Thoughts on the Market

Midterm elections, backlash against data centers and a U.S.-China summit. Michael Zezas and Ariana Salvatore discuss themes that could test investor confidence in the coming months.
Read more insights from Morgan Stanley.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Deputy Global Head of Research for Morgan Stanley.
Ariana Salvatore: And I'm Ariana Salvatore, Head of Public Policy Research.
Michael Zezas: Today, we'll look ahead to public policy catalysts that matter for investors this fall.
It's Wednesday, September 2nd at 10:30am in New York.
Okay, Ariana, there's a few days left in the summer, and investors are already starting to think about what's going to happen this fall. And there's a pretty heavy calendar; everything from midterm elections to some pretty important diplomatic dates. High level, what do you think people need to focus on?
Ariana Salvatore: So, I'll start with probably the most consequential catalyst of the list that you mentioned, and that's the midterm elections. Obviously, not until November 3rd, but the debate is going to start to emerge over the coming weeks – in terms of if Democrats were to win just one chamber versus both chambers; if Republicans were to keep control; what could that mean for markets? And what are the durable policy themes?
I think in this context, the biggest debate far and away is on data center pushback. And this has transitioned from more of a macro thematic. So, investors trying to understand the potential implications for the CapEx build-out, to more of a micro really granular question, right? Which races are the ones that we need to watch? Where are there states or jurisdictions that projects that are pending could be possibly called into question?
And that's, sort of, the continuous debate that I've had recently with investors, trying to pinpoint it more precisely to figure out where exactly the build-up could be impacted.
Michael Zezas: So, I hear from investors this general concern that the midterm elections will reveal that it's become a consensus preference amongst American voters and members of both parties to slow down on data center spending. Or perhaps even stop it or something more severe like that.
What type of midterm election outcome would point to that as a possibility?
Ariana Salvatore: Well, I would start by saying the politics here are scrambled in the sense that there's no clear fault lines when it comes to Democrats or Republicans around data center opposition, right? We are seeing some pretty notable pivots even from lawmakers that in the past were supportive of data centers. So that's why I think we have to zoom into these really specific races.
And there I would say there's some governorships that matter actually more than some of the Senate races; because remember, governors also in certain states can appoint public utility commissioners. And in places like Texas, that actually could be a really consequential outcome for the 2026 midterm elections, more so than who ends up sitting in Congress on a very federal level.
Michael Zezas: Okay. And so, would you say it's fair then that folks running for office who are challenging incumbents in both parties, who are expressing a desire for more regulation on data centers, that it kind of cuts across both parties? So, this is more about folks challenging incumbents than it is about one party or the other having a specific view on AI and the AI industrial build-out via data centers?
Ariana Salvatore: That's right. It's hard to sort into these really generic party umbrellas, and there are a few nuances under the surface. If you look at something like Ohio. The governor's race there, both the Republican and Democrat candidates are proposing a conditional build-out, basically. So, if certain projects meet criteria, they're going to be allowed to proceed.
In other races, like in Texas and Pennsylvania governorships, you're seeing the opponents basically propose a more restrictive form of the pause or directive that's already in place. So, I would say it's not very clean in terms of Democrat or Republican-led. And that just gives us conviction that this is going to persist and remain an issue even after November. Even though the federal policy incentives we don't think are likely going to change.
Michael Zezas: So, we could see investors taking a signal about the AI data center build-out from an outcome where incumbents don't do particularly well.
Now, I know we're still doing work on this, but what's the current thinking about – even if we were to see a result like that, how much should investors be concerned that the expectations around spending on data centers might not be realized because of new policy, other regulatory changes that would come as a result of the midterms?
Ariana Salvatore: So, I would say overall, we are still very constructive on AI CapEx, right? So, our internet team is still forecasting over a trillion dollars of spending for the hyperscalers next year, and there are a few reasons for that, one of which has to do with this AI sovereignty theme that we've been writing about.
So, this notion that governments are increasingly wanting to control their own stack and their own AI capabilities, so that's driving a bit of the spend. On the other hand, we are starting to see mitigation measures from some of these companies to appease some of that local community backlash. And there we don't see a one-size-fits-all approach.
We see very tailored solutions depending on what the source of the pushback is. Just to give a few examples. When you have communities that care about electricity price increases, for example, many hyperscalers have signed on to the Ratepayer Protection Pledge. When you have communities that care about the environmental impact, you've got companies like Google who said they want to put forward a regulatory framework for water usage; Amazon also disclosing their water usage in data centers.
And so, like I said, there's not really a uniformity to these responses, but enough that we think will mitigate the concern and still leaves us constructive on the overall build-out.
Michael Zezas: Right. And you actually bring up a really interesting point on the idea of AI sovereignty. Some of the kind of similar concerns that are driving voter anxiety around the build-out of AI, might also reinforce some of the spending that has to happen there. To the extent that voters and policymakers are concerned that AI should be controlled and aligned with American values would require some spending to make sure that there's sufficient supply chains and other variables in play that the U.S. is in control of.
Is that fair?
Ariana Salvatore: That's right. That's one of the clear policy consequences we see from this shift in sovereign AI and governments seeking that control. The other one is, of course, the potential for further tech restrictions and divergence between the U.S. and China on AI specifically.
Michael Zezas: So, on the topic of China and the U.S., one date that you point out here is September 24th, a date when the U.S. and China are going to be meeting again. What's on the table for discussion? What do investors need to know? Obviously, there have been concerns over the past year about the level of tariffs and trade tensions between the two.
Is there anything here that we need to pay specific attention to?
Ariana Salvatore: So, we think the overarching goal for both sides is to maintain this managed stability that was established in the May summit too. At that point, the clear deliverables were around trade, right? So agricultural purchases, Boeing purchases, et cetera.
We think there's likely some small incremental change to those deliverables, in particular when it comes to AI dialogue. But notably, we think there's potential for escalation into that summit, again, within the bounds of what we call tactical escalation. But we do think that there's plenty of room for more policy escalation between both the U.S. and China in line with some recent action that we've seen over the past few weeks.
Michael Zezas: Got it. And there's also a couple of important considerations around fiscal policy, funding, the National Defense Authorization Act (NDAA). Can you talk us through that a bit?
Ariana Salvatore: Yeah, so fiscal's been in the headlines recently as well, just given the Treasury buybacks and crossing that $40 trillion threshold. And I think in that context, it sort of puts a renewed spotlight on government funding.
There we see a potential latent risk of another shutdown come December, right? So, we saw a continuing resolution pass both the House and the Senate and sort of punt that debate until after the elections.
And then the NDAA is the annual bill that funds the Pentagon. It has to be done in December on a bipartisan basis. So, the elections have the potential to shift the incentive structure for some lawmakers, and we could see these, kind of, re-emerge as really big debates towards the end of the year.
Michael Zezas: Now, interestingly enough, we've got a bunch of catalysts to pay attention to: midterms, the potential for data center pushback as a consequence of it, a U.S.-China summit, which we think is going to result in the continuation of managed stability, and fiscal catalysts where, you know, the debt and the deficit have been in scope and concern, particularly for equity investors. All of that is happening against a backdrop where the historical norm going into midterm elections – is one where the equity market tends to struggle a bit. Is that fair?
Ariana Salvatore: Yeah. So, we tend to see a little bit of negative seasonality into the midterm elections, and our equity strategy team has pointed out the potential for a knee-jerk reaction if you were to see Democratic outperformance in November. We think that's not likely to be durable. We think it's more so the case that investors are going to pull forward the anticipation of Democrats doing well in the 2028 presidential election.
We don't think that's going to be a long-lasting theme in the market, but it's typically in line with what we see during elections.
Michael Zezas: So, this idea that there are going to be seasonal challenges to the equity market is important to take on board, particularly when there are a lot of policy narratives which in the investor's mind could reinforce the price action that comes with weak seasonality.
But our view is that you need to keep your eye on the secular trends here underpinning economic growth, including the AI build-out, which we think at the moment is going to be less sensitive to some of these policy outcomes than it might seem – given strong campaign rhetoric around restricting data centers.
Is that a fair statement?
Ariana Salvatore: Yes, that's right.
Michael Zezas: Great. Well, Ariana, thanks for taking the time to talk.
Ariana Salvatore: Pleasure speaking with you, Mike.
Michael Zezas: And thanks for listening. Ariana, what should our audience do next?
Ariana Salvatore: If you enjoyed the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

As AI agents gain access to sensitive enterprise systems, companies need new ways to control what they can do. Meta Marshall breaks down the emerging market for agentic identity security.
Read more insights from Morgan Stanley.

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Meta Marshall: Welcome to Thoughts on the Market. I’m Meta Marshall, Morgan Stanley’s U.S. Cybersecurity and Telecom & Network Equipment analyst.
Today: AI assistants are starting to act on our behalf at work, which brings up a critical question. What should these agents be allowed to do? And how should those permissions be granted?
It’s Tuesday, September 1st, at 10am in New York.
More and more, AI is helping us get through the workday. We ask it to summarize documents, analyze data and take notes during meetings. Increasingly, though, these tools are moving beyond just answering questions to acting on our behalf.
Suddenly, the security challenge shifts from managing a tool to governing a whole new digital workforce. In coming years, this problem should get bigger as we estimate seeing 79 AI agents and 109 machine identities for every human employee.
Now, traditional identity security at work was built to answer two basic questions: Who are you, and what can you access? Think of it as your office badge. It identifies you and determines what doors you can open.
AI agents, however, make that question much harder to answer. They can operate autonomously, move across applications and databases, collaborate with other agents. They take actions without direct human involvement.
So, companies need to know not only what an agent can access, but why it needs access, for how long, and what it actually did. That’s the core foundation of agentic identity solutions.
The risk environment from this problem is already substantial. About 80 percent of breaches in the work environment today involve stolen or misused credentials. Nine out of 10 organizations experienced an identity-related breach in the past year, and 83 percent experienced at least two. Now add potentially hundreds of machine and AI identities for every human; each operating continuously and at machine speed – and the problem is much larger.
One solution to managing AI agents is zero standing privilege.
Instead of giving an agent permanent access, you give it permission for a specific task and revoke that permission when the job is done. Here’s the issue though: Today, only 39 percent of privileged access is managed through this just-in-time or zero standing privilege architecture. And the reality is that humans can’t approve every request. More of those decisions will need to happen automatically, in real time, through what’s known as runtime governance.
We estimate, as a result, that agentic identity alone could become roughly a $33 billion global opportunity in our base case, which brings the overall identity market opportunity to more than $60 billion in coming years.
This need for agentic identity coming from AI could also push a historically fragmented industry towards a more unified platform. In one industry survey, 85 percent of organizations said fragmented identity systems delay their human response to identity threats, with respondents citing an average of 12 hours needed to respond per incident. We think that favors platforms that can manage human and machine identities together and make security decisions dynamically, overall making a more secure environment.
This transition won’t happen overnight. Agentic identity products are still early, and we don’t expect an immediate financial impact. But as enterprises move from experimenting with AI agents to deploying them more broadly, spending to secure those agents could become a more meaningful growth tailwind in 2027.
The longer-term growth opportunity comes down to a simple dynamic: more agents, with more autonomy, will require more control. And that could make identity security essential to scaling AI across the enterprise.
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.

Younger generations are reshaping caffeine consumption. Our U.S. Household Products and Beverage Analyst Dara Mohsenian discusses how the growing appetite for energy drinks could influence beverage habits for years to come.
Read more insights from Morgan Stanley.

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Dara Mohsenian: Welcome to Thoughts on the Market. I'm Dara Mohsenian, Morgan Stanley's U.S. Household Products and Beverage Analyst.
Today, we're going to talk about how the next generation of U.S. consumers is really redefining their daily caffeine boost.
It's Monday, August 31st at 10am in New York.
For generations of Americans, caffeine has been synonymous with coffee. You wake up, make a pot, or stop at a coffee shop and start your day.
But the picture today is different. Younger consumers have grown up with many more choices to jumpstart their day. Walk into a convenience store, gym, or college library these days, and you'll see that energy drinks are increasingly becoming an alternative for getting their caffeine boost.
The reason people are drinking more of these caffeinated beverages is pretty straightforward. They want more energy. Among consumers who increased their energy drink consumption over the prior three months, 61 percent said they needed more energy.
Experimentation is important, too. 44 percent cited trying new flavors, and 37 percent said they were trying new brands.
Our survey of roughly 3,000 U.S. consumers points to significant runway for energy drinks going forward. When we spoke to current energy drink consumers, a net positive 19 percent expected to increase their consumption over the next three months. That's well above our prior surveys and is true for both men and women.
Perhaps more interesting is who expects to drink more. Demographics have always been a key driver of energy consumption. The younger generation is increasingly choosing energy drinks over, historically, coffee and carbonated soft drinks. In our survey, importantly, if you look at the 25- to 34-year-old and 35- to 44-year-old age groups, they actually showed the strongest forward intentions to increase consumption. This means that the consumers who embrace energy drinks at the very young ages don't appear to be aging out of the category as they become older. They're taking the habit with them, essentially.
It's also important to point out that caffeinated drinks is not a zero-sum game. Yes, the generational preferences are shifting, but the total pie is really growing here. Energy drinks is the biggest share gainer within caffeinated drinks, but only 20 percent of incremental energy drink consumption in our survey came directly from switching from coffee, and 22 percent directly from switching from carbonated soft drinks. So, most of the demand is actually incremental to caffeinated drinks in general.
Going forward, we do expect energy drinks to be the highest growth segment within caffeinated drinks, growing at a high single-digit rate. We're even seeing it replace areas such as alcohol and snacks as it's moved to that affordable indulgence. And that's particularly driven by GLP-1, also accentuating the need for caffeine for consumers who are losing weight and have less energy.
So, we see robust high single-digit energy category growth as likely to continue. That's been the compound rate, 9 percent over the last 15 years. Going forward with the demand drivers we talked about in a rational pricing environment, we see that likely to sustain.
And much of the energy top-line momentum has been supported by new products and innovations. That includes zero sugar drinks. They're perceived as better for you. They're attracting new consumers, particularly women. And also, older consumers are sticking with the products as they age.
Energy drinks have also become more affordable versus other beverage categories, particularly beverages, where the price increases have been sharper. Convenience is another part of the appeal. Among consumers who recently switched from coffee to energy drinks, 57 percent cited more caffeine per beverage and 45 percent pointed to convenience. Nearly half preferred the flavor of energy drinks, while 45 percent cited greater flavor variety.
There may also be room for energy drinks to show up in more places. In our survey, 47 percent of consumers said they would buy more energy drinks if they were available in vending machines, 46 percent in fast food and fast casual restaurants, 37 percent in coffee shops, and this is showing up in custom energy drinks at a lot of the coffee shops covered by my colleague Brian Harbor. Again, it's expanding the pie. It's not just about taking share from carbonated soft drinks or coffee.
So, America's caffeine habit is really enduring, and it's expanding. Younger consumers, they have more flavors, more formats, more ways to fit caffeine into different parts of the day, and those caffeinated preferences don't appear to be tapering off as consumers age.
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.

Our Head of U.S. Public Policy Research Ariana Salvatore looks at what the midterms may reveal about politician’s appetite for tackling the faster-than-expected increase in the U.S. debt.
Read more insights from Morgan Stanley.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley.
Today, why fiscal is back in focus and what we can learn about the broader debt trajectory from the upcoming midterm elections.
It's Friday, August 28th at 10am in New York.
Fiscal policy has moved back onto investors' radars following Treasury's recent buyback announcements. Those came in the same week that total U.S. debt crossed $ 40 trillion for the first time, a milestone that arrived months earlier than most people expected.
As my colleague Andrew Sheets puts it, that's a big number. But the more useful question isn't the number itself. It's whether all this debt is starting to act as a brake on the economy.
We don't quite yet see a credibility problem in the Treasury market, but that's exactly why fiscal is back in the conversation. And it sits against a bigger backdrop.
The U.S. continues to run large deficits in an economy that isn't in a recession. Our economists expect the deficit to stay around 6 percent of GDP through 2027. And voters are clearly concerned about elevated debt levels.
So why isn't fiscal austerity coming up more in DC? Simply put, we think the political incentives point the other direction.
At the risk of oversimplifying, fiscal consolidation or deficit reduction means either less spending or more taxes. And the political costs of those choices land immediately. We think neither party, therefore, has the incentive to take on that type of policy change – if we don't see a meaningful cliff or a risk to existing programs, especially into an election.
But what about after? We think the midterms won't in and of themselves be a catalyst to fix the debt trajectory. But they can tell us something about where this goes next. And I'd point to two things in particular.
The first is Social Security. It's not likely to be the headline issue in November, but we could see a useful test case for the debt conversation more broadly because the deadline is creeping closer.
The latest trustees report projects the retirement trust fund will become insolvent in the fourth quarter of 2032. And at that point, it could only cover roughly 78 percent of scheduled benefits without a change in law. Now, that's likely to matter more in 2028 than in this cycle, since whoever wins the White House that year will be in office when it hits.
But the midterms can still show us where the politics are consolidating. Recent polling points to a fairly consistent pattern. Voters want lawmakers to act. They prefer raising taxes on high earners over broader benefit cuts. And they're notably more open to trimming benefits when it's targeted at the top of the income distribution.
That likely explains why a number of 2026 candidates have converged on lifting the payroll tax cap, while some Republicans have largely retreated from campaigning on things like a higher retirement age.
Watching which of those messages actually wins, especially in Senate races like New Hampshire or Maine, where a significant share of the electorate depends on these benefits, could provide some useful hints with respect to which of these policy changes actually resonate with voters and end up reflecting the eventual fix.
The second is the broader fiscal landscape after the election. If we get a divided government in November, that typically means more fiscal noise around the recurring deadlines, like government funding and the debt ceiling. Those two matter for markets in very different ways. A shutdown's bigger effect tends to be indirect. So, think delayed or lower quality government data since agencies can end up working from smaller survey samples.
That leaves investors and the Fed making decisions with less complete information for weeks at a stretch sometimes. The debt ceiling is more direct. That shows up most clearly in the Treasury bill market. Bills maturing around a potential deadline tend to cheapen relative to other short-term benchmarks as investors have to price default risk into that narrow window. And that's the case even when a resolution is still the base case.
So, here's the through line: fiscal likely isn't about to become Washington's top priority just because debt crossed $40 trillion. But the midterms are a chance to see whether the political incentives are starting to shift – on Social Security specifically, and on the broader appetite for political fights around funding deadlines more generally.
Either way, we think fiscal policy is set to stay in the headlines in the years to come. And especially so as we head into the 2028 presidential election season.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen. And share your Thoughts on the Market with a friend or colleague today.

Investors are keeping a close eye on Jackson Hole for signals on the economic outlook and the path for rates. Our Chief U.S. economist Michael Gapen joins Global Head of Macro Strategy Matthew Hornbach to discuss whether markets get what they want—or what the Fed needs.
Read more insights from Morgan Stanley.

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Matt Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy at Morgan Stanley.
Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist.
Matt Hornbach: Today, we'll be discussing the Jackson Hole Economic Symposium and Chairman Warsh's opening remarks.
It's Thursday, August 27th at 10am in New York.
So, Mike, let's get right into it and talk about the upcoming opening remarks by Chairman Warsh at the Jackson Hole Economic Symposium that will be delivered to the public at 10 am tomorrow, Friday. How are you thinking about what to expect from those opening remarks?
Michael Gapen: Well, historically, and by historically, I mean in a post-2008-2009 world, Jackson Hole has been used, not every year, but frequently as a venue to communicate to markets. The longest gap on the Fed's meeting calendar is between the July and September meetings. So, Jackson Hole falls between that and provides a useful opportunity to communicate what might be coming.
That's what's normally been done. Warsh has repeatedly stated he wants the Fed to talk less and communicate less and say less. So, I don't think we will see or hear, in this case, a lot about his views about how the economy is operating today and how monetary policy may be conducted into year-end. So, I don't think we'll hear a lot about, say, the December; the outlook for the economy from September to December, and what it might imply for interest rate policy or balance sheet policy.
So, little in the way of near-term forward guidance.
I do think, however, he did say in the July press conference that the venue would be good to tackle some of these big questions that he has talked about, that he's created these task forces for. So, whether it is the balance sheet or the inflation framework, or communication or AI and productivity or data quality and so forth. This would provide, I think, a reasonable opportunity for him to start talking about that.
I don't think maybe we'll get a lot of conclusions. But I would look for commentary that's more in the question; or in the spirit of those big questions and less about the near-term conduct of policy.
So maybe not what markets want, but this is what markets will get.
Matt Hornbach: Just rewinding a bit, the conference itself is on a somewhat of a niche topic. What exactly is the conference about? And, in terms of the papers that get released at the conference, do you have any sense as to where they might be headed?
Michael Gapen: So, the topic of this conference, the economic symposium, as you noted, is Financial Innovation: [its] Implications for [the] Payments [system] and [monetary] Policy.
So, I would expect there to be a lot of sessions for things like central bank digital currencies or stable coins or Bitcoins. Near money type innovation that has happened in recent years, which leads to things like competition for deposits from the non-financial sector vis-a-vis the financial sector.
So, a competition of near moneyness to money, if you will. Its implications for the interaction between the non-financial system and the financial system, competition for deposits. Does it create risks around financial disintermediation? And therefore, how might the regulatory environment and monetary policy work in that world?
So little more, I'll call it, esoteric and maybe arm's length from the day-to-day conduct of policy. But I would look at the speeches probably in that vein. Deposit competition, financial market stability, and what kind of regulatory framework might you need to ensure we can still conduct policy effectively in that world.
Matt Hornbach: Sounds like an exciting set of papers…
Michael Gapen: Yes. Yes.
Matt Hornbach: … for professors to read through.
Michael Gapen: This is why they don't often leak the schedule too far in advance, right? We all might decide not to listen.
Matt Hornbach: Indeed. Well, it is the end of August, and people are probably still on holiday here and there…
Michael Gapen: I'm doing my best, but you called me in today.
Matt Hornbach: Yeah, the least I could do. So, you did mention that this might be an opportunity for Chairman Warsh to maybe spotlight a bit these task forces and the topics that they're tackling, one of which is the inflation framework.
And that word framework, I think, is important because the investors that we've been speaking with are frustrated that the Fed has not really laid out a framework – for monetary policymaking in this new era of Chairman Warsh, and his leadership at the Fed.
So, I'm curious, if we're not going to get forward guidance on monetary policy and what will happen at the next meeting. And we're also not going to get much forward guidance on the framework that the Fed is using to decide on what to do with short-term interest rates. What are we meant to think about the framework?
Michael Gapen: Yeah, I think ultimately, of course, we're going to need to know this, and this is what economists would refer to as the ‘difference between forward guidance and the "reaction function." So, the framework is really, you've got a set of tools, how do you intend to use them to achieve your objectives?
A conventional Fed would say, "Well, if interest rates are low and inflation's too high, then we should raise rates," right? So high inflation brings high interest rates, low inflation brings low interest rates. All else equal, there's still the employment side of the mandate, of course. And the market had that view, at least initially, right?
As we were in the June-July period and Warsh was talking hawkishly, the curve generally flattened. Expectations for front-end yields moved higher, and inflation-fighting credibility maybe kept the back end stable or brought the back end down. So, you could argue the markets looked at Warsh as maybe bringing a conventional reaction function and a conventional framework.
But in the June and July FOMC meeting and in conversations with the press during the press conferences, Warsh – I don't want to say backtracked. He just didn't validate that and did say that we will achieve price stability. Didn't quite say how he would use the tools to do that. And even suggested maybe interest rates weren't the primary mechanism with which to influence, create, deliver price stability.
So, the curve then steepened out. So, I think the market is wondering what Fed chair we have and what his reaction function is? And if inflation's running hot, is it an interest rate answer or is it a balance sheet answer?
I'd also just add one last thing, Matt, is it makes a difference what the rest of the 18 people on the FOMC think. [Be]cause I think you would agree, and I'll put forward right now, I think they have a largely conventional view. Half of the committee thought it was time to raise rates in June. So, we have a balance between not knowing the chair's framework and having to intuit it. Or hope that we hear more. But then also knowing the other 18 who could band together and have greater voting power act in a largely conventional framework.
I think that's the debate and the dilemma that we're all dealing with.
Matt Hornbach: Yeah, I think investors, have certainly expressed frustration about the lack of guidance in any form or fashion. Perhaps with the exception of the balance sheet; we have a general idea that the balance sheet will be smaller in the future.
And we have a sense from what Chairman Warsh has said in front of the House of Representatives during his semi-annual testimony that any changes would happen gradually over time. But, in terms of the pricing of the July meeting, and what happened at the July meeting, investors were very disappointed that the Fed did not go ahead and raise rates in July.
Now, the market was only assigning about a one in three odds of a rate hike in July. And so, the fact that the Fed did not go ahead and raise interest rates in July was not a surprise in the sense of market pricing. But I do sense that investors were frustrated; that because they didn't get much forward guidance going into the July meeting, that the market might not have priced more probability on a July rate hike because the Fed, in fact, did not signal that they were leaning in that direction.
But I see it as somewhat ironic because it seems to me, and I'd like to get your view on this. It seems to me that Chairman Warsh doesn't want to provide that type of specificity. He'd rather have the markets tell him what to do at an upcoming meeting, as opposed to him telling markets what to do at an upcoming meeting.
How do you think about that?
Michael Gapen: Oh, I think it's… [It] strains credibility to think that by saying nothing, you get the market's interpretation of the economy, data, and events – without the market thinking what the Fed thinks about it. I don't think that there's a world where you get the unvarnished market expectation independent of the Fed.
So, I don't personally agree in the analogy of the market should play the ball and not the referee. The Fed is not a referee in markets. The Fed is a player in markets. Monetary policy acts through financial markets to achieve a set of financial conditions to deliver price stability and maximum employment.
So, the Fed and markets are on the field at the same time. The Fed, in some ways, is the 800-pound gorilla on the field at the same time. So, everybody else on the field has to know what the gorilla is doing in order to do what they're supposed to do.
Yes, there's always some circularity between Fed communication and market reaction to that. But I think that's natural and normal and important in making monetary policy effective – meaning it has to transmit through financial markets.
And so, you could diminish the effectiveness of monetary policy if you don't tell the market what, at least what your framework is and what your reaction function is. And the tools that you intend to use and how you would intend to use them. Then the market could be an inefficient transmitter of monetary policy.
So, I disagree with the notion that by saying less, the Fed learns more. But that's my view. I'm one of many. That's my opinion. The chair obviously has a different view.
Matt Hornbach: Well, I can certainly understand not wanting to be the referee, especially after what we saw at the World Cup. There were a couple of games where the referee…
Michael Gapen: And nobody likes the referee. At least half the people are upset with the referee.
Matt Hornbach: Indeed. Okay. So, Mike, I think we're going to leave it there.
Michael Gapen: Thanks for having me on, Matt.
Matt Hornbach: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.