Thoughts on the Market

Our Global Head of Macro Strategy Matthew Hornbach and Chief U.S. Economist Michael Gapen look at what could speed up tightening, what’s next for Treasury yields, and how the Fed can skip a hike now while signaling that more are coming.
Read more insights from Morgan Stanley.

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Matthew 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.
Matthew Hornbach: Today, the challenge facing the Fed: to not hike rates while still convincing investors that you think rate hikes are coming.
It's Tuesday, October 27th at 11am in New York.
So Mike, how do you think the Fed and Chairman Warsh in particular is going to deal with this challenge?
Michael Gapen: Well, I think the way that he can do it is to say, ‘Obviously we already did hike. So, we've started a process. You know we're serious about bringing inflation down in a timelier fashion. So essentially the question is: Do we want to raise rates at every meeting or do we want to take an action, assess incoming data and take a different action?’
So I do think the message here can be balanced in a way that says, ‘We didn't hike rates today. We didn't feel a tremendous sense of urgency to raise rates today. But we think more work is needed.’
So I'm not sure that there's urgency to raise rates every meeting. But you can still suggest that rates are going to go higher.
You can see I'm having trouble articulating the story as well. Warsh may have some of the same difficulty, but I think that's the basic message is – taking an action, assessing its effect, deciding to take another action.
Matthew Hornbach: At the Jackson Hole Symposium in August, Chairman Warsh gave a speech, and in the speech, he invoked this imagery of going on a hike around the mountains of Jackson Hole.
And he told us that there were, in essence, two types of hikes that one could go on around Jackson Hole. A more leisurely hike and a more aggressive hike around the mountains. Presumably because we don't think the Fed will hike rates at this meeting. Presumably the idea that he has in his head today is to go on a leisurely hike.
But if that's the case, how long does a leisurely hike last? How…
Michael Gapen: They can both be the same.
Matthew Hornbach: … long will the hike be.
Michael Gapen: Yes. So I think that I would interpret the leisurely hike also as the difference between, I think, what economists euphemistically call a recalibration of the policy stance – as opposed to a more aggressive tightening cycle.
So one's kind of leaning against the wind while the other one is trying to change the course of the economy. So I think you're right. And he called the leisurely hike the Ben Bernanke hike and as opposed to the Don Kohn aggressive hike. That's inside Fed speak if you know your former Fed staff.
And I think what the data is telling the Fed, on one hand growth is certainly resilient, and inflation is sticky. But the labor market doesn't look like it's overheating. We're only adding about 50,000 jobs a month. The unemployment rate is low, that's true. But wage growth is actually decelerating.
So from my perspective, and I think their perspective, even with the AI investment boom, there's not a lot of evidence the broader economy is overheating. And that's where I think the urgency story fits in. Are they behind? Do they need to get on top of something?
I think the answer to that is no. So you end up with this measured recalibration: Hey, we cut 75 basis points last year to support the labor market, should probably reverse those. That's what we should be thinking. We're not thinking we need to go all the way back to 2023 highs, which would be the more aggressive tightening cycle.
That's the way I split it out.
Matthew Hornbach: So what would have to happen with the weather in Jackson Hole to change the mind of the committee to go on a more aggressive hike? Maybe to get back into the lodge before the weather really turns inclement? What would have to happen in the economic data, do you think, to change their mind?
Michael Gapen: Well, I think that the most likely story there. I mean, what macro data would make them do that sooner than later would just be inflation has a lot more momentum than they think. Rather than being flat or decelerating slowly, it actually starts to firm.
So, the actual data that they have in hand, they wouldn't even have to decide where it's coming from. But if inflation's firming, they have to get on top of it. That could certainly shift them to hikes every meeting. So, I'll put that down as the most likely.
The other would be just what I said about the labor market. You would need evidence that says, "Wow, look at that labor market. Employment growth is picking up, the unemployment rate's moving lower, and wage growth is turning and starting to firm."
So that would tell you what was kind of a narrow business spending story is now a broad-based overheating story. That's likely to be a much-more-slower-moving train. But certainly that could get the Fed to more rate hikes in 2027 than we're thinking.
Matthew Hornbach: On the inflation point that you're raising here. One of the statistical quirks in how the Bureau of Labor Statistics and the Bureau of Economic Analysis put together the inflation data is that in the first month or two of the year, you typically have seen the seasonally adjusted inflation data come in much stronger. And then in the final couple of months of the year, you've tended to see inflation data come in lower than what you might otherwise expect – because these statistical agencies have had difficulty properly seasonally adjusting the data.
So presumably, because this has been going on for a couple of decades, we'll see this “residual seasonality" again in 2027. Of course, we may not. But if we do, how do you think the Fed will deal with that? Because that could very well show us that inflation is picking back up…
Michael Gapen: That residual seasonality, you're correct, it's still present in the data. There are many firms in different industries that raise their prices once a year. It varies over time. That's why the seasonal adjustment process doesn't capture it.
So we get big, kind of, one-off annual increases in January and February. The Fed knows this, you know this, I know this. But the point is to decide either to stop raising rates, or maybe even at some point to cut rates, you have to ascertain where the underlying trend is. So this makes it harder for them to know what the underlying trend is.
So in our view, it actually means you still get one additional rate hike in March, then after that, it only starts to become clear that inflation is decelerating and the Fed stops hiking.
So in my view, I think the way that they deal with it is they have to wait and get more data to decide that inflation's either going in the direction they want or it's not going in the direction they want.
So Matt, I'd like to turn it back to you if I can. We've seen a lot of volatility in the Treasury market. As you know, for many months yields were backing up. The 10-year Treasury yield peaked above 5.25. It's now back down to about 5 percent. How do you read what's happening in the Treasury market today?
Matthew Hornbach: So the biggest explanatory factor in the sell-off in the Treasury market since, really since the beginning of March, has been a combination of what has happened with energy prices. Both outside of the country and within the country. And then, how the central bank ended up shifting its perspective on rate policy as a result of the effects of these higher energy prices on underlying inflation.
And so, as the Fed transitioned from easing monetary policy in 2025 to now tightening monetary policy in 2026, and on your forecasts into 2027, the bond market had to reprice. And this is a typical behavioral response to a big change in monetary policy expectations.
The more recent price action in the Treasury market, where the 10-year yield went from 5 percent up to 5.25 percent, we think was driven much more by technical flows related to a very large fixed income marketplace that includes more than just U.S. Treasury securities.
Of course, we have agency mortgage-backed securities. There's a huge corporate bond market as well. And so, we see the last 25 basis points as more of a technical dynamic that was driving yields to those peak levels. And once those technical flows stopped, then we saw yields settle back down to a level that was more aligned with fair value, given how the Fed is expected to behave with monetary policy.
But what that means, though, is that as the data come in over the course of the next several quarters, how the market thinks about the path of Fed policy over the course of 2027 will become an increasingly important factor in the Treasury market once again.
So if the investor base decides that maybe the Fed, after having delivered these rate hikes that you're expecting, is comfortable keeping rate policy where it is. And as the disinflationary process resumes, might even consider reversing some of these rate hikes that they have put into place, I would expect 10-year Treasury yields to fall alongside – of those expectations for monetary policy.
So ultimately, we have had a big move in the U.S. Treasury market this year. It has been very much aligned with how investors have thought about the changing narrative around Fed policy. And so 2027 will likely hold more of the same.
As we make our mind up about where the Fed is heading with monetary policy, we will very likely see the bond market move in sympathy with that. And I guess we'll keep an eye on inflation, the labor market, as well as the Treasury market as we look forward towards the next FOMC meeting in early December. And considering the question again: hike or no hike?
Thanks for this, Mike.
Michael Gapen: Thanks for having me on, Matt.
Matthew 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.

Is the end of the correction in sight? Our CIO and Chief U.S. Equity Strategist Mike Wilson looks at what could bring this pullback to an end.
Read more insights from Morgan Stanley.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist.
Is the end of this equity market correction in sight? Today on the podcast, I’ll share what I think could turn the tide.
It's Monday, October 26th at 11:30 am in New York.
So, let’s get after it
The correction that began in June is now well advanced beneath the surface. But I believe the high-quality S&P 500 index may still have some unfinished business. Until that plays out, I don’t think we can say the adjustment is complete.
The real question to ask: how bad does it have to get before it gets better?
We have described this correction as a classic mid-cycle transition. The peak rate of change in earnings revisions arrived right on schedule, about a year after the recession troughed. And the market responded the way that it usually does: early-cycle leaders with more operating and financial leverage started to underperform, while higher-quality, asset-light, services-oriented businesses moved to the front.
This quality rotation is now well understood though, and positioning has followed it. Ironically, the final step is usually a convergence between the resilient high quality S&P 500 index and the weaker breadth beneath. We may already be seeing the beginning of that meeting in the middle. If the index does move lower, I believe 7100-7200 on the S&P 500 is where the correction should find material support.
The reason I believe we will ultimately have a positive resolution to this transition is that a lot of damage has already occurred. Roughly 60 percent of Russell 3000 stocks are down more than 20 percent since June. And the hit has been even more severe in early-cycle areas like Semiconductors, Autos, Consumer Cyclicals, and Capital Goods.
At the same time, hedge-fund positioning has come down meaningfully leaving us near the lows for the past 12 months. That is encouraging, but sentiment overall is not yet at the kind of extreme that typically marks a durable low. I think we are close but we’re not quite there.
So, what gets us there? I see three clearing events ahead.
The first is AI. Investors are questioning the eventual return on capital, the cost of capital, and whether credit markets can fund all the spending that has been promised. Over the next few weeks, the market will need to absorb more supply, and lower-quality players may continue to see wider spreads and even lower stock prices.
I view the supply as the event itself. Once it clears, the risk should begin to fade. Semiconductors remain at the center of this concern, and may offer a good benchmark to monitor for the broader market correction. Specifically, I see another 10 to 15 percent lower for the Semiconductor index into mid-November.
The second clearing event is the midterm elections. Markets dislike uncertainty, and this election has plenty. A blue wave is not a surprise anymore though. The larger overhang is what may happen after the vote, including the possibility of a renewed military escalation in Iran.
I have no special edge in forecasting geopolitics. But I do know that these kinds of shocks often create very good buying opportunities. Historically, post-midterm returns have been very strong, so I would be ready to embrace a sharp downdraft in stocks in the days and weeks around election day.
The third, and most important, clearing event is liquidity. Financial conditions have tightened sharply through a combination of higher rates, slower balance-sheet growth, stronger demand for capital, and higher energy prices.
The tightening is beginning to resemble 2018, and it is not far from what we experienced in 2022 despite very modest tightening from the Fed so far. In fact, the market may be doing the Fed’s tightening for it; and if that tightening begins to create funding stress or destabilizes credit markets, the Fed and Treasury have tools to respond. The question is whether conditions need to deteriorate further before they act.
Bottom line, I think the correction in equity markets that began in June is in the final stages, but the final stage can be very uncomfortable. We may still need one more index-level drawdown and bout of volatility. Or one more moment when investors conclude that something has broken. That may be exactly what clears the path for the Fed to pivot and the next leg higher for stocks.
For now, I want to stay with quality stocks that have already corrected more than the index in areas like capital goods. More importantly, if these clearing events create a sharp downdraft, I would view it less as a reason to run from risk and more as the opportunity we have been waiting for to buy. So be ready.
Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!

The energy shock is global, but the policy response isn’t uniform. In the second of our two-part roundtable, our economists unpack the forces shaping interest rates across the U.S., Europe and Asia.
Read more insights from Morgan Stanley.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research.
Michael Gapen: I'm Michael Gapen, Chief U.S. Economist.
Jens Eisenschmidt: I'm Jens Eisenschmidt, Chief Europe Economist.
Chetan Ahya: And I’m Chetan Ahya, Chief Asia Economist.
Seth Carpenter: Yesterday, we talked about why global growth is continuing to power on, why investment is playing a larger role, and how that investment cycle is spreading across regions.
Today, we're going to take a deeper dive and think about monetary policy and what's going on.
It's Friday, October 23rd, at 10am New York.
Jens Eisenschmidt: 4pm in Frankfurt.
Chetan Ahya: And 10pm in Hong Kong.
Seth Carpenter: When I look around the world and think about especially developed market central banks, well, they're kind of all tightening at the same time – but maybe for somewhat different reasons.
Let's start with just a really broad policy question. Why are the Fed, the ECB, the Bank of England, and the Bank of Japan all tightening policy when their economies look so different?
Mike, I'm going to start with you back here in the U.S. with the Fed. How are you thinking about what the Fed is doing right now?
Are they just recalibrating the stance of policy? Or is this a fundamental change where they're trying to rein in growth in the economy?
Michael Gapen: The way I look at it is this is a story about persistent inflation, and I would look at it as a recalibration of policy. I think the majority of participants on the FOMC know the Fed can't pump more oil or get, you know, oil through the Strait of Hormuz. So, it's about leaning against second-round effects.
Inflation is gradually moving lower. They've characterized this as dissatisfaction with the speed of convergence to the target.
So, I think the Fed is tightening based on persistent inflation, and it appears to me to be more about a recalibration than it is about meaningfully tightening policy and leaning into demand.
Seth Carpenter: All right, Jens. Same question coming to you, and I have to say the energy shock is a global shock. So how do you think about what's going on with the tightening of the ECB and the Bank of England?
Jens Eisenschmidt: Yeah. No, I mean, first of all, if you sort of talk about both central banks – and here again, I guess the Fed comparison also matters. The starting point is important. The ECB was the only central bank that got inflation back to target, and so was already well advanced in its sort of rate normalization cycle, had cut back rates to 2 percent – which by most measures is sort of neutral, maybe leaning a little bit towards expansionary side of things.
And so, it was probably easiest for that central bank, when the supply shock came to tighten again, simply by getting a little bit towards the restrictive end of the neutral range, say. I think that is probably what has happened here, more than anything else.
And for the Bank of England, of course, the discussion is a different one. They were running for a long time a relatively restrictive monetary policy. And so there was more scope to wait it out, essentially. A little bit like the Fed, essentially. This is where the similarities come in.
Now, if you look ahead, essentially, it becomes a question of how strong is your economy holding up? And, you know, the strength of that holding up in the face of a certain given energy shock will determine how much of the inflation that you experience today will be inflation of tomorrow, carried to the next period through stronger wage agreements.
I think that's basically the policy problem facing both central banks here. And I guess that in the end results in essentially a resolve to at least gradually further tighten the stance. I think that has to be the expectation. And so, from that perspective, this is where we arrive at essentially a current positioning that is not super hawkish, if you think about it.
So, it's not like we have to gung ho every sequential meeting increase rates. But we see a gradual increase in rates. And so, for instance, for the ECB, we have a meeting around the corner next week. We don't think there will be an increase. But the risks have sort of stacked up and are really to the upside for inflation.
So, it will be very hard to avoid a tightening for the ECB in the December meeting. So that's the gradual pace I was just referring to.
Seth Carpenter: Got it. Ok, Chetan, the developed market central bank in Asia that most people are staring at is the Bank of Japan. So big change there. 25 years of essentially stagnant nominal in GDP growth to now we're on a clear hiking path.
How far do you think the Bank of Japan is likely to go? What's driving it? And how important is this global energy shock to the Bank of Japan's plans?
Chetan Ahya: We expect the BOJ to hike its policy rate twice, first in December and then again in March next year. This compares with market pricing of three more rate hikes. So, what explains our dovish forecast? Well, we think that Japan's inflation has been largely driven by FX weakness and higher commodity prices and not due to demand-side pressures. To elaborate, Japan's real consumption is still one percent below pre-COVID levels. Hence, we think BoJ will avoid taking up more aggressive policy tightening.
Seth Carpenter: So, Mike, let me come back to you for the U.S. We have seen globally a rise in interest rates. The long end of the curve has sold off everywhere. Some of that is being driven by energy prices. We've seen credit spreads in the U.S. start to widen.
Some of that's being driven by hyperscaler debt issuance, among other factors. But I guess what's important is when Chair Warsh first took over the helm of the Fed, his characterization of how restrictive monetary policy and financial conditions were – was not particularly forceful, right? He said it's hard-pressed to say that it's uniformly restrictive.
But the world feels a little bit different now than it did when Chair Warsh took over. So how does the Fed need to react to the fact that longer-term interest rates have sold off and that credit spreads are starting to widen?
Michael Gapen: Financial conditions have tightened. We would characterize financial conditions as, let's call it moderately restrictive.
So, I think the Fed needs to look at that and then ask itself essentially, "Where is this inflation coming from? What inflation are we trying to stop?" I don't think there's a tremendous amount of evidence that points to an overheating labor market. Rates have risen, but long-run inflation expectations remain stable.
So, I still think the right answer is to lean against potential second-round effects from the energy price shock. And here, I think that would show up in airfares, apparel, new and used cars, motor vehicles and parts.
We got some evidence in the September inflation report that these other goods prices were firm. We'll see if that continues, and this is an early sign of energy pass-through into other parts of core. But with financial conditions already moderately restrictive, it doesn't suggest they have a tremendous amount of work to do unless there's evidence that AI spending is broadening out to greater labor demand and higher wages. Then it would be a different story.
For now, I think a few more rate hikes – we have two more rate hikes penciled in, and 75 basis points of rate hikes in total – is probably where we think the Fed will be going by March of next year.
Seth Carpenter: Jens, let me turn that to you as well because rates in Europe have also gone up. And importantly, we've seen spreads for French sovereign debt over German debt widen a lot. So, OAT spreads are pretty high. How much has the tightening in financial conditions done the work of the ECB for it?
And as a result, is that a reason to maybe expect less in the way of rate hiking than what the market has priced in?
Jens Eisenschmidt: I think that's exactly the debate that I would expect to be raging in the governing council next week. We have already seen indications in the accounts in September that it was brought up.
Since then, it hasn't gotten better. So, there is tightening. We had seen Philip Lane coming out essentially saying in very simplistic ways, ‘Well, this is AI. This is good for the U.S. It's not so clear it's as good for Europe. But, you know, rates have increased here too, and so we need to be super careful.’ That this is not representing us with much more tightening than we actually can stomach.
So, to your point, indeed, I think the market is pricing too many rate hikes. We have one more at this stage in December, and that's it.
We have to acknowledge that since we made that change in call, we have seen more inflation and probably also more resiliency than we had thought. So that would push us at the margin to maybe one more in March.
But then again, we have seen the tightening at the long end. If that continues, we may very well end up being right with that call without any need to change it. Again, that has to be closely watched. It will very likely depend on the growth outlook in the end.
But yeah, long story short, the market currently prices 3/25. I still think this is too much from the ECB here.
Seth Carpenter: So, Chetan, maybe I’ll wrap up with you because we focused on some of the bigger central banks of the bigger economies. But there are different outcomes across different central banks. Here in the Americas, for example, down south, the Brazilian Central Bank, the BCB, is still easing, albeit gradually. Banxico in Mexico is holding rates, not hiking.
So, when you think about other central banks, across Asia, like say maybe Korea and India, where we're still seeing some strong domestic growth. Are they conforming to the same stories we've talked about for these major DM central banks?
Chetan Ahya: Yeah, the situation in Asia is somewhat different. They don't have a big inflation problem, but we are seeing strength in growth coming in because of exports. And so, for most central banks, we are expecting them to take up rate hikes. But those will be more countercyclical in nature.
As such, core inflation, except for Australia and Korea is pretty much in the central bank's comfort zone. And so, we don't expect them to react to higher inflation. But to the extent to which, you know, U.S. rates are going up, growth is strong, most central banks will take up countercyclical rate hikes in the coming quarters.
Seth Carpenter: That's super helpful, and that helps make, I guess, a key observation or theme about what's going on. Inflation is a global phenomenon. We are seeing somewhat resilient growth, and major central banks generally are tightening. But it is not a uniform story in every single place. And so, there are some interesting nuances in all of the details here.
That point also means that the endpoint for hiking cycles at different central banks might not be fully synchronized either. And it will depend, I suspect, in different jurisdictions on the specific evidence that each central bank is looking at – be it inflation itself, wage dynamics, what's going on in labor markets, domestic demand, foreign demand, external demand for exports, depending on the economy. And of course, as we touched on a bit, what's going on in financial conditions.
Well, Mike, Jens, Chetan, thank you so much for helping us connect all of those dots. And to the listener, thank you for listening. And if you enjoy this show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

In the first of a two-part discussion, our roundtable explores how AI investment, trade and consumer spending are sustaining global growth, and what could put that resilience at risk.
Read more insights from Morgan Stanley.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research.
Michael Gapen: I'm Michael Gapen, Chief U.S. Economist.
Jens Eisenschmidt: I'm Jens Eisenschmidt, Chief Europe Economist.
Chetan Ahya: And I'm Chetan Ahya, Chief Asia Economist.
Seth Carpenter: And today, our fourth quarterly economic roundtable discussion is going to try to take a wide-angle view on the global economy – and it has held up despite higher interest rates, higher energy prices, geopolitical uncertainty, you name it.
It's Thursday, October 22nd at 10am in New York.
Jens Eisenschmidt: And 4pm in Frankfurt.
Chetan Ahya: And 10 pm in Hong Kong.
Seth Carpenter: All right then. Let me start with that big question Why has global growth held up better than maybe would have been expected given everything that we've seen ?
Mike, maybe I'll start from the U.S. perspective with you. What do you think has mattered most? What is driving – if I dare use an overused word – the resilience of the economy?
Michael Gapen: Most of us believe AI-related spending is interest rate insensitive and geopolitically insensitive. And certainly, I think the data has borne that out. And in the direct translation of AI hypercaler Capex spending to growth, we find that AI is accounting for 4/10 to 6/10 contribution to growth in any given quarter. You could nudge that a little higher if you think it’s creating productivity, which we do.
And that spending is underpinning asset market appreciation – or certainly has for the past several years. And that is underpinning resilient spending by upper income households.
So, I think in the U.S. the clear answer is AI-related spending, but also its linkage to asset markets and upper-income households.
Seth Carpenter: Jens, let me come to you for the European view. I mean the AI story has been a little bit different in Europe. I think consumer behavior sometimes can differ in Europe than in the United States.
What would you say is the story behind the resilience of economic growth there in Europe?
Jens Eisenschmidt: It’s similar in the sense that there is a clear element of also of AI-related external demand. That even in Europe now the phones are ringing, given that we are more typically seen as on the more higher cost end of the spectrum.
So, I think there was clearly in the second quarter data, export-led growth elements related to AI or delivery into that. There was also an element of geopolitical tensions helping some of those producers – say, chemical industry in Germany comes to mind – that would deliver products that would previously be delivered out of the Strait [of Hormuz].
So, that is another element. And then, yeah, the consumer held up better than had expected. Or that you could have expected given the rise in energy prices. So all in all, that got us a relatively solid second quarter print. And we expect this to be more or less repeated also in the third.
Seth Carpenter: Chetan, the export story is pretty important. You've been writing about a big CapEx cycle and big industrial cycle in Asia. So, when you think about the Asia story and why the economic growth held up in spite of the global shocks, how would you characterize that?
Chetan Ahya: Yeah. So, Asia is benefiting from a strong pickup in CapEx, which initially was led by the tech sector, but is now broadening out to energy, defense, and broader industrial investments. Exports are strong, and showing some signs of broadening out from tech to non-tech goods too.
This has meant that the region has faced positive terms of trade situation despite higher oil prices. Higher export prices have boosted corporate profits and in turn government tax revenues, offsetting the fiscal pressures from higher fuel subsidies.
And when you're thinking about higher interest rates that you are seeing globally and also in Asia, what is different in this cycle is that the macro stability indicators are in a good place. Current account surpluses in the region have widened quite significantly. In fact, it is $1.6 trillion or 4.2 percent of GDP.
Also what we have is the private sector balance sheets outside of China are quite healthy.
So, all in all, both higher oil prices and interest rates have not disturbed the CapEx and growth cycle in the region.
Seth Carpenter: Is there a lot of dispersion across sectors, across countries for this cycle that you’re talking about? Can you go a little deeper there?
Chetan Ahya: Yeah. So let me start first with the story on investment versus consumption So initially, the growth story in the region started with a pickup in exports and CapEx. But what we have seen is that this has now broadened out into a dynamic where we see an improvement in the labor market and therefore consumption growth.
So, we have this recovery broadening out from exports to CapEx to consumption.
And within the region, when you're thinking about different economies. Initially, we saw very strong growth in Korea and Taiwan. But now we have seen growth being strong in all parts of the region, especially in economies like India, Japan, and also some of the Southeast Asian economies like Malaysia and Singapore.
Seth Carpenter: I want to stay on this broadening theme, Michael.
Is all of the CapEx spending, all the investment spending, by business in the United States, is it just an AI story? Are we seeing any broadening of the investment story in the U.S. beyond AI? Or should we just resign ourselves that the rest of the economy is going to stagnant?
Michael Gapen: No, I do think we are seeing evidence of some broadening out. It is most clear in manufacturing.
So, I do think it points to some broadening out in the AI story beyond the narrow AI story into something that is broader that both Chetan and Jens have referenced about in a multipolar world needing to build out redundancies in supply chain.
Maybe there's some incentive to do some reshoring. So, whether it's a spillover effect from AI or a spillover effect from geopolitics writ large, I do think there's some evidence that we're seeing the broadening out.
I would just caution and say, just remember, manufacturing in the U.S. is relatively small. It's only about 10 percent of output and maybe 10 percent of employment. But nonetheless, it's there. So, it's not just an AI story. I think you can characterize it as a bit broader.
Seth Carpenter: Let me come to you, Jens, on this. We've seen an investment story play out for a while in Europe. There was a lot of discussion about defense especially in Germany –infrastructure especially in Germany.
Is that still an important part of spending in Europe, the investment side of things? And how important is investment relative to household?
Jens Eisenschmidt: Yeah. No, I mean, I think in, in terms of the shares; and GDP shares in spending, you're talking about 50 percent versus 20 percent. So, consumption is the more important one…
If you talk about relative expectations, so I think there your question really points at a key component of the forecast. If anything, you could expect maybe some more dampening from here, given that energy prices have increased further, and at some point the consumer will just capitulate. Or at least, need to show some signs of retracement. While investment has so far, in the aggregate at least, not shown any signs of a big revival.
And if anything, this is what we would expect more investment from here – be it related to, you know, a progressive AI build out.
Or be it because we anyway expect some more positive investment dynamics given where we are in the cycle and given that the ECB has decreased rates last year. And at some point, this typically shows up in investment demand.
So, long story short, the relative importance as a growth driver should increase of investments, vis-a-vis consumption. I think that is that is relatively clear. The question is just the magnitude here.
Seth Carpenter: How much do you worry then that not only is investment going to become bigger share of growth? That consumption could weaken even more because energy prices chip away at purchasing power of households? Is that a relevant factor for Europe?
Jens Eisenschmidt: I think that has to be the number one growth worry going forward So essentially, you come down in terms of wage increases from very high level that were reflective of past inflation.
So, the European wage setting process always lags inflation, and so basically today's wage agreements are reflective of yesterday's inflation.
But now we are going above 4 percent, very likely on our forecast. Not an awful lot above 4 percent, but still above.
Then it becomes a question of how long this is going to persist. If you just believe the future curves in energy markets – not long. But then if you look at more details in terms of, for instance, where diesel prices are likely heading, you can become more pessimistic, and ultimately, this is what matters for the consumer. So long story short, big risks here, of course.
Seth Carpenter: All right. So, a consumer that's not exactly pulling its weight leads me back to China. Key economy in the world, one of the biggest economies going. But when it comes to demand, aggregate demand, China has been in this deflationary cycle for a while. The household sector has been pretty soft in terms of its demand.
What are we looking at there in terms of the consumer in China, the demand side of things in China? is that likely to change anytime soon? And can the global economy look to China as a source of extra demand to keep this expansion going?
Chetan Ahya: Unfortunately, I think the short answer to your question is no. We are still very cautious on China's consumption outlook. And what we have been characterizing the China growth story as it's going through a K-shaped recovery.
On one side, you have the strength in exports and AI CapEx. And on the other hand, we have a very weak consumer.
Now, why is the consumption growth weak in China? So firstly, the property sector has still not completed the adjustment cycle.
So, from consumer standpoint, they have still a weak labor market and wage income growth. On top of that, they have seen this massive decline in asset prices. And, so they are actually, de-leveraging at a very rapid pace. The outstanding debt for consumers is contracting at the rate of 1.5 percent. 1.5 percent is not a big number, but just to see that contraction is quite surprising.
And so therefore, all in all, China's consumption growth continues to remain weak. We do think that there is a possibility that the policymakers respond to this weak growth and provide some support. But we're not expecting that support to be big fiscal expansion in a way that you get a major surprise on the consumption outlook for China.
Seth Carpenter: But as we started off saying, things are holding up, and so that fact brings up a question in my mind. Where are the risks? Where are the downside risks? And so, Mike, maybe I'll start with you.
What do you think would lead to a downturn in the U.S.? Where's the biggest vulnerability? What do we have to look out for?
Michael Gapen: Well, I think in the, the near term, I do think higher rates pose a vulnerability. So, I would say if the central bank has to shift to a much more dramatic tightening cycle and interest rates go a lot higher, that would be a near-term vulnerability. But I think if we look further out, if the resiliency of the economy is driven by the AI investment cycle, then I think a potential over-investment cycle is the greater risk.
Seth Carpenter: Alright. Jens, what about in, in Europe?
Jens Eisenschmidt: Clearly we have a discussion among European, in particular monetary policymakers, as evidenced by the latest accounts of the ECB about the degree to which long rates have increased. Maybe, too much and, you know, present a significant tightening of financial conditions.
And juggling that in a good way will certainly be a risk and reason to be cautious.
So, I would say, here the three risks. Again, consumption because of energy prices, interest rates, or a too tight monetary policy stance. And of course, the investment cycle overall.
Seth Carpenter: Chetan, you get the last word in Asia
Chetan Ahya: So, I would say, Seth, two risks. One is higher oil prices and the second one is, if you see a contraction in AI investments in the U.S. and therefore in Asia as well.
So, on oil prices, I would say a threshold of $130 to $150 of oil would be a problem for the region. It would make the governments finally do resort to higher oil prices for the consumers.
And if you get a combination of higher oil prices and lower AI investments, that would be quite a big shock to the region's growth outlook.
Seth Carpenter: Super helpful. And I think that's probably a good place for us to stop for today.
We talked about global growth. It's been holding up really well. Sources of that resilience probably differ a bit across regions, but investment is important and becoming probably more important over time. And that investment boom is spreading through trade. Domestic demand in parts for Asia. Europe has got its own story going on. And obviously, the consumer around the world matters a lot.
That current outlook though, of a reasonably strong economy with this shock from energy that's driving up inflation, means that the policy side of things, especially monetary policy, is now becoming kind of complicated.
So, what should a central bank do? When we come back tomorrow, we're going to ask questions about the Fed, the ECB, the Bank of England, the Bank of Japan. How they're thinking about what's going on, the tightening that needs to be done, whether or not this is going to be a fully synchronized hiking cycle.
And I guess most of all, what's going to tell us when the policy hiking has gone far?
Mike, Jens, Chetan, thanks so much for joining today. And to the listener, thank you for listening, and be sure to tune in tomorrow for part two of our conversation.
And if you enjoy this show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

Can markets absorb this much new debt? Our panel examines strong demand for investment-grade bonds, stress in high-yield debt and the macro risks that could shape the next six to twelve months in credit markets.
Read more insights from Morgan Stanley.

----- Transcript -----

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.
Anish Shah: I'm Anish Shah, Global Head of Debt Capital Markets.
Rehan Latif: I am Rehan Latif, Global Head of Credit Trading.
Samer Oweida: And I'm Samer Oweida, Global Head of Foreign Exchange and Emerging Markets.
Andrew Sheets: Today, a discussion of historical levels of bond issuance and how it could affect the broader markets.
It's Wednesday, October 21st at 9am in New York.
Gentlemen, it's great to talk with you. I think what we're talking about is an issue that really cuts across all parts of Morgan Stanley's businesses, from issuance to credit trading to macro markets and beyond.
And I'd like to get into it, but just quickly to kind of frame where we are. Anish, we are in the midst of a historic investment cycle in AI CapEx. We're in the midst of a very large pickup in M&A activity that I also want to make sure we get into.
But you sit at the intersection of our capital markets businesses. Talk a little bit about what we're seeing in the bond issuance space.
Anish Shah: Sure, Andrew. I look after all of our new issue capital markets business in credit, and that's across the credit spectrum and across geographies. And I'm constantly looking to Rehan for the latest in investor sentiment and how we can deliver the right product for our issuing clients. And to Samer on macro views that impact our clients every day.
We are in the midst of a significant decommoditization of new issue credit markets and a decompression in credit. It's really driven by four important factors.
One is, as you note, unprecedented levels of issuance. Investment grade debt volumes are up almost 25 percent on the year. That's driven by the AI CapEx theme and a resurgence in M&A.
Number two is the rate backdrop has been, to date, pretty constructive for credit. We've seen $100 billion of new cash come into investment grade credit. We've seen new pools of investors drive tremendous new capacity into credit markets, whether it be insurance, capital fueled by annuity investments or other private credit.
We're also seeing an increase in complexity, and that's driven by the AI CapEx cycle and the interconnectedness between hyperscalers, the chip makers, the neo clouds, the data centers, and that's requiring an unprecedented level of innovation in structuring new solutions for issuers.
And the last is the market is grappling with supply-demand dynamics and winners and losers in the AI thematic.
Andrew Sheets: Rehan, that's actually a great place to turn to you because you're on the other side of this. You're focused on can markets absorb all of this supply? And I often kind of hear two narratives.
You know, one is everything is great. You've got record issuance and record supply into the credit markets. And the other is cracks are forming. You're seeing widening of CCC spreads. You're seeing some headlines around some issuers running into more trouble. From your perch, how do you see things?
Rehan Latif: So, Andrew, instead of two, I'll give you three narratives within public credit trading.
One, I agree with Anish. I think first of all, I've got to thank Anish because it's never been busier on the public credit side because of the amount of issuance coming through. But there are, really, three different themes coming through.
One, investment grade has been incredibly strong. The higher quality part of the credit market is benefiting from all this new investor money coming through at these higher rate levels. For the longest period of my 20-year career, 20-plus year career, we were in a zero-rate environment. At current yield levels, investment grade has never looked like a more attractive proposition.
You add in growth in the U.S. and across the rest of the world, the reality is that investment grade looks like a very interesting investment thesis. And I think spreads continue to be appropriately priced for the risk.
On the CCC side of the market, that's where we're seeing real dispersion.
Where we're seeing investors from the distressed community, from the high yield community, really have to figure out how to refinance some of these names. And that's been where the real challenge has been from a credit perspective.
And then obviously, you've got the hyperscalers that have come through in significant wave across many different parts of the capital market.
So, one thing Anish mentioned was the number of different financings that are available to the hyperscalers. So, I do think that given the cash flows that these hyperscalers actually have, you've managed to be able to attract a new investor base to our market as well.
Andrew Sheets: Samar, we just heard that, you know, Anish has never been busier. Rehan has never been busier. There's clearly a very credit-specific story here. But, you know, this is something that I imagine is also top of mind in the macro markets.
You've got all of this supply. You've got AI that's kind of driving the market, but you've also got all these other broader issues around energy and deficits. How do you see the historic wave of credit supply fitting into the macro piece?
Samer Oweida: Well, maybe I'll start by also thanking Anish because our corporate derivative business, where we hedge exposure, whether it's on a deal basis or on a normal course basis for these issuers, has never been busier. And part of that is because of the historic issuance that's been discussed.
But part of that, Andrew, is also about the uncertainty that you mentioned in these markets. And so, this epic wave that we're seeing around hyperscalers and AI is happening at a time where energy prices are high, inflation is sticky, fiscal concerns abound, and there's a lot of uncertainty in the forward.
And so, what we've seen from a behavioral standpoint is clients having much more appetite to engage on these discussions because of the uncertainty and hedge that exposure.
What we've also seen is a lot of re-racking of traditional macro models and how do we think about what is the rate level that the economy can handle? What does that rate level mean for winners and losers by jurisdiction or by sector, as Rehan mentioned earlier?
And we've seen that manifest itself in a lot of the invested decisions that our clients have made over the course of the year, where we've seen capital and engagement go up with names both corporate and sovereign. Where there's a positive commodity story and there's a positive AI hyperscaler story.
And we've seen less investment around the jurisdictions and the names where that story is not the case. And so we're seeing some amount of divergence, but I think also given that the economic background globally, and particularly in the U.S., continues to be strong. We've just seen very high levels of activity coming out of our corporate and sponsors-based businesses.
Andrew Sheets: So, Anish, that brings me to a question I wanted to ask you about – which is, you know, Samer, you mentioned this, really important macro question is: at what point do higher rates slow down activity?
And yet, so far, activity's still been very solid, and it's not just AI. We've also seen a lot of strategic activity, a lot of M&A activity. I would love for you to take us inside the conversations that you're having with these companies – and how they're thinking about the environment. How much these current levels of interest rates are impacting their decision-making?
Anish Shah: Andrew, you could probably break that question down into two pieces.
One is in the AI ecosystem, where, you know, certainly there's a lot of optimism on the return on these investments. And so, sitting in the shoes of a hyperscaler or a data center developer or a chip maker, there's a lot of optimism that – notwithstanding the current higher rate environment, that the long-term return on these investments is going to be very, very attractive.
And so, we're seeing a relative level of insensitivity on rates from the issuer's perspective in accessing capital. The first wave of all of the AI CapEx has predominantly been in the investment-grade bond market. That's the deepest, most liquid, fastest way to raise capital and speed.
Now you're seeing some of these companies diversify into different currencies and different products, and that's been a really healthy technical for the markets. From an M&A context, I think a lot of the resurgence in activity is driven by the fact that there's a meeting of the minds in terms of valuation.
So, for the first time in many years, we're seeing large-scaled sponsor private equity-owned assets come to market and be acquired by an investment-grade corporate strategic. Yes, they are borrowing at higher rates than they would have a few years ago. But the view is that they're able to acquire these assets at an appropriate valuation, and it makes long-term strategic sense, and we're seeing just a big pickup in that activity.
I think that also has another implication for credit markets, which is some of these assets that have been long held by private equity sponsors had multi-billion dollar debt complexes that are going to be repaid as part of these transactions.
That's a recycling of credit. That's going to free up some capacity in the leverage finance markets as well.
Andrew Sheets: And yeah, Rehan, how do you think about that? Because, you know, again, we have these big macro forces of AI CapEx, and then these very micro company-specific stories around M&A. How do you see that impacting your backdrop?
Rehan Latif: Within credit, the biggest driver is always growth. You pay the rate that you pay simply because there's an expectation towards growth. When Anish talks about some of these developments that are happening within the market, these are all, you know, big paradigm shift in growth.
And, AI investment the reality is that we are at the forefront of creating the capital for that. And the reality is that the yield that is being paid; or the coupon that is being paid is essentially the price for that investment.
Investors are seeing that across all these different markets. I think we have to be very deliberate about the difference between investment-grade, investments in newer sectors, and what is actually happening within the more distressed part of the credit market.
Simply because that market has been challenged for a long time. That market was held together to a certain degree by a zero-rate environment. And that has changed quite dramatically as rates went higher and as the global economy has evolved as well.
So, from my perspective, this is all very healthy.
Rehan Latif: Samar, I'll let you have the last word here. You know, Anish and Rehan have talked about these historic waves of credit issuance. Part of that's coming from AI, but part of it's coming from M&A and strategic transactions. You know, we're sitting here on the eve of our Morgan Stanley Credit Symposium in New York. It's tomorrow. We have over 1,000 investors attending. I think that indicates just the amount of interest and focus on this space.
And yet, as you hear Anish talk about kind of the almost insensitivity of rates for some of these key borrowers, how does this impact how you're thinking about macro markets and how they could trade over the next six to twelve months?
Samer Oweida: I think it speaks to what both Anish and Rehan said in that between the growth and the higher level of rates, there are going to be winners and losers.
And what we can't predict is what energy markets or political developments or fiscal developments might have in store. But generally speaking, macro markets are responsive to underlying growth, inflation, and policy discipline. And I think as we go into the depths of what is one of the most consequential CapEx cycles in post-Industrial Revolution history, the governments, the jurisdictions, and the corporates that have discipline and capacity around this growth will be the winners.
We think so. We see that as on the go forward. And those that don't have a clear policy will suffer the consequences. I think that is still a very early innings discussion to be had. Lots of data still has to come through.
I think what we know is what is on the docket for the next year or two in terms of how much capital needs to be raised and debt issued. But what we don't know is how does that affect underlying economic activity.
And I think as that data manifests in conjunction with policy initiatives globally, there's a lot to be excited about. And there's a lot to be quite concerned about. And looking at how policy mistakes one way or the other might affect a lot of the behavioral patterns in credit markets and from an issuer standpoint.
Andrew Sheets: Gentlemen, thank you for taking the time to talk, and see you tomorrow at the conference. And thank you for listening. If you enjoy Thoughts the Market, please take a moment to rate and review us wherever you listen and tell a friend or colleague about us today.

Anish Shah is a member of Morgan Stanley’s Global Capital Markets Division. Rehan Latif and Samer Oweida are members of Morgan Stanley’s Fixed Income Division. They are not members of Morgan Stanley’s Research Department. Unless otherwise indicated, their views are their own and may differ from the views of the Morgan Stanley Research Department and from the views of others within Morgan Stanley.