single digit growth in nominal incomes, we get an improvement in affordability over the next 12 months that we've only seen a handful of times over the past 30 years.
Jay Bacow: Now this six and a quarter forecast is certainly good news versus spot rates. It's almost two per cent below the peaks we saw last year, but I don't really think it solves the lock-in effect that we've discussed on this podcast previously.
Close to 80 per cent of homeowners have a mortgage rate below 5 per cent. So, they're still out of the money versus our expectations for our mortgage rates going next year.
James Egan: Right, and we think that's a very important point. You made the point earlier about thinking about supply and demand with respect to mortgage rates versus treasuries, and we're going to talk about it here in the housing market. We have to think about affordability improvement in terms of both that supply and demand piece.
If we look back towards the start of this year, I'd say that demand increased a little bit faster, a little bit stronger than we thought. Typically, when you see sharp improvements in affordability, it doesn't always lead to immediate increases in sales volumes. However, what we saw from November to January seemed to be a little bit quicker to stir animal spirits, perhaps because of how healthy this improvement in affordability was. Home prices were still climbing. Mortgage rates weren't even coming down because the Fed was cutting; it was because of market expectations for future fed cuts in a soft landing environment. But on the supply side, while we expect for sale listing volumes to increase as rates come down, they aren't going to race higher because of that lock-in dynamic that you just described.
Jay Bacow: So, Jim, you think more people will list their homes; but what will actually happen to sales volumes? Will people buy them?
James Egan: Right. So, I think we have to delineate between existing home sales and new home sales here. Yes, we think existing listings are going to increase on the margins. New home inventory has already increased.
Historically, new homes make up about 10 to 20 per cent of the for-sale inventory on a monthly basis. Right now, they're between 30 and 35 per cent, and that's been the case for a little while. So, when we think about our forecasts for sales volumes, we're confident that new home sales will increase more than existing home sales. And that that growth in new home sales will spur single unit starts to increase more than both of them.
Our specific spot forecasts, 10 per cent growth in new home sales, 5 per cent growth in existing home sales, with single unit starts edging out a double digit return of about 15 per cent growth.
Jay Bacow: Do you have specific spot forecasts for home prices as well?
James Egan: We do. As supply increases, the pace of home price growth should slow from where it is right now. It's been accelerating for the past several months, but the absolute level of supply is still pretty tight. We're at 3.8 months of supply as we're recording this podcast. Any reading below 6 is really associated with home price growth, not just today, but at least over the course of the next 6 months -- and we're well below 6 months of inventory.
Right now, home prices are growing at about 6.5 per cent. We think they're growing to slow to about 2 per cent by the end of 2024, before accelerating to 3 per cent in 2025. So, while growing inventory leads to deceleration, tight inventory keeps home price appreciation positive.
Jay Bacow: Alright so, home sale activity is going to pick up. It's going to be led by starts, which we think will be up 15 percent and more new home sales than existing home sales. There’s new home sales up 10 per cent. Home prices we now think will end the year positive; up 2 per cent in 2024 and up 3 per cent in 2025.
Jim, always a pleasure talking.
James Egan: Great speaking with you, Jay.
Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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Why is the US economy poised for a strong second half of the year, despite slowing GDP growth? Our Chief US Economist points to population growth, housing demand and anticipated Fed rate cuts.
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Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief US Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our mid-year outlook for the US economy.
As we near the midpoint of this year, we refresh our outlook for the second half of the year. In our base case, the US economy remains strong, but US GDP growth is slowing, and slowing from 3.1 percent on a fourth quarter over fourth quarter basis last year, to 2.1 percent this year and in 2025.
Okay, so what's behind the continued strength? Well, it's something we've been intensely following this year. Faster immigration and population growth will continue to expand the labor supply and support economic activity, and all without increasing inflationary pressures. So, whereas the mid-pandemic labor market was characterized by persistent shortage of labor, the supply of labor is now increasing, and we think will outstrip demand this year.
This will drive the unemployment rate higher, which we expect will end this year half a point above 2023 at 4.2 per cent and rise further to 4.5 per cent in 2025. And wage gains should moderate further as the unemployment rate rises. We think consumer activity will continue to slow this year and into 2025 as that cooling labor market weighs on growth in real disposable income and elevated interest rates keep borrowing costs high.
Tight lending standards also limit credit availability. That said, we do think lower rates are on the horizon, and this should spur a pickup in housing demand and goods spending around the middle of next year. In fact, after substantial reflation numbers in the first quarter of 2024, we expect lower inflation numbers ahead. We've already seen that in the April data, as rents, goods, and services prices decelerate.
The Fed has held the policy rate steady at a range of 5.25 to 5.5 per cent since July 2023, and we expect it will deliver the first quarter point cut in September this year. In total, we expect three quarter point cuts this year, and four more by the middle of next year, which lowers the policy rate to around 4.5 per cent in the fourth quarter this year to about 3.5 per cent in the fourth quarter of 2025. But even before rate cuts, the Fed has announced it will start phasing out Quantitative Tightening, or QT, in June. We expect QT to end around March 2025, when the Fed's balance sheet is a little above 3 trillion.
Finally, let's talk about housing. We expect continued growth in residential investment through 2025, with a rapid rise in housing starts, solid new home sales, and a bit more turnover in existing home sales as mortgage rates fall. Home building and increased brokerage commissions should keep residential investment on the boil, posting a 4.6 per cent rise on a 4th quarter over 4th quarter basis this year and 3.2 per cent in 2025. Our residential investment forecasts are a good deal stronger than we expected in the year ahead outlook we published last November. Booming first quarter growth probably reflected a combination of the warm winter and the temporary downswing in mortgage rates. We don't expect the same outperformance later in the year. But at the same time, housing demand is greater than we had anticipated amid that faster population growth.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Cross-Asset Strategist and Global Chief Economist discuss the state of asset markets at the midway point of 2024, and why the current backdrop suggests positive directions for several key markets.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.
Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross Asset Strategist.
Seth Carpenter: And yesterday, Serena, you and I discussed Morgan Stanley's global economic mid-year outlook. And today, I'm going to turn the tables on you, and we'll talk about asset markets.
It's Tuesday, May 21st, at 10am in New York.
Okay, so yesterday we talked about all sorts of different parts of the macro environment. Disinflation, inflation, central bank policy, growth. But when you think about all of that -- that macro backdrop -- what does it mean to you for markets across the world?
Serena Tang: Right, I think the outlook laid out by your team of stable growth, disinflation, rate cuts. That is a great backdrop for risk assets, one of the reasons why we got overweight in global equities. Now, there will likely be low visibility and uncertainty beyond year end, and why we recommend investors should focus on the triple C's of cheap optionality, convexity, and carry.
That very benign backdrop suggests more bullish possibilities. Your team has noted several times now that the patterns we're seeing now and what we expect have parallels to what happened in the mid 1990s -- when the Fed cut in small increments, US growth was sustained at high levels, and the labor market was strong. And now I'm not suggesting that this is 1990s and we should party like it. But just that the last time we found ourselves in this kind of benign macro environment, risk assets -- actually most markets did really well.
Seth Carpenter: So, I will say the 1990s was a pretty good decade for me. However, you mentioned some uncertainty ahead, low visibility. We titled our macroeconomic outlook ‘Are we there yet?’ Because I agree, we do feel like we're on a path to something pretty good, but we're not out of the woods yet. So, when you say there's some low visibility about where asset markets are going, maybe beyond year end, what do you mean by that?
Serena Tang: I think there's less visibility going into 2025. And specifically, I'm talking about the US elections. When I think about the range of possible outcomes, all I can confidently say is that it's wide, which I think you can see reflected in our strategist's latest forecast. Most teams actually have relatively constructive forecast returns for their assets in the base case, but there's an unusually wide gap between their bull and bear cases for bond and equity markets.
Seth Carpenter: Let me narrow it down a little bit because equity markets have actually performed pretty well during the first half of the year. So what do you think is going to happen specifically with equities going forward? How should we be thinking about equity markets per se?
Serena Tang: Equities have rallied a lot, but we've actually gotten more bullish. I talked about the three Cs of cheap optionality, convexity, and carry earlier, and I think European and Japanese equities really tick these boxes. Both of these markets also have above average dividend yields, especially for a dollar-based FX hedge investor.
Serena Tang: Where we think there might be some underperformance is really in EM equities, but it's a bit nuanced. Our China equity strategy team thinks that consensus mid-teens earnings growth expectation for this year will still likely to disappoint given the Chinese growth forecast that you talked about yesterday.
Seth Carpenter: Alright, in that case. Let me flip over to fixed income. A lot of that is often driven by central banks. Around the world, you just mentioned EM equities may be struggling a little bit. A lot of EM central banks are either cutting a little bit ahead of the Fed, but being cautious, worrying about not getting too far ahead of the Fed. So, if that's what's going on with policy rates at the very front end of the curve, what's happening in fixed income more broadly?
Serena Tang: We generally see government bond yields lower over the forecast horizon for two reasons. On your team's forecast of central banks cutting rates and also in the US, an optical rise in the unemployment rate, our macro strategy team forecasts for the 10 year U.S. Treasury yields to fall to just above 4 per cent by the end of this year. And because government bond yields will be coming down, we also expect yields for spread products like agency MBS, investment grade, etc. to also come down. But I think for these spread products, returns can be positive beyond that duration piece.
Serena Tang: So, credit loves moderation, and I think the mild growth backdrop your team is forecasting for is exactly that. US fixed income more generally should also see renewed flows from Japanese investors as FX hedging costs come down over the next six months. All of this supports tighter than average spreads.
Seth Carpenter: Okay, so we talked about equities, we talked about fixed income. Big asset class that we haven't talked about yet are commodities. How bullish are you going into the summer? What do you think is going to go on and can that bullish view that you guys have last even longer?
Serena Tang: So for crude oil, our strategists see market tightness over the summer, which could drive Brent to about $90 per barrel. You have demand coming in stronger than expected, and of course OPEC has extended its production agreement.
But we also don't really expect prices to hold over the medium term. Non-OPEC supply should meet most of the global demand growth later this year and into 2025, which sort of leaves very little room for OPEC to unwind production cuts. We expect Brent to revert back steadily to its long-term anchor, which is probably somewhere around $80 per barrel.
Serena Tang: For copper, it’s actually our metal strategist's top pick right now, and it's very much driven by, I think, tightening supply and demand balance. You've had significant mine supply disruptions, but also better than expected demand and new drivers such as -- we've talked about AI a lot, data centers and increasing participation.
Serena Tang: And on gold, in our view, pricing is likely to remain pretty choppy as investors have to weigh inflation risk, incoming data, and the Fed path. But historically, that first rate cut tends to be a very positive catalyst for gold. And we see risks more skewed to our bull case at the moment.
Seth Carpenter: Okay, so talked about equities, talked about fixed income, talked about commodities. These are global markets, and often when investors are looking around the world and thinking about what it means for them, currencies come into it, and everybody's always going to be looking at the dollar. So why don't you run us through the Morgan Stanley view on where the US dollar is going to go over the rest of this year, and maybe over the next 12 months.
Serena Tang: The short answer is we see the dollar staying stronger for longer. Yes, we expect central banks to begin cutting this year. But the pace of cuts and ultimate destinations are likely to vary widely. Now another potential dollar tailwind is an increased risk premium being priced for the 2024 US elections. We think that investors may begin to price in material risks to dollar positive changes in US foreign and trade policy as the election approaches, which we assume will sort of begin ramping up in the third quarter.
Seth Carpenter: All right, let's step back from the details. I want you to bring us home now. Give me some strategy. So where should people lean in, where should we be looking for the best returns and where do we need to be super cautious?
Serena Tang: In our asset allocation recommendation, we recommend overweight in global equities, overweight in spread products, equal weight in commodities, and underweight in cash.
We really like European and Japanese equities on the back of pretty strong earnings revision, attractive relative valuations, and good carry for a dollar based investor. We like spread products. Not so much that our strategists are not expecting duration to do well. We are still expecting yields to come down.
Serena Tang: Where we are most cautious on, really, continues to be EM equities. From a very top down perspective, the outlook we have is constructive stable growth, continued disinflation, rate cuts. These make for a good environment for risk assets. But uncertainties beyond year end, that really argues for investors to look for assets which have those triple Cs, cheap optionality, convexity, and carry.
And we think Japanese and European equities and spread products within fixed income take those boxes.
Seth Carpenter: Alright, looking at the clock, I'm going to have to cut you off there. I could talk to you all day. Thank you for coming in and letting me turn the tables relative to yesterday when you were asking me all the questions.
Serena Tang: Great speaking with you, Seth. And yes, I know we can go on forever.
Seth Carpenter: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you get your podcasts. And share this episode with a friend or a colleague today.
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Our Global Chief Economist and Global Cross-Asset Strategist discuss the state of the global economy at the midpoint of 2024, including how the U.S. and Europe are on growth trajectories despite volatile economic data.
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Serena Tang: Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's chief global cross-asset strategist.
Seth Carpenter: And I’m Seth Carpenter. Morgan Stanley's global chief economist.
Serena Tang: And on this two-part episode of the podcast, we'll discuss Morgan Stanley's global mid-year outlook. Today we'll focus on economics, and tomorrow we'll turn our attention to strategy.
It's Monday, May 20th, at 10am in New York.
So, Seth, we've seen a lot of volatile economic data since you published your 2024 year ahead outlook last November. The US has gone through a few months of downside inflation and upside growth surprises, followed by renewed inflationary pressures; and in China, real growth surprise to the upside, but deflation deepened. In contrast, India and Japan, your two strongest conviction bullish views, have played out so far.
So, with all this in mind, Seth, what is your outlook for the global economy and its growth trajectory for the second half of this year and into 2025?
Seth Carpenter: So, we're pretty optimistic. We see some mild deceleration in the US relative to last year's particularly strong growth but not collapsing. And I think that part is really important. The euro area growth, all the signs that we've had since we wrote the outlook in November, updating now it says that growth is actually bottomed out there and we're starting to see the initial recovery. Now, don't get carried away. It's not that it's gonna be this massive rebound. But there should be now a bottoming out gradual growth as inflation keeps coming down. That means that real wage growth is actually going to get stronger, and we think consumption starts to lead the way.
China though, there we've surprised the upside but just an inflation adjusted growth because fiscal policy has been adding to capacity they're adding to the ability. And so, deflation has stayed. It's one of the longest and deepest deflationary episodes China has had. We think that's actually going to be exporting deflation to the rest of the world. But in terms of real growth, they're actually hanging in there around 5 per cent.
Serena Tang: I'm glad you kind of highlighted the difference between what we're expecting for the US and Europe and what we're expecting for China, because one of the themes that I think you touched on in this outlook is divergence that you see some slowing in the US -- even though it's very stable, while the rest of the world really is where growth starts to pick up.
So, what is driving this divergence? How persistent do you think it will be? And what does it mean for central bank policy?
Seth Carpenter: Let me start with Europe and the US, the way you framed it. Like I said, European growth is probably bottom. They had more adverse shocks than the US did. So, the energy shock -- that was particularly damaging to German manufacturing, really slowed the European economy down. Whereas in the US, we had a lot of strong growth last year. Last year we had growth in the US at just over three per cent. Non-trivial amount of that growth was enabled by the surge of immigration, but we still see some residual impetus from fiscal policy.
And so, where are we now? Inflation in the euro area is continuing to fall. In fact, it's clearer signal down than it has been, at least for the fourth quarter this year in the US. Growth is picking up, but not so much that it's going to re-spark inflation. So, we think the ECB is going to start to cut rates as soon as next month, as soon as the June meeting. Whereas for the US, we still have strong growth. Inflation sort of gave us that head fake in the first quarter, so the Fed's going to have to wait, we think probably until September.
Serena Tang: And on the point of inflation, can you actually give us a snapshot of where we are right now and what your projections from here will be? You know, you talked about disinflation in the US. What's gonna be driving that?
Seth Carpenter: I think the first thing to keep in mind is that just globally we see further disinflation and so the run up in inflation that was, by and large, a global phenomenon, we do see as abating. For the US specifically, though, I think there are a few parts that are really important and always the conversation has to deal with housing.
There, in the United States, we measure housing inflation through rents, and we know various things. One recent readings on rents in the market right now have actually been moving roughly sideways. The statistical agency, the Bureau of Labor Statistics, that creates the CPI, takes those market-based rents and then spreads it through an algorithm. And the official statistics reflect what's going on now over the next couple of quarters. So, for that reason alone, we think rent inflation, which is 40 per cent of core CPI, we think that keeps trending down over the rest of the year.
We see some deflation in consumer goods. That's especially in automobiles. The deflation that we see in China, that's probably being exported to the rest of the world, contributes a little bit more to that downward pressure. So, we feel pretty convicted that the high inflation that we saw in the first quarter was more noise than signal, and we get greater disinflation as the year goes on.
Serena Tang: So finally, I want to ask you about Japan specifically. It's the region where we're actually expecting rate hikes. Since it has gone through a structural shift recently, decades of deflation are now over, seems to be over. And so, what are your expectations there?
Seth Carpenter: I think it is a fundamental shift here. We did have decades of essentially zero nominal growth and that is now clearly, in the rear-view mirror. We see wage inflation; we see price inflation. When I talk to our colleagues in research in Tokyo who cover the consumer sector, the mindset has shifted, and consumers are willing to accept these higher inflation prints.
And so, in that regard, we do think very much we've shifted from that zero nominal growth, that sort of disinflationary-deflationary equilibrium, to one where inflation will be sustained above target. As a result, the Bank of Japan got rid of negative interest rate policy. And we think they're gonna hike into positive territory in July of this year. Probably again in the beginning of next year.
All, as long as we're right, that inflation is here to stay and that seems very much the case. Now, why only two rate hikes then as opposed to more if the world is fundamentally different? And this, I think, is critical. Governor Ueda, the BOJ, is committed to making sure that we have shifted to this reflationary environment. And so, I do think he's going to be cautious and only hike as much as he can be confident that inflation stays high for the foreseeable future.
Serena Tang: Seth, thanks so much for taking the time to talk.
Seth Carpenter: Serena, it's always great to talk to you.
Serena Tang: And thanks for listening. Please be sure to tune in for Part Two of this episode, where Seth and I will discuss our mid-year strategy outlook. If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.
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Our Head of Corporate Credit Research explains why the debt of high-rated EM countries is a viable alternative for investors looking for high yields with longer duration.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why – for buyers of investment grade bonds – we see better value in Emerging Markets.
It's Friday May 17th at 2pm in London.
This is a good backdrop for corporate credit. The asset class loves moderation and our forecasts at Morgan Stanley see a US soft landing with growth about 2 percent comfortably above recession, but also not so strong that we think we need further rate increases from the Federal Reserve. Corporate balance sheets are in good shape, especially in the financial sector and the demand for investment grade corporate bonds remains high – thanks to yields, which hover around five and a half percent.
For all these reasons, even though the additional yield that you currently get on corporate bonds, relative to say government bonds is low, we think that spread can remain around current levels, given this unusually favorable backdrop. But we're less confident about longer maturity bonds. Here, credit spreads are much more extreme, near their lowest levels than 20 years. So, what can investors do if they're looking to get some of the advantages of this macro backdrop but still access higher risk premiums.
For investors who are looking for high rated yield with longer duration, we see a better alternative: the debt of high rated countries in the Emerging Markets, or EM. Adjusting for rating, high grade Emerging Market debt currently trades at a discount to corporate bonds. That is for bonds of similar ratings, the spreads on EM debt are generally higher. And this is even more pronounced when we're looking at those longer dated borrowings; the bonds with the maturity over 10 years. In investment grade credit, you get paid relatively little incremental risk premium to lend to a company over 30 years, relative to lending it to 10. But that's not the case in Emerging Market sovereigns. There, these curves are steep. The incremental premium you get for lending at a longer maturity is much higher.
So, what's driving this difference? Well one has been relatively different flows between these different but related asset classes. Corporate bonds have been very popular with investors, enjoying strong inflows year to date. But Emerging Market bond funds have not, and have seen money come out. Relatively weaker flows may help explain why risk premiums in the EM debt market are higher.
Another reason is that the same EM investors who are often seeing outflows have been asked to buy an unusually large amount of EM bonds. Issuance from Emerging Market sovereigns has been unusually high year to date and unusually focused on longer dated debt. We think this may help explain why Emerging Market risk premiums are even higher for longer dated bonds.
The good news? Our EM strategy team thinks some of this issuance surge will moderate in the second half of the year. It's a good backdrop for high rated credit and this week's CPI number, which showed continued moderation. And inflation is further reinforcing the idea that the US can see a soft landing. The challenge is that – that good news has tightened spreads in the corporate market.
While we think those risk premiums can stay low, we currently see better relative value for investors, looking for yield and risk premium in high-rated EM sovereigns – especially for those looking at longer maturities.
Thanks for listening. Subscribe to Thoughts on the Market wherever you get your podcasts and leave us a review. We'd love to hear from you.
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Our research shows travelers are willing to spend more this summer than last. U.S. Thematic Strategist Michelle Weaver explains how this will impact the airline, cruise and lodging industries.
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Welcome to Thoughts on the Market. I’m Michelle Weaver, Morgan Stanley’s US Thematic Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the summer travel trends we’re expecting to see this year.
It’s Thursday, May 16th at 10am in New York.
With Memorial Day just around the corner, most of us are getting really excited about our summer vacation plans. We recently ran a survey, and our work shows that nearly 60 percent of US consumers are planning to travel this summer. This figure though skews significantly higher for upper income consumers. 75 percent of consumers making $75,000 to $150,000 are planning to travel and this figure rises to 78 percent for those who make more than $150,000.
And travel remains a key spending priority for higher-income consumers. They place travel as one of their top priorities when compared to other discretionary purchases. This picture reverses though when you look at lower-income consumers making less than $50,000 a year. Travel tends to be among their lowest priorities when they are thinking about their discretionary purchases.
What really matters for companies though is if consumers are going to spend more this year than they did last year. And consumers who are planning a vacation are inclined to spend more this year, with 49 percent expecting to spend more and 16 percent intending to spend less. So that yields a net plus-32 percent increase in spending intentions for summer travel.
And what does this mean for key players in the travel industry? For starters, let’s look at airlines, where demand no longer seems to be a market debate within the space. It’s remained very resilient so far in 2024, contrary to what many had feared when we were going into this year. Our Transportation Analyst also has a positive view of US Airlines, especially Premium carriers. And the reason: This category caters to high-end consumers who are more likely to fly regardless of the state of the economy. Since the pandemic, Premium air travel has been one of the fastest growing and likely most resilient parts of the US Airlines industry, with premium cabin outperforming the main cabin consistently.
And then what’s in store for cruise companies this summer? The outlook seems to be broadly positive, according to our analysts. The largest cruise operators source the majority of their guests from the US. And these companies provide leisure travel – as opposed to business travel – almost exclusively, so their revenues are closely tied to the health of the US consumer. Of the 60 percent of consumers who are planning to travel this summer, 6 percent are planning a cruise. That’s a little bit lower than pre-COVID, but cruise passengers tend to skew older and more affluent. So, they take more than one vacation frequently. This keeps the outlook broadly supportive for cruise companies.
Finally, let’s think about Gaming and Lodging. These are your hotels and casinos. Investor sentiment is generally cautious for this space, but our analyst believes the data is encouraging. Yes, there’s been a slowdown in demand, compounded by continued – but moderating – labor inflation. This has created margin pressure for companies with higher operating leverage but the data suggests that upscale and luxury operators are outpacing midscale and economy ones. In addition, the Las Vegas strip, which tends to skew higher end, has outpaced regional casinos. And even when you look within the Las Vegas strip, baccarat is outpacing slot demand and luxury properties are outpacing more affordable options.
So, all in all, the summer looks bright for travel operators, especially those who have more exposure to the high-end consumer.
Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Head of Fixed Income and Thematic Research explains that the Biden administration’s new tariffs on Chinese imports are narrower than those of 2018 and 2019, but still send a signal about the economic relationship between the US and China.
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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of newly announced tariffs by the United States.
It's Wednesday, May 15th at 10:30am in New York.
Yesterday, the Biden administration announced new tariffs on the import of certain goods from China. These include semiconductors, batteries, solar cells and critical minerals among other products. For investors, this might remind them of the tariff escalation in 2018 and 2019 that led to global economic concerns. But we’d caution investors not to arrive at similar conclusions from this latest action.
Consider that the scope of this action is far more muted than the tariffs actions from a few years ago. New tariffs will affect a projected $18 billion of imports, or only about 0.5 percent of all China’s exports. And as our chief Asia economist Chetan Ahya has explained in his recent work, the sectors in scope for this round are areas where China has substantial spare capacity. Said differently, the tariffs are narrowly scoped and appear to be targeted at areas where the US perceives specific risk of imbalanced trade and market conditions. That contrasts with tariffs on roughly $360 billion of imports from China in the 2018-2019 period – a much broader approach that was in part aimed at forcing broad trade concessions from China but carried greater economic consequences by crimping corporate’s capital spending globally as they re-evaluated their production strategies.
There is some signal for investors here though. While the scope of the Biden administration's efforts here are more narrow, it does signal something we’ve known for a few years now. There’s continuity across presidential administrations and across political parties in the US on the topic of the economic relationship with China. While each party has different tactics, there’s clear overlap in their goals, in particular on the idea that the US must continue taking steps to protect critical and emerging technologies in order to preserve its economic and national security.
This suggests that the laws of gravity won’t apply to US tariffs any time soon, regardless of the US election outcome. So, the rewiring of the global economy in the emerging multipolar world will continue, and investors can still focus on some key regional beneficiaries of this secular trend – namely Mexico, India, and Japan.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Retail Analyst discusses the key strategies that have propelled a select few companies in U.S. consumer retail amid a challenging demand backdrop.
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Welcome to Thoughts on the Market. I’m Simeon Gutman, Morgan Stanley’s Hardlines, Broadlines & Food Retail Analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss how some retail businesses are responding to daunting consumer challenges.
It’s Tuesday, May 14th at 10am in New York.
There have been dramatic shifts within the consumer sector over the past three years. During the pandemic, we all had to redirect our spending away from services, such as travel and leisure, to various goods, which we were able to purchase online and have delivered at home. Consumer packaged goods, for example, experienced two years of outsized growth during the pandemic. But since 2022, consumption has been declining across the value chain.
For some categories, this dynamic may not be a temporary, post-COVID phenomenon, but rather a continuation of a longer-standing secular trend that had started prior to the pandemic. For example, non-durable goods – such as clothing, footwear and food at home – were already losing wallet share pre-COVID. Grocery spend was losing to dining out, as consumers placed more value on convenience. And although some sectors experienced unprecedented pricing power between 2020 and 2023, they’re now seeing this pricing power decline as inflation moderates.
Against this backdrop, Consumer Packaged Goods companies and retailers are attempting to find new growth levers in the face of stagnating – or even declining – sales and decreasing pricing power. A select few companies in US consumer retail, automotive, communication services and IT hardware have been able to navigate the current consumer environment of slowing growth. We believe there’s a powerful lesson in the combination of strategies these successful outliers have deployed to reposition themselves in the face of tepid demand.
For example, these companies are shifting their value proposition by focusing on products in faster-growing markets. They are also exiting underperforming areas to optimize their core brand and product portfolios. They’re streamlining their internal operations by changing organizational structures, revamping their supply chains, and using AI to automate processes. All of this helps to reduce costs and enhance productivity. Successful retail companies are also looking to alternative revenue sources and profit pools to grow their businesses, focusing on higher growth areas within their industries. Discount retail is a prime example as it focuses on high margin digital media, which has the potential to lift operating profit margins for the entire sector. Furthermore, a shift to omni-channel has revolutionized Retail, by capturing greater consumer wallet share and reducing delivery costs. And finally, successful companies have prioritized free cash flow by divesting non-core assets in less profitable areas.
Businesses that have been able to deploy these strategies have been rewarded by the market. They have seen their average 12-month price to earnings multiples expand more than 35 percent over the past five years, meaning that the market's outlook for these companies is considerably better than it was previously. Several of these strategies have also led to stronger top-line growth and margin expansion, which our US equity strategists identify as the two major drivers of shareholder value across consumer staples and consumer discretionary.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our experts highlight their biggest takeaways from the International Monetary Fund’s recent meetings, including which markets around the globe are on an upward trajectory.
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Simon Waever: Welcome to Thoughts on the Market. I'm Simon Waever, Morgan Stanley's Global Head of Emerging Markets, Sovereign Credit and Latin America Fixed income strategy.
Neville Mandimika: And I'm Neville Mandimika from the Emerging Markets Credit Strategy team with a focus on Central and Eastern Europe, Middle East and Africa.
Simon Waever: And on this episode of Thoughts on the Market, we'll discuss what we believe investors should take away from the International Monetary Fund’s Spring Meetings in Washington, DC.
It's Monday, May 13th at 10am in New York.
Neville Mandimika: And it's 3 pm in London.
To give some context, every year, the Spring Meetings of the International Monetary Fund (IMF) and the World Bank provide a forum for country officials, private sector market participants and academics to discuss critical global economic issues. This time around, the meetings were held against a backdrop, as you might imagine, of rising geopolitical tensions, monetary policy pivots, and limited fiscal space.
Simon, we were both at the event, and I wanted to discuss what we took away from our own meetings, as well as discussions with other market participants. How would you describe the mood this time around compared to the annual meetings in October last year?
Simon Waever: So, I would say sentiment was cautiously optimistic. Of course, it did happen in the backdrop of inflation; the first quarter not being as well behaved as everyone had hoped for. So that really put the focus on central banks being more cautious in their easing paths, which is actually a point the IMF also made back in October.
But away from that, growth has held up better than expected. In the US for sure, but also more globally. So, I would say it could have been a lot worse.
Neville Mandimika: Was it just me or there was a particular focus on fiscals this time around? What did you make of this?
Simon Waever: No, there was for sure and interestingly it was focused on both developed economies and developing economies, which isn't usually the case. And I think it's clear that not only the IMF but also the markets are worried that we're still some distance away from stabilizing debt in most countries. And not only that but that it's going to be hard to close that gap due to lower growth and spending pressures. So that meant that there was a lot of discussions on how much term premier there needs to be in government bond curves and whether they need to be steeper.
Neville Mandimika: It's often very difficult to talk about, you know, the global economic dynamics without talking about AI, which seems to be the catchphrase this year. How is the fund viewing this in light of the potential for the global economy?
Simon Waever: So, the issue is that the IMF has often had to revise down medium-term growth outlook; something that it pretty much had to do every year since 2010, actually. And today it stands at only 2.8 globally. If you look at the IMF's publications, they attribute the key reasons to this to misallocation of capital and labor.
But what they also did this time around was look at what could turn it around; and maybe unsurprisingly structural reforms that reduces that misallocation would be the larger potential factor that could boost this up again. They estimate about around 1.2 per cent of GDP. But then to your point the adoption of AI is seen as another new driver.
Of course, it's also a lot more uncertain because there needs to be a lot of a lot more work done around it. But they think it could add nearly one percentage point to global growth in a positive scenario.
But Neville, with that, let's dig deeper into the issues of developing countries which, after all, is the focus of the meetings. The cost of debt is rising, which has led to some countries experience debt distress. But from our side, we've also frequently pushed back against the idea that there is a growing debt crisis. So, coming back from the meetings, what kind of debt restructuring progress has been made? And how do you see it playing out for the remainder of the year?
Neville Mandimika: Yeah, interestingly, there was still plenty of talk in the meetings about EM (emerging market) debt crisis, but the backdrop to the conversation was significantly better this time around compared to October 2023.
Since last year, we've seen progress from Suriname, which is a small part of the Emerging Market Bond Index, close its restructuring, Zambia reaching a deal with private bondholders with the expectation that all of this could be buttoned up by June this year, multiple proposals in Sri Lanka and Ukraine making some progress.
This gives me some hope that the number of sovereigns in default will be lower by the end of this year. And I think more importantly, we don't expect any country, any new country, to get into default -- as countries like Pakistan and Tunisia have made some progress in avoiding restructuring its own debt.
The other important thing that came out from my vantage point is that the Global Sovereign Debt Roundtable seems to be making some progress, particularly on outlining the structure of EM debt crises, which is, you know, emphasizing parallel negotiations between official and private creditors and, of course, timely sharing of information between stakeholders.
Simon Waever: Then another focus has been that the IMF has been making some concessions to try to increase financing for countries that need it. Do you think there was progress on this front?
Neville Mandimika: Yeah, it certainly seems so. You know, there seems to be some momentum on that front. You'd remember that last year, there was a resolution to increase the IMF's lending capacity by increasing country quotas by 50 per cent. Once this is buttoned up, heavy borrowers like Egypt and Argentina would greatly benefit, I think.
Until this is done, the fund extended its temporary higher access limits to allow countries to borrow more in the meantime. There was also increased dialogue on reducing surcharges, which is the additional interest payments the IMF imposes on borrowers. The reduction of these would greatly help the likes of Argentina and Ecuador. Unfortunately, not much concrete progress has been made on this front.
Simon Waever: And then finally, across all the meetings we held, which countries did you come away more positive on and which ones would still be of concern?
Neville Mandimika: Yeah, I certainly came out a lot more positive on Senegal, as fears of large policy changes like leaving the CFA franc were eased. Egypt was also another clear positive, given the commitment to reforms, despite large financing that was received earlier this year. Nigeria, there was also some momentum on this front as reforms is still very much front and center from the political authorities. And lastly, Turkey saw authorities affirming their commitment to fighting inflation and loosening the grip on the foreign exchange market.
And I'll throw the same question to you, Simon. Which countries are you positive on?
Simon Waever: Yeah, I mean, it was pretty hard to take away the excitement from Egypt, but I would say that Argentina is another country where people came away pretty positive. The imbalances are significant, but they're just making very good headway in unwinding them; and they have the support of the IMF to do so. Ecuador would be the other one where sentiment in general is positive. On the more cautious side, I would point towards those countries where fiscal deficits are heading in the wrong direction, which goes back to the worries about fiscals we spoke about earlier -- and Colombia is one such example.
But with that, let's wrap it up. Neville, thanks for taking the time to talk.
Neville Mandimika: Great speaking with you, Simon.
Simon Waever: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to the podcast. It helps more people find the show.
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Morgan Stanley’s Chief Latin America Strategist explains the importance of Mexico’s upcoming presidential election, laying out the possible investment implications of potential policy reforms.
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Welcome to Thoughts on the Market. I’m Nik Lippman, Morgan Stanley’s Chief Latin America Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll talk about why Mexico’s upcoming election matters for markets.
It's Friday, May 10, at 10am in Sao Paulo.
Voters in Mexico will choose a new president in less than a month, on June 2. The two leading candidates – Claudia Sheinbaum and Xóchitl Gálvez – have presented strong campaigns amidst a tense political backdrop. And yet, asset prices have not yet begun to react to potential election outcomes.
There’s significant policy differences between Sheinbaum and Galvez – thus an important investment debate around each of them. However, polls suggest a strong lead for Sheinbaum, who is the candidate from the ruling party Morena. In fact, it seems that the key debate that markets are focused on right now is not so much who wins, but rather what type of president Sheinbaum would be, if she does get elected.
If she does indeed win, the expectation is for policy continuity post-election—particularly as it relates to Mexico’s nearshoring – or moving industrial supply chains from Asia to North America. This trend has been a major driver of the country’s economy and major asset classes.
And so the market seems to be focusing squarely on policy decisions that may be taken by the incoming administration. Mexico is in a strong position to benefit from its relationship with the United States and as well as the nearshoring opportunities. We see a positive skew for both equities and credit, and think the election can act as a catalyst for assets that have traded cheaply.
Yet, significant reforms are necessary to take full advantage of this setup. Indeed, we would argue that rapid and deep structural reforms would be crucial, especially when it comes to fiscals and the energy space. For example, we think there could be a need for stronger partnership between the public and the private sector and a rethink of parts of Mexico’s electricity model. If Mexico solves its electricity supply-side challenges, it can build on its favorable nearshoring position. But on the other hand, there’s no industrial revolution without electricity.
However, the risk-reward for the Mexican peso is slightly different. It has already benefited from the rise in foreign investment - and the high interest rate differential between Mexico and the United States.
With all that said, there are risks from the elections, too. If any political party wins two-thirds majority, it opens the possibility for changes to the constitution. And current proposals by Mexico’s sitting president could open the door for larger fiscal deficits; and potentially some more unorthodox policies down the road. We will continue to keep you posted on Mexico’s election outcomes.
Thank you for listening. If you enjoy Thoughts on the Market, take a moment to rate and review us wherever you listen. It helps more people find the show.
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