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Recorded at our 2025 Technology, Media and Telecom (TMT) Conference, TMT Credit Research Analyst Lindsay Tyler joins Head of Investment Grade Debt Coverage Michelle Wang to discuss the how the industry is strategically raising capital to fund growth.
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Lindsay Tyler: Welcome to Thoughts on the Market. I'm Lindsay Tyler, Morgan Stanley's Lead Investment Grade TMT Credit Research Analyst, and I'm here with Michelle Wang, Head of Investment Grade Debt Coverage in Global Capital Markets.
On this special episode, we're recording at the Morgan Stanley Technology, Media, and Telecom (TMT) Conference, and we will discuss the latest on the technology space from the fixed income perspective.
It's Thursday, March 6th at 12 pm in San Francisco.
What a week it's been. Last I heard, we had over 350 companies here in attendance.
To set the stage for our discussion, technology has grown from about 2 percent of the broader investment grade market – about two decades ago – to almost 10 percent now; though that is still relatively a small percentage, relative to the weightings in the equity market.
So, can you address two questions? First, why was tech historically such a small part of investment grade? And then second, what has driven the growth sense?
Michelle Wang: Technology is still a relatively young industry, right? I'm in my 40s and well over 90 percent of the companies that I cover were founded well within my lifetime. And if you add to that the fact that investment grade debt is, by definition, a later stage capital raising tool. When the business of these companies reaches sufficient scale and cash generation to be rated investment grade by the rating agencies, you wind up with just a small subset of the overall investment grade universe.
The second question on what has been driving the growth? Twofold. Number one the organic maturation of the tech industry results in an increasing number of scaled investment grade companies. And then secondly, the increasing use of debt as a cheap source of capital to fund their growth. This could be to fund R&D or CapEx or, in some cases, M&A.
Lindsay Tyler: Right, and I would just add in this context that my view for this year on technology credit is a more neutral one, and that's against a backdrop of being more cautious on the communications and media space.
And part of that is just driven by the spread compression and the lack of dispersion that we see in the market. And you mentioned M&A and capital allocation; I do think that financial policy and changes there, whether it's investment, M&A, shareholder returns – that will be the main driver of credit spreads.
But let's turn back to the conference and on the – you know, I mentioned investment. Let's talk about investment.
AI has dominated the conversation here at the conference the past two years, and this year is no different. Morgan Stanley's research department has four key investment themes. One of those is AI and tech diffusion.
But from the fixed income angle, there is that focus on ongoing and upcoming hyperscaler AI CapEx needs.
Michelle Wang: Yep.
Lindsay Tyler: There are significant cash flows generated by many of these companies, but we just discussed that the investment grade tech space has grown relative to the index in recent history.
Can you discuss the scale of the technology CapEx that we're talking about and the related implications from your perspective?
Michelle Wang: Let's actually get into some of the numbers. So in the past three years, total hyperscaler CapEx has increased from [$]125 billion three years ago to [$]220 billion today; and is expected to exceed [$]300 billion in 2027.
The hyperscalers have all publicly stated that generative AI is key to their future growth aspirations. So, why are they spending all this money? They're investing heavily in the digital infrastructure to propel this growth. These companies, however, as you've pointed out, are some of the most scaled, best capitalized companies in the entire world. They have a combined market cap of [$]9 trillion. Among them, their balance sheet cash ranges from [$]70 to [$]100 billion per company. And their annual free cash flow, so the money that they generate organically, ranges from [$]30 to [$]75 billion.
So they can certainly fund some of this CapEx organically. However, the unprecedented amount of spend for GenAI raises the probability that these hyperscalers could choose to raise capital externally.
Lindsay Tyler: Got it.
Michelle Wang: Now, how this capital is raised is where it gets really interesting. The most straightforward way to raise capital for a lot of these companies is just to do an investment grade bond deal.
Lindsay Tyler: Yep.
Michelle Wang: However, there are other more customized funding solutions available for them to achieve objectives like more favorable accounting or rating agency treatment, ways for them to offload some of their CapEx to a private credit firm. Even if that means that these occur at a higher cost of capital.
Lindsay Tyler: You touched on private credit. I'd love to dig in there. These bespoke capital solutions.
Michelle Wang: Right.
Lindsay Tyler: I have seen it in the semiconductor space and telecom infrastructure, but can you please just shed some more light, right? How has this trend come to fruition? How are companies assessing the opportunity? And what are other key implications that you would flag?
Michelle Wang: Yeah, for the benefit of the audience, Lindsay, I think just to touch a little bit…
Lindsay Tyler: Some definitions,
Michelle Wang: Yes, some definitions around ...
Lindsay Tyler: Get some context.
Michelle Wang: What we’re talking about.
Lindsay Tyler: Yes.
So the – I think what you're referring to is investment grade companies doing asset level financing. Usually in conjunction with a private credit firm, and like all financing trends that came before it, all good financing trends, this one also resulted from the serendipitous intersection of supply and demand of capital.
On the supply of capital, the private credit pocket of capital driven by large pockets of insurance capital is now north of $2 trillion and it has increased 10x in scale in the past decade. So, the need to deploy these funds is driving these private credit firms to seek out ways to invest in investment grade companies in a yield enhanced manner.
Lindsay Tyler: Right. And typically, we're saying 150 to 200 basis points greater than what maybe an IG bond would yield.
Michelle Wang: That's exactly right. That's when it starts to get interesting for them, right? And then the demand of capital, the demand for this type of capital, that's always existed in other industries that are more asset-heavy like telcos.
However, the new development of late is the demand for capital from tech due to two megatrends that we're seeing in tech. The first is semiconductors. Building these chip factories is an extremely capital-intensive exercise, so creates a demand for capital. And then the second megatrend is what we've seen with the hyperscalers and GenerativeAI needs. Building data centers and digital infrastructure for GenerativeAI is also extremely expensive, and that creates another pocket of demand for capital that private credit conveniently kinda serves a role in.
Lindsay Tyler: Right.
Michelle Wang: So look, think we've talked about the ways that companies are using these tools. I'm interested to get your view, Lindsay, on the investor perspective.
Lindsay Tyler: Sure.
Michelle Wang: How do investors think about some of these more bespoke solutions?
Lindsay Tyler: I would say that with deals that have this touch of extra complexity, it does feel that investor communication and understanding is all important. And I have found that, some of these points that you're raising – whether it's the spread pickup and the insurance capital at the asset managers and also layering in ratings implications and the deal terms. I think all of that is important for investors to get more comfortable and have a better understanding of these types of deals.
The last topic I do want us to address is the macro environment. This has been another key theme with the conference and with this recent earnings season, so whether it's rate moves this year, the talk of M& A, tariffs – what's your sense on how companies are viewing and assessing macro in their decision making?
Michelle Wang: There are three components to how they're thinking about it.
The first is the rate move. So, the fact that we're 50 to 60 basis points lower in Treasury yields in the past month, that's welcome news for any company looking to issue debt. The second thing I'll say here is about credit spreads. They remain extremely tight. Speaking to the incredible kind of resilience of the investment grade investor base. The last thing I'll talk about is, I think, the uncertainty. [Because] that's what we're hearing a ton about in all the conversations that we've had with companies that have presented here today at the conference.
Lindsay Tyler: Yeah. For my perspective, also the regulatory environment around that M&A, whether or not companies will make the move to maybe be more acquisitive with the current new administration.
Michelle Wang: Right, so until the dust settles on some of these issues, it's really difficult as a corporate decision maker to do things like big transformative M&A, to make a company public when you don't know what could happen both from a the market environment and, as you point out, regulatory standpoint.
The thing that's interesting is that raising debt capital as an investment grade company has some counter cyclical dynamics to it. Because risk-off sentiment usually translates into lower treasury yields and more favorable cost of debt.
And then the second point is when companies are risk averse it drives sometimes cash hoarding behavior, right? So, companies will raise what they call, you know, rainy day liquidity and park it on balance sheet – just to feel a little bit better about where their balance sheets are. To make sure they're in good shape…
Lindsay Tyler: Yeah, deal with the maturities that they have right here in the near term.
Michelle Wang: That's exactly right. So, I think as a consequence of that, you know, we do see some tailwinds for debt issuance volumes in an uncertain environment.
Lindsay Tyler: Got it. Well, appreciate all your insights. This has been great. Thank you for taking the time, Michelle, to talk during such a busy week.
Michelle Wang: It's great speaking with you, Lindsay.
Lindsay Tyler: And thanks to everyone listening in to this special episode recorded at the Morgan Stanley TMT Conference in San Francisco. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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While central bank policy will always matter for markets, our Head of Corporate Credit Research Andrew Sheets explains why investors should not be worried about the number of Fed cuts in 2025.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about why the number of Fed rate cuts this year may matter less than you think.
It's Wednesday, March 5th, at 2pm in London.
Financial markets spend a lot of time discussing the Federal Reserve. And for good reason. The central bank of the world’s largest economy plays a central role in fighting inflation and setting interest rates. And what they’ll do this year is topical and shifting. At Morgan Stanley, our economists think that US Tariff and Immigration policy will lead the Fed to keep rates somewhat higher, for somewhat longer, than they did at the start of the year.
Yet we think there may be just a little bit too much focus on just how much the Fed changes policy over the course of the year. Indeed, we’d go as far as to say that given the choice, investors should be rooting for less change, not more.
To start, for all that’s happened in the world since the end of October of 2024, expectations for the Fed’s interest rate path have been remarkably stable. The US 2-year Treasury, which is a decent proxy of where the Fed’s rate will average over the next 24 months, has hovered in a very narrow range. It simply hasn’t been telling us very much; other factors have been moving markets.
There’s also a pretty reasonable rule of thumb from history: stability is good. A stable Fed funds rate, almost by definition, implies a stable equilibrium that doesn’t involve overly high inflation pushing rates further up, or overly weak growth pushing them further down. The best growth in recent history, in the mid-1990s, occurred after the Fed reduced interest rates less than one-percent, and then kept them stable, at a pretty elevated rate for a pretty extended period of time.
Large changes in rates, on the other hand, in either direction are a different story. Some of the markets worst losses have coincided with the largest declines in the Fed’s target rate – because those large rate cuts usually occur only when there is a large, unexpected slowing in the economy; something markets often don’t like.
Meanwhile, we think the Fed also very much wants to avoid a scenario where it has to start raising rates again, given the potential confusion that this could signal after it only recently continued to lower them. And so if over the course of this year, the Fed does need to raise rates, given the very high bar we think they’ve given themselves for action – it probably suggests that something unexpected, and not in a necessarily good way, has occurred.
Central bank policy will always matter for markets. But for investors, the question of whether the Fed will cut once, which is the Morgan Stanley base-case, twice, or not at all in 2025 may not matter all that much, at least for credit. Far more important is the performance of the economy, and whether big changes to tariffs or immigration policy drive big changes to growth and inflation. Those big changes, which could drive big changes in Fed policy responses, are the scenario that worries us.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our U.S. Public Policy and Currency analysts, Ariana Salvatore and Andrew Watrous, discuss why the dollar fell at the beginning of the first Trump administration and whether it could happen again this year.
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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist.
Andrew Watrous: And I'm Andrew Watrous, G10 FX Strategist here at Morgan Stanley.
Ariana Salvatore: Today, we'll focus on the U.S. dollar and how it might fare in global markets during the first year of the new Trump administration.
It's Tuesday, March 4th at 10am in New York.
So, Andrew, a few weeks ago, James Lord came on to talk about the foreign exchange volatility. Since then, tariffs and trade policy have been in the news. Last night at midnight, 25 percent tariffs on Mexico and Canada went into effect, in addition to 10 percent on China. So, let's set the scene for today's conversation. Is the dollar still dominant in global currency markets?
Andrew Watrous: Yes, it is. The U.S. dollar is used in about $7 trillion worth of daily FX transactions. And the dollar's share of all currency transactions has been pretty stable over the last few decades. And something like 80 percent of all trade finance is invoiced in dollars, and that share has been pretty stable too.
A big part of that dollar dominance is because of the depth and safety of the Treasury security market.
Ariana Salvatore: That makes sense. And the dollar fell in 2017, the first year of the Trump administration. Why did that happen?
Andrew Watrous: Yeah, so 2017 gets a lot of client attention because the Fed was hiking, there was a lot of uncertainty about would happen in NAFTA, and the U.S. passed a fiscally expansionary budget bill that year.
So, people have asked us, ‘Why the U.S. dollar went down despite all those factors?’ And I think there are three reasons. One is that even though the possibility that the U.S. could leave NAFTA was all over the headlines that year, U.S. tariffs didn't actually go up. Another factor is that global growth turned out to be really strong in 2017, and that was helped in part by fiscal policy in China and Europe. And finally, there were some political risks in Europe that didn't end up materializing.
So, investors took a sigh of relief about the possibility that I think had been priced in a bit that the Eurozone might break up. And then a lot of those factors went into reverse in 2018 and the U.S. dollar went up.
Ariana Salvatore: So, applying that framework with those factors to today, is it possible that we see a repeat of 2017 in terms of the U.S. dollar decline?
Andrew Watrous: Yeah, I think it's likely that the U.S. dollar continues to go lower for some of the same reasons as we saw in 2017. So, I think that compared to 2017, there's a lot more U.S. dollar positive risk premium around trade policy. So, the bar is higher for the U.S. dollar to go up just from trade headlines alone.
And just like in 2017, European policy developments could be a tailwind to the euro. We've been highlighting the potential for German fiscal expansion as European defense policy comes into focus. And unlike in 2017, when the Fed was raising rates, now the Fed is probably going to cut more this year. So that's a headwind to the dollar that didn't exist back in 2017.
So, on trade, Ariana. What developments do you expect? Do you think that Trump's new policies will make 2025 different in any way from 2017?
Ariana Salvatore: So, taking a step back and looking at this from a very high level, a few things are different in spite of the fact that we're actually talking about a lot of similar policies. Tariffs and tax policy were a big focus in 2017 to 2019, and to be sure, this time around, they are too, but in a slightly different way.
So, for example, on tax cuts, we're not talking about bringing rates lower on the individual and corporate side. We're talking about extending current policy. And on tariffs and trade policy, this round I would characterize as much broader, right? So, Trump has scoped in a broader range of trading partners into the discussion like Mexico and Canada; and is talking about a starting point that level-wise is much higher than what we saw in the whole 2018 2019 trade friction period.
The highest rate back then we ever saw was 25 percent, and that was on the final batch of Chinese goods, that list four. Whereas this time, we're talking about 25 percent as a starting point for Mexico and Canada.
I think sequencing is also a really important distinction. In 2017, we saw the tax cuts through the Tax Cuts and Jobs Act (TCJA) come first, followed by trade tensions in 2018 to 2019. This time around, it's really the inverse. Republicans just passed their budget resolution in the House. That lays the groundwork for the tax cut extensions.
But in the meantime, Trump has been talking about tariff implementation since before he was even elected. And we've already had a number of really key trade related catalysts in the just six weeks or so that he's been in office.
Andrew Watrous: So, you mentioned expectations for fiscal policy. What are recent developments there, and what do you think will happen with U.S. fiscal?
Ariana Salvatore: I mentioned the budget resolution in the house that was passed last week. And you can really think of that as the starting point for the reconciliation process to kick off. And consequently, the extension of the Tax Cuts and Jobs Act.
To be clear, we think that House Republicans will be able to align behind extending most of the expiring Tax Cuts and Jobs Act, but that's still in the books until the end of 2025. So, we see many months needed to kind of build this consensus among cohorts of the Republican caucus in Congress, and we already know there's some key sticking points in the discussion.
What happens with the SALT [State and Local Tax] cap? What sort of clawbacks occur with the Inflation Reduction Act? All these are disagreements that right now are going to need time to work their way through Congress. So not a lot of alignment just yet. We think it's going to take most of the year to get there.
But ultimately, we do see an extension of most of the TCJA, which is like I said, current law until the end of 2025.
But Andrew from what I understand when it comes to fiscal policy, there are really two stages in terms of the market impact that we saw in the last administration. Can you walk us through those?
Andrew Watrous: Yeah, so one lesson from 2016 to 2018 is that there were really two stages of when fiscal developments boosted the dollar. The first was right after the U.S. election in 2016, and the second was much later after the Tax Cuts and Jobs Act passed. So right after the 2016 election, within a couple of weeks, the dollar index rallied from 98 up to 103, and 10-year Treasury yields rose as well.
And then things sort of moved sideways in between these two stages. Ten-year Treasury yield just moved sideways. Fiscal wasn't as supportive to the U.S. dollar. And as we know, the dollar went down. And then we had the second stage more than a year later. So, the TCJA was passed in December 2017. And then the dollar rallied after that along with the rise in Treasury yield.
So, we think that now, what we've seen is actually very similar to what happened in 2017, where the dollar and yields moved a lot after the 2024 election; but now the budget reconciliation process probably won't be a tailwind to the dollar until after a tax cuts extension passes Congress. And as you mentioned, that's not going to be for many, many months. So, in the interim, we think there's a lot of room for the dollar to go down.
Ariana Salvatore: And just to level set our expectations there to your point, it is probably going to be later this year. House Republicans have to align on a number of key sticking points. So, we have passage somewhere on the third or fourth quarter of 2025.
But when we think about the fiscal picture, aside from the deficit and the macro impacts, a really key component is going to be what these tax changes mean for the equity market. The extension of certain tax policies will matter more for certain sectors versus others. For example, we know that extending some of the corporate provisions, aside from the lower rate, will have an impact across domestically oriented industries like industrials, healthcare, and telecom.
But Andrew, to bring it back to this discussion, I want to think a little bit more about how we can loop in our expectations for the equity market and map that to certain dollar outcomes. How do you think that this as a barometer has changed, if at all, from Trump's first term?
Andrew Watrous: Yeah, currency strategists like me love talking about yield differentials. But from 2016 to 2018, the U.S. dollar did not trade in line with yield differentials. Instead, in the initial years of President Trump's first term, equities were a much better barometer than interest rates for where the U.S. dollar would go.
After President Trump was elected in 2016, U.S. stocks really outperformed stocks in the rest of the world, and the U.S. dollar went up. Then in 2017, stocks outside the U.S. caught up to the move in U.S. stocks, and the U.S. dollar fell. Then in 2018, all that went into reverse, and U.S. stocks started outperforming again, and the U.S. dollar went up.
So, what we've been seeing in stocks today really echoes 2017, not 2018. Stocks outside the U.S. have caught up to the post election rise in U.S. stocks. And so, just like it did in 2017, we think that the U.S. dollar will decline to catch up to that move in relative stock indices.
Ariana Salvatore: Finally, Andrew, we already discussed the U.S. dollar negative drivers from 2017. But what happened to these drivers the following year in 2018? And is that any indication for what might happen in 2026?
Andrew Watrous: So 2018, as you mentioned, does offer a blueprint for how the U.S. dollar could go up. So, for example, if trade tensions evolve in a direction where our economists would have to significantly downwardly revise their global growth forecasts, then the U.S. dollar could start to look more attractive as a safe haven. And in 2018, there was a big rise in long-end Treasury yields. That's not what we're calling for; but if that were to happen, then the U.S. dollar could catch a bid.
Ariana Salvatore: Andrew, thanks for taking the time to talk.
Andrew Watrous: Great speaking with you, Ariana.
Ariana Salvatore: 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.
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Our Semiconductors and Software analysts Joe Moore and Keith Weiss dive into the biggest market debate around AI and why it’s likely to shape conversations at Morgan Stanley’s Technology, Media and Telecom (TMT) Conference in San Francisco.
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Joe Moore: Welcome to Thoughts on the Market. I'm Joe Moore, Morgan Stanley's Head of U.S. Semiconductors.
Keith Weiss: And I'm Keith Weiss, Head of U.S. Software.
Joe Moore: Today on the show, one of the biggest market debates in the tech sector has been around AI and the Return On Investment, or ROI. In fact, we think this will be the number one topic of conversation at Morgan Stanley's annual Technology, Media and Telecom (TMT) conference in San Francisco.
And that's precisely where we're bringing you this episode from.
It's Monday, March 3rd, 7am in San Francisco.
So, let's get right into it. ChatGPT was released November 2022. Since then, the biggest tech players have gained more than $9 trillion in combined market capitalization. They're up more than double the amount of the S&P 500 index. And there's a lot of investor expectation for a new technology cycle centered around AI. And that's what's driving a lot of this momentum.
You know, that said, there's also a significant investor concern around this topic of ROI, especially given the unprecedented level of investment that we've seen and sparse data points still on the returns.
So where are we now? Is 2025 going to be a year when the ROI and GenAI finally turns positive?
Keith Weiss: If we take a step back and think about the staging of how innovation cycles tend to play out, I think it's a helpful context.
And it starts with research. I would say the period up until When ChatGPT was released – up until that November 2022 – was a period of where the fundamental research was being done on the transformer models; utilizing, machine learning. And what fundamental research is, is trying to figure out if these fundamental capabilities are realistic. If we can do this in software, if you will.
And with the release of ChatGPT, it was a very strong, uh, stamp of approval of ‘Yes, like these transformer models can work.’
Then you start stage two. And I think that's basically November 22 through where are today of, where you have two tracks going on. One is development. So these large language models, they can do natural language processing well.
They can contextually understand unstructured and semi structured data. They can generate content. They could create text; they could create images and videos.
So, there's these fundamental capabilities. But you have to develop a product to get work done. How are we going to utilize those capabilities? So, we've been working on development of product over the past two years. And at the same time, we've been scaling out the infrastructure for that product development.
And now, heading into 2025, I think we're ready to go into the next stage of the innovation cycle, which will be market uptake.
And that's when revenue starts to flow to the software companies that are trying to automate business processes. We definitely think that monetization starts to ramp in 2025, which should prove out a better ROI or start to prove out the ROI of all this investment that we've been making.
Joe Moore: Morgan Stanley Research projects that GenAI can potentially drive a $1.1 trillion dollar revenue opportunity in 2028, up from $45 billion in 2024. Can you break this down for our listeners?
Keith Weiss: We recently put out a report where we tried to size kind of what the revenue generation capability is from GenerativeAI, because that's an important part of this ROI equation. You have the return on the top of where you could actually monetize this. On the bottom, obviously, investment. And we took a look at all the investment needed to serve this type of functionality.
The [$]1.1 trillion, if you will, it breaks down into two big components. Um, One side of the equation is in my backyard, and that's the enterprise software side of the equation. It's about a third of that number. And what we see occurring is the automation of more and more of the work being done by information workers; for people in overall.
And what we see is about 25 percent, of overall labor being impacted today. And we see that growing to over 45 percent over the next three years.
So, what that's going to look like from a software perspective is a[n] opportunity ramping up to about, just about $400 billion of software opportunity by 2028. At that point, GenerativeAI will represent about 22 percent of overall software spending. At that point, the overall software market we expect to be about a $1.8 trillion market.
The other side of the equation, the bigger side of the equation, is actually the consumer platforms. And that kind of makes sense if you think about the broader economy, it's basically one-third B2B, two-thirds B2C. The automation is relatively equivalent on both sides of the equation.
Joe Moore: So, let's drill further into your outlook for software. What are the biggest catalysts you expect to see this year, and then over the coming three years?
Keith Weiss: The key catalyst for this year is proving out the efficacy of these solutions, right?
Proving out that they're going to drive productivity gains and yield real hard dollar ROI for the end customer. And I think where we'll see that is from labor savings.
Once that occurs, and I think it's going to be over the next 12 to 18 months, then we go into the period of mainstream adoption. You need to start utilizing these technologies to drive the efficiencies within your businesses to be able to keep up with your competitors. So, that's the main thing that we're looking for in the near term.
Over the next three years, what you're looking for is the breakthrough technologies. Where can we find opportunities not just to create efficiencies within existing processes, but to completely rewrite the business process.
That's where you see new big companies emerge within the software opportunity – is the people that really fundamentally change the equation around some of these processes.
So, Joe, turning it over to you, hardware remains a bottleneck for AI innovation. Why is that the case? And what are the biggest hurdles in the semiconductor space right now?
Joe Moore: Well, this has proven to be an extremely computationally intensive application, and I think it started with training – where you started seeing tens of thousands of GPUs or XPUS clustered together to train these big models, these Large Language Models. And you started hearing comments two years ago around the development of ChatGPT that, you know, the scaling laws are tricky.
You might need five times as much hardware to make a model that's 10 percent smarter. But the challenge of making a model that's 10 percent smarter, the table stakes of that are very significant. And so, you see, you know, those investments continuing to scale up. And that's been a big debate for the market.
But we've heard from most of the big spenders in the market that we are continuing to scale up training. And then after that happened, we started seeing inference suddenly as a big user of advanced processors, GPUs, in a way that they hadn't before. And that was sort of simple conversational types of AI.
Now as you start migrating into more of a reasoning AI, a multi pass approach, you're looking at a really dramatic scaling in the amount of hardware, that's required from both GPUs and XPUs.
And at the same time the hardware companies are focused a lot on how do we deliver that – so that it doesn't become prohibitively expensive; which it is very expensive. But there's a lot of improvement. And that's where you're sort of seeing this tug of war in the stocks; that when you see something that's deflationary, uh, it becomes a big negative. But the reality is the hardware is designed to be deflationary because the workloads themselves are inflationary.
And so I think there's a lot of growth still ahead of us. A lot of investment, and a lot of rich debate in the market about this.
Keith Weiss: Let's pull on that thread a little bit. You talked initially about the scaling of the GPU clusters to support training. Over the past year, we've gotten a little bit more pushback on the ideas or the efficacy of those scaling laws.
They've come more under question. And at the same time, we've seen the availability of some lower cost, but still very high-performance models. Is this going to reshape the investments from the large semiconductor players in terms of how they're looking to address the market?
Joe Moore: I think we have to assess that over time. Right now, there are very clear comments from everybody who's in charge of scaling large models that they intend to continue to scale.
I think there is a benefit to doing so from the standpoint of creating a richer model, but is the ROI there? You know, and that's where I think, you know, your numbers do a very good job of justifying our model for our core companies – where we can say, okay, this is not a bubble. This is investment that's driven by these areas of economic benefit that our software and internet teams are seeing.
And I think there is a bit of an arms race at the high end of the market where people just want to have the biggest cluster. And that's, we think that's about 30 percent of the revenue right now in hardware – is supporting those really big models. But we're also seeing, to your point, a very rich hardware configuration on the inference side post training model customization. Nvidia said on their on their earnings call recently that they see several orders of magnitude more compute required for those applications than for that pre-training. So, I think over time that's where the growth is going to come from.
But you know, right now we're seeing growth really from all aspects of the market.
Keith Weiss: Got it. So, a lot of really big opportunities out there utilizing these GPUs and ASICs, but also a lot of unknowns and potential risks. So, what are the key catalysts that you're looking for in the semiconductor space over the course of this year and maybe over the next three years?
Joe Moore: Well, 2025 is, is a year that is really mostly about supply.
You know, we're ramping up, new hardware But also, several companies doing custom silicon. We have to ramp all that hardware up and it's very complicated.
It uses every kind of trick and technique that semiconductors use to do advanced packaging and things like that. And so, it's a very challenging supply chain and it has been for two years. And fortunately, it's happened in a time when there's plenty of semiconductor capacity out there.
But I think, you know, we're ramping very quickly. And I think what you're seeing is the things that matter this year are gonna be more about how quickly we can get that supply, what are the gross margins on hardware, things like that.
I think beyond that, we have to really get a sense of, you know, these ROI questions are really important beyond 2025. Because again, this is not a bubble. But hardware is cyclical and there; it doesn't slow gracefully. So, there will be periods where investment may fall off and it'll be a difficult time to own the stocks. And that's, you know, we do think that over time, the value sort of transitions from hardware to software.
But we model for 2026 to be a year where it starts to slow down a little bit. We start to see some consolidation in these investments.
Now, 12 months ago, I thought that about 2025. So, the timeframe keeps getting pushed out. It remains very robust. But I think at some point it will plateau a little bit and we'll start to see some fragmentation; and we'll start to see markets like, you know, reasoning models, inference models becoming more and more critical. But that's where when I hear you and Brian Nowak talking about sort of the early stage that we are of actually implementing this stuff, that inference has a long way to go in terms of growth.
So, we're optimistic around the whole AI space for semiconductors. Obviously, the market is as well. So, there's expectations, challenges there. But there's still a lot of growth ahead of us.
So Keith, looking towards the future, as AI expands the functionality of software, how will that transform the business models of your companies?
Keith Weiss: We're also fundamentally optimistic about software and what GenerativeAI means for the overall software industry.
If we look at software companies today, particularly application companies, a lot of what you're trying to do is make information workers more productive. So, it made a lot of sense to price based upon the number of people who are using your software. Or you've got a lot of seat-based models.
Now we're talking about completely automating some of those processes, taking people out of the loop altogether. You have to price differently. You have to price based upon the number of transactions you're running, or some type of consumptive element of the amount of work that you're getting done. I think the other thing that we're going to see is the market opportunity expanding well beyond information workers.
So, the way that we count the value, the way that we accrue the value might change a little bit. But the underlying value proposition remains the same. It's about automating, creating productivity in those business processes, and then the software companies pricing for their fair share of that productivity.
Joe Moore: Great. Well, let me just say this has been a really useful process for me. The collaboration between our teams is really helpful because as a semiconductor analyst, you can see the data points, you can see the hardware being built. And I know the enthusiasm that people have on a tactical level. But understanding where the returns are going to come from and what milestones we need to watch to see any potential course correction is very valuable.
So on that note, it's time for us to get to the exciting panels at the Morgan Stanley TMT conference. Uh, And we'll have more from the conference on the show later this week. Keith, thanks for taking the time to talk.
Keith Weiss: Great speaking with you, Joe.
Joe Moore: 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.
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Our Global Head of Fixed Income Research and Public Policy Strategy explains why conflicting news on tariffs and government spending may point to a case for bonds.
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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today we’ll be discussing recent U.S. public policy headline noise and the signal within that for investors.
It’s Friday, February 28th, at 12:30 pm in New York.
For investors paying attention to events in Washington, D.C., the past few weeks have been disorienting. Tariff announcements have continued, but with shifting details on timing and magnitude. And Congress passed a bill to enable substantial spending cuts, but subsequent media reports made clear the votes to actually enact these cuts later this year may not be there.
Our recent client conversations have revealed that investors’ confusion has reached new heights, and there’s little consensus, or conviction, about whether U.S. policy choices are set to help or hurt the economy and markets.
Net-net, it's a lot of policy noise, and very little signal. That said, here’s what we think investors can anchor to.
For all the headlines on potential new tariffs for China, Mexico, Canada and on products like copper, actual tariff actions have followed a graduated pace, in line with our base case of ‘fast announcement, slow implementation’ – where tariffs on China start and continue to climb, but tariffs on the rest of world move slowly and are more subject to negotiation. Tariffs on Mexico and Canada appear, in our view, likely to be pushed out once again given progress in negotiation on harmonizing trade policy and progress in reduced border crossings.
On the other hand, tariffs on China, already raised an incremental 10 percent a few weeks back, seem likely to step up again as there are much bigger disagreements that the two nations don’t appear close to resolving.
But even if tariffs move according to the pace that we expect, that doesn’t mean they come without cost. The U.S.’s goal is to bring more investment onshore, with an aim toward increasing goods production, thereby reducing trade deficits, securing important supply chains, and growing industrial jobs. The theory is that higher tariff barriers might incentivize more direct investment into the U.S., as companies build supply chains in the U.S. to avoid the higher tariff costs.
But even if that theory plays out, there’s a cost to that transition. In a recent blue paper, my colleague Rajeev Sibal led a team through an analysis demonstrating that the next phase of supply chain realignment would be considerably costlier to companies, given the complexity of production that must be shifted. So either way, companies take on new costs – tariffs, CapEx, or both. That challenges corporate margins, and economic growth, at least for a time. And there’s plenty of execution risk along the way.
So what’s an investor to do? Our cross asset and interest rate strategy teams think it's time to lean more heavily into bonds. Equity markets may do just fine here, with investors looking through these near term costs, but the risk of something going wrong with, for example, tariffs escalation or broader geopolitical conflict, may keep a ceiling on investors’ risk appetite.
Conversely, a growth slowdown presents a clearer case for owning bonds, particularly since it wasn’t that long ago that better economic data helped the Treasury market price out most of the expected monetary policy cuts for 2025.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Two recent surveys indicate that U.S. consumer confidence has shown a notable decline amid talks about inflation and potential tariff. Our Head of Corporate Credit Research Andrew Sheets discusses the market implications.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about the consumer side of the confidence debate.
It’s Thursday, February 27th at 2pm in London.
Two weeks ago on this program I discussed signs that uncertainty in U.S. government policy might be hitting corporate confidence, as evidenced by an unusually slow start to the year for dealmaking. That development is a mixed bag. Less confidence and more conservatism in companies holds back investment and reduces the odds of the type of animal spirits that can drive large gains. But it can be a good thing for lenders, who generally prefer companies to be more cautious and more risk-averse.
But this question of confidence is also relevant for consumers. And today, I want to discuss what some of the early surveys suggest and how it can impact our view.
To start with something that may sound obvious but is nonetheless important, Confidence is an extremely powerful psychological force in the economy and financial markets. If you feel good enough about the future, you’ll buy a stock or a car with little regard to the price or how the economy might feel at the moment. And if you’re worried, you won’t buy those same things, even if your current conditions are still ok, or if the prices are even cheaper. Confidence, you could say, can trump almost everything else.
And so this might help explain the market’s intense focus on two key surveys over the last week that suggested that US consumer confidence has been deteriorating sharply.
First, a monthly survey by the University of Michigan showed a drop in consumer confidence and a rise in expected inflation. And then a few days later, on Tuesday, a similar survey from the Conference Board showed a similar pattern, with consumers significantly more worried about the future, even if they felt the current conditions hadn't much changed.
While different factors could be at play, there is at least circumstantial evidence that the flurry of recent U.S. policy actions may be playing a role. This drop in confidence, for example, was new, and has only really showed up in the last month or two. And the University of Michigan survey actually asks its respondents how news of Government Economic policy is impacting their level of confidence. And that response, over the last month, showed a precipitous decline.
These confidence surveys are often called ‘soft’ data, as opposed to the hard economic numbers like the actual sales of cars or heavy equipment. But the reason they matter, and the reason investors listened to them this week, is that they potentially do something that other data cannot. One of the biggest challenges that investors face when looking at economic data is that financial markets often anticipate, and move ahead of turns in the underlying hard economic numbers. And so if expectations are predictive of the future, they may provide that important, more leading signal.
One weak set of consumer confidence isn’t enough to change the overall picture, but it certainly has our attention. Our U.S. economists generally agree with these respondents in expecting somewhat slower growth and stickier inflation over the next 18 months; and Morgan Stanley continues to forecast lower bond yields across the U.S. and Europe on the expectation that uncertainties around growth will persist.
For credit investors, less confidence remains a double-edged sword, and credit markets have been somewhat more stable than other assets. But we would view further deterioration in confidence as a negative – given the implications for growth, even if it meant a somewhat easier policy path.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief U.S. Economist Michael Gapen discusses the possible economic implications of restrictive immigration policies in the U.S., highlighting their potential effect on growth, inflation and labor markets.
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Welcome to Thoughts on the Market. I’m Michael Gapen, Morgan Stanley’s Chief U.S. Economist. Today I’ll talk about the way restrictive immigration policies could potentially slow U.S. economic growth, push up inflation, and impact labor markets.
It’s Wednesday, February 26th, at 2pm in New York.
Lately, investors have been focused on the twists and turns of Trump’s tariffs. Several of my colleagues have discussed the issue of tariffs from various angles on this show. But we think the new administration’s immigration policy deserves more attention.
Immigration is more than just the entry of foreign citizens into the U.S. for residency. It's a complex process with significant implications for our economy. According to the Bureau of Labor Statistics, as of June 2024, 19 per cent of the US workforce was made up of immigrants – which is over 32 million people. This is a significant increase from 1994, when only about 10 per cent of the workforce was foreign-born. Immigrants tend to be employed in sectors like agriculture, construction and manufacturing, but also in face-to-face services sectors like retail, restaurants, hotels and healthcare.
Immigration surged to about 3 million per year after the pandemic. In fact, immigration rates in 2022 to 2024 were more than twice the historical run rate. This surge helped the US economy to "soft land" following a period of high inflation. It boosted both the supply side and the demand side of the U.S. economy. Labor force growth outpaced employment, which helped to moderate wage and price pressures.
However, Trump’s policymakers are changing the rules rapidly and reversing the immigration narrative. Already by the second half of 2024, border flows were slowing significantly based on the lagged effects of steps previously taken by the Biden administration. Under the new administration, news reports suggest immigration has slowed to near zero in recent weeks.
In our 2025 year-ahead outlook, we noted that restrictive immigration policies were a key factor in our prediction for slower growth and firmer inflation. We estimate that immigration will slow from 2.7 million last year to about 1 million this year and 500,000 next year. The recent data suggests immigration may slow every more forcefully than we expect.
If immigration slows broadly in line as we predict, the result will be that population growth in 2025 will be about 4/10ths of 1 per cent. That’s less than half of what the U.S. economy saw in 2024. The impact of slower immigration on labor force measures should be visible over time. For the moment though, there is enough noise in monthly payrolls and the unemployment rate to mask some of the labor force effects. But over three or six months, the impact of slower immigration should become clearer.
In terms of economic growth, if immigration falls back to 1 million this year and 500,000 next year, this could reduce the rate of GDP growth by about a-half a percentage point this year and maybe even more next year, and put upward pressure on inflation, particularly in services, and to some extent overall wages. Slower immigration could pull short-run potential GDP growth down from the 2.5-3.0 per cent that we saw in recent years to 2 per cent this year, and 1-1.5 per cent next year.
On the other hand, the unemployment rate might fall modestly as immigration controls reduce the number of households with high participation rates and low spending capacity. This could lead to tighter labor markets, moderately faster wage growth, and upward pressure on inflation. So we think we are looking at a two-speed labor market. Slower employment growth will feel soft and sluggish. But a low unemployment rate suggests the labour market itself is still tight.
Given all of this, we think more restrictive immigration policies could lead to tighter monetary policy and keep the Fed on its currently restrictive stance for longer. All of this supports our expectation of just one cut this year and further rate cuts only next year after growth slows.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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A shift to private destinations for cruise lines could affect both operators and guests by 2030. Our Europe Leisure & Travel analyst Jamie Rollo explains.
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Welcome to Thoughts on the Market. I’m Jamie Rollo, Morgan Stanley’s Europe Leisure & Travel Analyst. And today I’ll talk about an intriguing trend – the cruise lines’ accelerating expansion into private islands.
It’s Tuesday, February the 25th, at 2 PM in London.
Now the lure of a private island cruise is simple. You get almost exclusive access to a tropical retreat. You can lounge or snorkel on a pristine beach, you can enjoy a meal in a private cabana, you can even book a massage or a yoga class. The only other people around are fellow passengers on your vacation. So this isn't just the stuff of popular TV shows. It’s potentially the future of cruising.
Cruise lines have actually been offering private islands for more than a decade. So it’s hardly a new phenomenon. In fact, in 2019, we estimate the majority of Caribbean cruise passengers visited a private island.
As it happens, the Caribbean is the world's largest cruise destination. About saw 36 million cruise calls were there last year; that’s about 40 percent of global passenger capacity. And that’s surpassing the second largest region, the Mediterranean, at about 17 percent. Of course, the Caribbean’s proximity to North America and its year-round tropical climate make it a prime location for cruising. But despite these advantages, historically the Caribbean’s been seen as more of a lower-yielding market compared to regions like Europe or Alaska, which arguably have even more amazing scenery or historic sites.
Interestingly, recent trends suggest that reputation might be changing. And new private islands over the last few years have reinvigorated the Caribbean cruise market.
So what’s a private destinations or islands offer? For your guests, they get a seamless integration with the cruise experience. There’s no transfer required to a destination. There’s no external visitors coming into the resort. No-hassle, no-traffic, and very low crime.
And for the cruise lines, well, they get greater control over the customer experience. They create superior customer satisfaction, which generates more repeat business. In addition, they can get that on-island spend that the guest would have spent with external vendors. And they can charge premium rates for exclusive areas.
On top of that, many of these islands are quote close to the U.S. mainland, so you’re saving on fuel because the ship doesn’t have to steam so far; and on port fees. And then finally, proximity to the U.S. also can increase the short cruise duration market, which widens the addressable market for new-to-cruise passengers. And also can limit anti-tourism or anti-cruise sentiment because it moves guests out of congested areas and prevents unwanted visitors.
All in all, the private island model offers a very high return on invested capital and may well be the future of the cruise line industry. In fact, if we add up the expansion plans of the biggest listed cruise lines, we think their private island guest count will double over the next few years. And that could add over 10 per cent to top line sales and 30 per cent earnings-per-share for the fastest growing cruise lines.
So very considerable financials, but also it’s a private paradise within reach … and an idea we can all set sail to.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our CIO and Chief U.S. Equity Strategist Mike Wilson explains the challenges to growth for U.S. stocks and why some investors are looking to China and Europe.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing new headwinds for growth and what that means for equities.
It's Monday, Feb 24th at 11:30am in New York.
So let’s get after it.
Until this past Friday’s sharp sell off in stocks, the correlation between bond yields and stocks had been in negative territory since December. This inverse correlation strengthened further into year-end as the 10-year U.S. Treasury yield definitively breached 4.5 per cent on the upside for the first time since April of 2024. In November, we had identified this as an important yield threshold for stock valuations. This view was based on prior rate sensitivity equities showed in April of 2024 and the fall of 2023 as the 10-year yield pushed above this same level. In our view, the equity market has been signaling that yields above this point have a higher likelihood of weighing on growth. Supporting our view, interest rate sensitive companies like homebuilders have underperformed materially. This is why we have consistently recommended the quality factor and industries that are less vulnerable to these headwinds.
In our year ahead outlook, we suggested the first half of 2025 would be choppier for stocks than what we experienced last fall. We cited several reasons including the upside in yields and a stronger U.S. dollar. Since rates broke above 4.5 per cent in mid-December, the S&P 500 has made no progress. Specifically, the 6,100 resistance level that we identified in the fall has proven to be formidable for the time being. In addition to higher rates, softer growth prospects alongside a less dovish Fed are also holding back many stocks. As we have also discussed, falling rates won’t help if it’s accompanied by falling growth expectations as Friday’s sharp selloff in the face of lower rates illustrated.
Beyond rates and a stronger US dollar, there are several other reasons why growth expectations are coming down. First, the immediate policy changes from the new administration, led by immigration enforcement and tariffs, are likely to weigh on growth while providing little relief on inflation in the short term. Second, the Dept of Govt Efficiency, or DOGE, is off to an aggressive start and this is another headwind to growth, initially.
Third, there appears to have been a modest pull-forward of goods demand at the end of last year ahead of the tariffs, and that impulse may now be fading. Fourth, consumers are still feeling the affordability pinch of higher rates and elevated price levels which weighed on last month's retail sales data. Finally, difficult comparisons, broader awareness of Deep Seek, and the debate around AI [CapEx] deceleration are weighing on the earnings revisions of some of the largest companies in the major indices.
All of these items are causing some investors to consider cheaper foreign stocks for the first time in quite a while – with China and Europe doing the best. In the case of China, it’s mostly related to the news around DeepSeek and perhaps stimulus for the consumer finally arriving this year. The European rally is predicated on hopes for peace in Ukraine and the German election results that may lead to the loosening of fiscal constraints. Of the two, China appears to have more legs to the story, in my opinion.
Our Equity Strategy in the U.S. remains the same. We see limited upside at the index level in the first half of the year but plenty of opportunity at the stock, sector and factor levels. We continue to favor Financials, Software over Semiconductors, Media/Entertainment and Consumer Services over Goods. We also maintain an overriding penchant for quality across all size cohorts.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explores how a potential peace deal in Ukraine could reshape the global airline industry.
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Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Today’s topic is how a potential peace deal in Ukraine could affect global airlines.
It’s Friday, February 21st, at 2pm in Hong Kong.
The situation remains fluid, but we believe a potential peace deal in Ukraine could have broad implications for the global airline industry. From the reopening of Russian airspace to potential changes in fuel prices and flight routes, there are many variables at play.
Russian airspace is currently off-limits due to the conflict, but a peace agreement could change that. The reopening of Russian airspace would be a significant catalyst for global airlines, reducing travel times and fuel consumption on routes between Europe, North America, and Asia.
Fuel prices account for 20-40 per cent of airlines' costs, so any changes can have a significant impact on their bottom line. We believe a peace deal could lead to a moderate fall in fuel prices, benefiting all airlines, but particularly those with high-cost exposure and low margins.
There could also be specific regional implications. The European air travel market could benefit significantly from an end to the Ukraine conflict. The reopening of Russian airspace would improve European airlines’ competitiveness on Asian routes, while a fall in fuel prices would reduce their operating costs. There would also be lower congestion in the intra-European market.
Asian airlines, particularly Chinese ones, could experience a mixed impact. On the one hand, they could see an increase in wide-body utilization and passenger numbers if more direct flights to the U.S. are introduced. On the other hand, losing their advantage over European airlines of flying through Russian airspace would be negative. But, at the same time, Chinese airlines should remain competitive on pricing given meaningfully lower labor costs.
U.S. airlines could also benefit in two significant ways. They could see a boost in revenues from adding back profitable routes such as U.S. to India or U.S. to South Korea that may have been suspended. Being able to fly directly over Russia would mean shorter, more direct flight paths resulting in less fuel burn and lower costs. U.S. airlines could also see a cost decrease from a moderate fall in jet fuel prices.
Finally, Latin American carriers could also benefit from a peace deal. If global carriers reallocate capacity to China, it could tighten the market even further, creating an attractive capacity environment for the LatAm region.
We’ll continue to bring you relevant updates on this evolving situation.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Chief Economist Seth Carpenter explains the potential domino effect that President Trump’s reciprocal tariffs could have on the U.S. and global economies.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'm going to talk about downside risks to the U.S. economy, especially from tariffs.
It's Thursday, February 20th at 10am in New York.
Once again, tariffs are dominating headlines. The prospect of reciprocal tariffs is yet one more risk to our baseline forecast for the year. We have consistently said that the inflationary risk of tariffs gets its due attention in markets but the adverse growth implications that's an underappreciated risk.
But we, like many other forecasters, were surprised to the upside in 2023 and 2024. So maybe we should ask, are there some upside risks that we're missing?
The obvious upside risk to growth is a gain in productivity, and frequent readers of Morgan Stanley Research will know that we are bullish on AI. Indeed, the level of productivity is higher now than it was pre-COVID, and there is some tentative estimate that could point to faster growth for productivity as well.
Of course, a cyclically tight labor market probably contributes and there could be some measurement error. But gains from AI do appear to be happening faster than in prior tech cycles. So, we can't rule very much out. In our year ahead outlook, we penciled in about a-tenth percentage point of extra productivity growth this year from AI. And there is also a bit of a boost to GDP from AI CapEx spending.
Other upside risks, though, they're less clear. We don't have any boost in our GDP forecast from deregulation. And that view, I will say, is contrary to a lot of views in the market. Deregulation will likely boost profits for some sectors but probably will do very little to boost overall growth. Put differently, it helps the bottom line far more than it helps the top line. A notable exception here is probably the energy sector, especially natural gas.
Our baseline view on tariffs has been that tariffs on China will ramp up substantially over the year, while other tariffs will either not happen or be fleeting, being part of, say, broader negotiations. The news flow so far this year can't reject that baseline, but recently the discussion of broad reciprocal tariffs means that the risk is clearly rising.
But even in our baseline, we think the growth effects are underestimated. Somewhere in the neighborhood of two-thirds of imports from China are capital goods or inputs into U.S. manufacturing. The tariffs imposed before on China led to a sharp deterioration in industrial production. That slump went through the second half of 2018 and into and all the way through 2019 as a drag on the broader economy. Just as important, there was not a subsequent resurgence in industrial output.
Part of the undergraduate textbook argument for tariffs is to have more produced at home. That channel works in a two-economy model. But it doesn't work in the real world.
Now, the prospect of reciprocal tariffs broadens this downside risk. Free trade has divided production functions around the world, but it's also driven large trade imbalances, and it is precisely these imbalances that are at the center of the new administration's focus on tariffs. China, Canada, Mexico – they do stand out because of their imbalances in terms of trade with the U.S., but the underlying driving force is quite varied. More importantly, those imbalances were built over decades, so undoing them quickly is going to be disruptive, at least in the short run.
The prospect of reciprocity globally forces us as well to widen the lens. The risks aren't just for the U.S., but around the world. For Latin America and Asia in particular, key economies have higher tariff supply to U.S. goods than vice versa.
So, we can't ignore the potential global effects of a reciprocal tariff.
Ultimately, though, we are retaining our baseline view that only tariffs on China will prove to be durable and that the delayed implementation we've seen so far is consistent with that view. Nevertheless, the broad risks are clear.
Thanks for listening. And if you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our co-heads of Securitized Products Research, James Egan and Jay Bacow, explain how the increase in home prices, a tight market supply and steady mortgage rates are affecting home sales.
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James Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.
Jay Bacow: And I'm Jay Bacow, the other co-head of Securitized Products Research at Morgan Stanley.
Today, a look at the latest trends in the mortgage and housing market.
It's Wednesday, February 19th, at 11am in New York.
Now, Jim, there's been a lot of headlines to kick off the year. How is the housing market looking here? Mortgage rates are about 80 basis points higher than the local lows in September. That can't be helping affordability very much.
James Egan: No, it is not helping affordability. But let's zoom out a little bit here when talking about affordability. The monthly payment on the medium-priced home had fallen about $225 from the fourth quarter of 2023 to local troughs in September. About a 10 percent decrease. Since that low, the payment has increased about $150; so, it's given back most of its gains.
Importantly, affordability is a three-pronged equation. It's not just that payment. Home prices, mortgage rates, and incomes. And incomes are up about 5 percent over the past year. So, affordability has improved more than those numbers would suggest, but those improvements have certainly been muted as a result of this recent rate move.
Jay Bacow: Alright. Affordability is up, then it’s down. It’s wrong, then it’s right. It sounds like a Katy Perry song. So, how have home sales evolved through this rollercoaster?
James Egan: Well, you and I came on this podcast several times last year to talk about the fact that home sales volumes weren't really increasing despite the improvement in affordability. One point that we made over and over again was that it normally takes 9 to 12 months for sales volumes to increase when you get this kind of affordability improvement. And that would make the fourth quarter of 2024 the potential inflection point that we were looking for. And despite this move in mortgage rates, that does appear to have been the case. Existing home sales had a very strong finish to last year. And in the fourth quarter, they were up 8 percent versus the fourth quarter of 2023. That's the first year-over-year increase since the second quarter of 2021.
Jay Bacow: All right. So that's pretty meaningful. And if looking backward, home sales seem to be inflecting, what does that mean for 2025?
James Egan: So, there's a number of different considerations there. For one thing, supply – the number of homes that are actually for sale – is still very tight, but it is increasing. It may sound a little too simplistic, but there do need to be homes for sale for homes to sell, and listings have reacted faster than sales. That strong fourth quarter in existing home sales that I just mentioned, that brought total sales volumes for the year to 1 percent above their 2023 levels. For sale inventory finished the year up 14 percent.
Jay Bacow: Alright, that makes sense. So, more people are willing to sell their home, which means there's a little bit more transaction volume. But is that good for home prices?
James Egan: Not exactly. And it is those higher listings and our expectation that listings are going to continue to climb that's been the main factor behind our call for home price growth to continue to slow. Ultimately, we think that you see home sales up in the context of about 5 percent in 2025 versus 2024.
Our leading indicators of demand have softened, a little, in December and January, which may be a result of this sharp increase in rates. But ultimately, when we look at turnover in the housing market, and we're talking about existing sales as a share of the outstanding homes in the U.S. housing market, we think that we're kind of at the basement right now. If we're wrong in our sales volume call, I would think it's more likely that there are more sales than we think. Not less.
Jay Bacow: Let me ask you another easy question. How far would rates have to fall to really incentivize more supply and/or demand in the housing market?
James Egan: That's the $45 trillion question. We think the current housing market presents a fascinating case study in behavioral economics. Even if mortgage rates were to decline to 4.5 percent, only 35 percent of people would be in the money. And that's still over 200 basis points from where we are today.
That being said, we think it's unlikely that mortgage rates need to fall all the way to that level to unlock the housing market. While the lack of any historical precedent makes it difficult for us to identify a specific threshold at which activity could increase meaningfully, we recently turned to Morgan Stanley's AlphaWise to conduct a consumer pulse survey to get a better sense of how people were feeling about their housing options.
Jay Bacow: I like data. How are those people feeling?
James Egan: All right, so 31 percent of people anticipate buying a home over the next two years, and almost half are considering buying over the next five. Interestingly, only 21 percent are considering selling their home over the next two years. In other words, perceived demand is about 50 percent greater than marginal supply, at least in the immediate future, which we think could be a representation of that lock-in effect.
Current homeowners’ expectations of near-term listings are depressed because of how low their mortgage rate is. But we did ask: What if mortgage rates were to fall from 6.8 percent today to 5. 5 percent? In that world, 85 to 90 percent of the people planning to buy a home in the next two years stated that they would be more likely to execute on that purchase.
So, we think it's safe to say that a decline in mortgage rates could accelerate purchase decisions. But Jay, are we going to see that decline?
Jay Bacow: Well, our interest rate strategists do think that rates are going to rally from here. They've updated their 10-year forecast to expect the tenure note ends 2025 at 4 percent. If the tenure note's at 4 percent, mortgage rate should come down from here, but not to that 4.5 percent, or probably even that 5.5 percent level that you quoted. You know, honestly, you don't really want to stay, you don't really want to go. We're probably talking about like a 6 percent mortgage rate. Not quite that level.
But Jim, this is a national level, a national mortgage rate, and housing markets about location and location and location. Are there geographical nuances to your forecast?
James Egan: People all over the country are asking, should they stay or should they go now, and that answer is different depending on where you live, right? If you look at the top 100 MSAs in the country, 8 of the top 11 markets showing the largest increases in inventory over the past year can be found in Florida.
So, we would expect Florida to be a little bit softer than our national numbers. On the other hand, inventory growth has been most subdued in the Northeast and the Midwest, with several markets continuing to see inventory declines.
Jay Bacow: All right, well selfishly, as somebody that lives in the Northeast, I am a little bit happy to hear that. But otherwise, Jim, it's always a pleasure listening to you.
James Egan: Pleasure talking to you too, Jay. Thanks for listening, and if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
DISCLAIMER
Jay Bacow: So, Jim, the lock-in effect is: You don’t really want to stay. No. But you don’t really want to go.
James Egan: That is exactly; that is perfect! Wow. That is the whole issue with the housing market.
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Our CIO and Chief U.S. Equity Strategy Mike Wilson suggests that stock, factor and sector selection remain key to portfolio performance.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing equities in the context of higher rates and weaker earnings revisions.
It's Tuesday, Feb 18th at 11:30am in New York.
So let’s get after it.
Since early December, the S&P 500 has made little headway. The almost unimpeded run from the summer was halted by a few things but none as important as the rise in 10-year Treasury yields, in my view. In December, we cited 4 to 4.5 percent as the sweet spot for equity multiples assuming growth and earnings remained on track. We viewed 4.5 percent as a key level for equity valuations. And sure enough, when the Fed leaned less dovish at its December meeting, yields crossed that 4.5 percent threshold; and correlations between stocks and yields settled firmly in negative territory, where they remain. In other words, yields are no longer supportive of higher valuations—a key driver of returns the past few years.
Instead, earnings are now the primary driver of returns and that is likely to remain the case for the foreseeable future. While the Fed was already increasingly less dovish, the uncertainty on tariffs and last week’s inflation data could further that shift with the bond market moving to just one cut for the rest of the year. Our official call is in line with that view with our economists now just looking for just one cut–in June. It depends on how the inflation and growth data roll in.
Our strategy has shifted, too. With the S&P 500 reaching our tactical target of 6100 in December and earnings revision breadth now rolling over for the index, we have been more focused on sectors and factors. In particular, we’ve favored areas of the market showing strong earnings revisions on an absolute or relative basis.
Financials, Media and Entertainment, Software over Semiconductors and Consumer Services over Goods continue to fit that bill. Within Defensives, we have favored Utilities over Staples, REITs and Healthcare. While we’ve seen outperformance in all these trades, we are sticking with them, for now. We maintain an overriding preference for Large-cap quality unless 10-year Treasury yields fall sustainably below 4.5 percent without a meaningful degradation in growth. The key component of 10-year yields to watch for equity valuations remains the term premium – which has come down, but is still elevated compared to the past few years.
Other macro developments driving stock prices include the very active policy announcements from the White House including tariffs, immigration enforcement, and cost cutting efforts by the Department of Government Efficiency, also known as DOGE. For tariffs, we believe they will be more of an idiosyncratic event for equity markets. However, if tariffs were to be imposed and maintained on China, Mexico and Canada through 2026, the impact to earnings-per-share would be roughly 5-7 percent for the S&P 500. That’s not an insignificant reduction and likely one of the reasons why guidance this past quarter was more muted than fourth quarter results.
Industries facing greater headwinds from China tariffs include consumer discretionary goods and electronics. Lower immigration flow and stock is more likely to affect aggregate demand than to be a wage cost headwind, at least for public companies. Finally, skepticism remains high as it relates to DOGE’s ability to cut Federal spending meaningfully. I remain more optimistic on that front, but realize greater success also presents a headwind to growth before it provides a tailwind via lower fiscal deficits and less crowding out of the private economy—things that could lead to more Fed cuts and lower long-term interest rates as term premium falls.
Bottom line, higher backend rates and growth headwinds from the stronger dollar and the initial policy changes suggest equity multiples are capped for now. That means stock, factor and sector selection remains key to performance rather than simply adding beta to one’s portfolio. On that score, we continue to favor earnings revision breadth, quality, and size factors alongside financials, software, media/entertainment and consumer services at the industry level.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Head of Fixed Income and Public Policy Research, Michael Zezas, joins our Chief U.S. Economist, Michael Gapen, to discuss the possible outcomes for President Trump’s immigration policies and their effect on the U.S. economy.
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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.
Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist for Morgan Stanley.
Michael Zezas: Our topic today: President Trump's immigration policy and its economic ramifications.
It's Friday, February 14th at 10am in New York.
Michael, migration has always been considered an important feature of the global economy. In fact, you believe that strong immigration flows were an important element in the supply side rebound that set the stage for a U.S. soft landing. If we think back to the time before President Trump took office almost a month ago, how would you categorize immigration trends then?
Michael Gapen: So, we saw a very sharp increase in immigration coming out of the pandemic. I would say, if you look at longer term averages, say the 20 years leading up to the pandemic, normally we'd get about a million and a half immigrants, per year into the United States. A lot of variation around that number, but that was the long-term average.
In 2022 through 2024, we saw immigration surge to about 3 million per year. So about twice as fast as we saw normally. And that happened at a very important time. It allowed for very significant and rapid growth in the labor force, just at a time when the economy was emerging from the pandemic and demand for labor was quite high.
So, it filled that labor demand. It allowed the economy to grow rapidly, while at the same time helping to keep wages lower and inflation starting to come down. So, I do think it was a major underpinning force in the ability of the U.S. economy to soft land after several years of above target inflation.
Michael Zezas: Got it. And so now, with a second President Trump term, are we set up for a reversal of this immigration driven boost to the economy?
Michael Gapen: Yeah, I think that's the key question for the outlook, and our answer is yes. That if we are going to significantly restrict immigration flows, the risk here is that we reverse the trends that we've just seen in the previous year.
So, I certainly believe one of the main goals of the Trump administration is to harden the border and initiate greater deportations. And these steps in my mind come on the back of steps that the Biden administration already took around the middle of last year that began to slow immigration flows.
So yes, I do think we should look for a reversal of the immigration driven boost to the economy. But Mike, I would actually throw this question back to you and say on the first day of his presidency, Trump issued a series of executive orders pertaining to immigration. Where are we now in that process after these initial announcements? And what do you expect in terms of policy implementation?
Michael Zezas: Well, I think you hit on it. There's two levers here. There's stepped up deportations and removals and there's working with Mexico on border enforcement. Things like the remain in Mexico policy where Mexico agrees to keep those seeking asylum on their side of the border; and to facilitate that, they've stepped up their military presence to do that.
Those are really kind of the two levers that the U.S. is pushing on to try and reduce the flow of migrants coming into the U.S. Still to be determined how much these actually have an impact, but I think that's the direction of policy travel.
Michael Gapen: And are there any catalysts specifically that you're watching for? I mean, recently the administration proposed tariffs on Mexico and Canada around border control, but those have been delayed. Is there anything on the horizon we should look for this time around?
Michael Zezas: Yeah. So obviously the president tied the potential for tariffs on Mexico and Canada to the idea that there should be some improvement on border enforcement. It's going to be difficult for investors, I think, to assess in real time how much progress has been made there. Mostly it's a data challenge here. There are official government statistics which have a good amount of detail about removals and folks stopped at the border and demographics in terms of age and, and whether or not they were working. That might really kind of help us piece together the story in terms of whether or not there's going to be future tariffs – and Michael, probably for you, to what extent there's an impact on the economy if folks are already in the labor force.
But that data is on a lag, it'll be really difficult to tell what's happening now for at least several months. Maybe we're going to get some hints about what's going on for comments coming in earnings calls, for example, from companies that deal in construction and food service and hospitality. But I don't know that those anecdotes would be sufficient to really draw substantial conclusions. So, I think we're a bit in a fog for the next couple months on exactly what's happening.
But based on all this, Michael, what's your outlook for immigration this year and beyond?
Michael Gapen: Yeah, so we, as I mentioned, we were getting about 3 million immigrants per year between 2022 and 2024; long run averages before the pandemic were more like a million and a half a year. Our outlook is that immigration flows should slow below pre- COVID averages to about 1 million this year and about 500,000 in 2026. And again, that would be the well below the long run average of about a million and a half per year.
Now, as you mentioned, understanding these flows in real time is hard and there's a lot of uncertainty around this and how effective policies may be. So, I think people should consider ranges around this baseline, if you will. On one hand, we could see a reduction in unauthorized immigration replaced by more authorized immigration. So maybe there's a benign scenario where immigration slows back to its one and a half million per year. But it's more through legal and formal channels than unauthorized channels.
Alternatively, it could be the case that some of the policies, you mentioned in terms of, say, stepped up deportations or other measures, and maybe there's a chilling effect. That there's just like an externality on immigration behavior. And in fact, we slow maybe to about 500,000 this year and see a decline in about 250,000 next year.
So, I think there's a lot of uncertainty about it. We think immigration slows below its longer run averages, which would represent a major shift from what we've seen over the last three years.
Michael Zezas: Got it. So, lots of crosscurrents here, about how the actual labour supply is impacted. But bottom line, if we do arrive at a point where there’s a significant reduction in immigration, what’s the expectation about what that means for the U.S. economy?
Michael Gapen: Yeah, so a lot of cross currents here. Number one, I think with a high degree of confidence, we can say reduced immigration should lead to slower potential growth, right? So, a slower growth in the labor force should mean slower growth in trend hours, right? Potential GDP is really only the sum of growth in trend hours and trend productivity.
So, the surge in immigration we saw really boosted potential growth up to 2.5 per cent to 3 per cent in recent years. So, if we reduce immigration, potential growth should slow. I think back towards, say, 2 per cent this year, maybe even 1 to 1.5 per cent next year. So, you slow down growth in the labor force, potential should moderate.
Second, and I think the more difficult question is, well, okay, if you also reduce growth in the labor force, you're going to get less employment, and that's a demand side effect. So, which dominates here, the supply side or the demand side? And here, I think to go back to your first question – yeah, I do think we're going to get a reversal of the outcome that we just saw.
So, I think it'll moderate both potential and actual growth. So, I think actual growth slows. The amount of employment we see should decline and soften. We're not saying the level of employment will decline, but the growth rate of employment should slow. But it should coincide with a low unemployment rate, so it's going to be a very different labor market. A lot less employment growth, but still a tight labor market in terms of low unemployment.
That should keep wages firm, particularly in the service sector where a lot of immigrants work, and we think it'll also help keep inflation firm. So, it could keep the Fed on the sideline for a significant period of time, for example.
And I'd just like to close, Mike, by saying I think this is an underappreciated risk for financial markets. I think investors have digested trade policy uncertainty, but I'm not convinced that risks around immigration and their effect on the economy are well understood.
Michael Zezas: Got it. Well Michael, thanks for taking the time to talk.
Michael Gapen: Thank you.
Michael Zezas: Thanks for listening. If you enjoy the show, leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
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Our Head of Foreign Exchange & Emerging Markets Strategy James Lord discusses how much tariff-driven volatility investors can expect in currency markets this year.
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Welcome to Thoughts on the Market. I’m James Lord, Morgan Stanley’s Head of Foreign Exchange & Emerging Markets Strategy.
Today – the implications of tariffs for volatility on foreign exchange markets.
It’s Thursday, February 13th, at 3pm in London.
Foreign exchange markets are following President Trump’s tariff proposals with bated breath. A little over a week ago investors faced significant uncertainty over proposed tariffs on Mexico, Canada, and China. In the end, the U.S. reached a deal with Canada and Mexico, but a 10 per cent tariff on Chinese imports went into effect. Currencies experienced heightened volatility during the negotiations, but the net impacts at the end of the negotiations were small. Announced tariffs on steel and aluminum have had a muted impact too, but the prospect of reciprocal tariffs are keeping investors on edge.
We believe there are three key lessons investors can take away from this recent period of tariff tension. First of all, we need to distinguish between two different types of tariffs. The first type is proposed with the intention to negotiate; to reach a deal with affected countries on key issues. The second type of tariff serves a broader purpose. Imposing them might reduce the U.S. trade deficit or protect key domestic industries.
There may also be examples where these two distinct approaches to tariffs meld, such as the reciprocal tariffs that President Trump has also discussed.
The market impacts of these different tariffs vary significantly. In cases where the ultimate objective is to make a deal on a separate issue, any currency volatility experienced during the tariff negotiations will very likely reverse – if a deal is made. However, if the tariffs are part of a broader economic strategy, then investors should consider more seriously whether currency impacts are going to be more long-lasting. For instance, we believe that tariffs on imports from China should be considered in this context. As a result, we do see sustained dollar/renminbi upside, with that currency pair likely to hit 7.6 in the second half of 2025.
A second key issue for investors is going to be the timing of tariffs. April 1st is very likely going to be a key date for Foreign Exchange markets as more details around the America First Trade Policy are likely revealed. We could see the U.S. dollar strengthen in the days leading up to this date, and investors are likely to consider where subsequently there will be a more significant push to enact tariffs.
A final question for investors to ponder is going to be whether foreign exchange volatility would move to a structurally higher plane, or simply rise episodically. Many investors currently assume that FX volatility will be higher this year, thanks to the uncertainty created by trade policy. However, so far, the evidence doesn’t really support this conclusion. Indicators that track the level of uncertainty around global trade policy did rise during President Trump's first term, specifically around the period of escalating tariffs on China. And while this was associated with a stronger [U.S.] dollar, it did not lead to rising levels of FX volatility.
We can see again, at the start of Trump's second term, that rising uncertainty over trade policy has been consistent with a stronger U.S. dollar. And while FX volatility has increased a bit, so far the impact has been relatively muted – and implied volatility is still well below the highs that we’ve seen in the past ten years. FX volatility is likely to rise around key dates and periods of escalation; and while structurally higher levels of FX volatility could still occur, the odds of that happening would increase if tariffs resulted in more substantial macro economic consequences for the U.S. economy.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen. And share Thoughts on the Market with a friend or a colleague today.
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The down-to-the-deadline nature of Trump’s trade policy has created market uncertainty. Our Head of Corporate Credit Research Andrew Sheets points out a silver lining.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about a potential silver lining to the significant uptick in uncertainty around U.S. trade policy.
It's Wednesday, February 12th at 2pm in London.
One of the nuances of our market view is that we think credit spreads remain tight despite rising levels of corporate confidence and activity. We think these things can co-exist, at least temporarily, because the level of corporate activity is still so low, and so it could rise quite a bit and still only be in-line with the long-term trend. And so while more corporate activity and aggression is usually a negative for lenders and drives credit spreads wider, we don’t think it’s quite one yet.
But maybe there is even less tension in these views than we initially thought.
The first four weeks of the new U.S. Administration have seen a flurry of policy announcements on tariffs. This has meant a lot for investors to digest and discuss, but it’s meant a lot less to actual market prices. Since the inauguration, U.S. stocks and yields are roughly unchanged.
That muted reaction may be because investors assume that, in many cases, these policies will be delayed, reversed or modified. For example, announced tariffs on Mexico and Canada have been delayed. A key provision concerning smaller shipments from China has been paused. So far, this pattern actually looks very consistent with the framework laid out by my colleagues Michael Zezas and Ariana Salvatore from the Morgan Stanley Public Policy team: fast announcements of action, but then much slower ultimate implementation.
Yet while markets may be dismissing these headlines for now, there are signs that businesses are taking them more seriously. Per news reports, U.S. Merger and Acquisition activity in January just suffered its lowest level of activity since 2015. Many factors could be at play. But it seems at least plausible that the “will they, won’t they” down-to-the-deadline nature of trade policy has increased uncertainty, something businesses generally don’t like when they’re contemplating big transformative action.
And for lenders maybe that’s the silver lining. We’ve been thinking that credit in 2025 would be a story of timing this steadily rising wave of corporate aggression. But if that wave is delayed, debt levels could end up being lower, bond issuance could be lower, and spread levels – all else equal – could be a bit tighter.
Corporate caution isn’t everywhere. In sectors that are seen as multi-year secular trends, such as AI data centers, investment plans continue to rise rapidly, with our colleagues in Equity Research tracking over $320bn of investment in 2025. But for activity that is more economically sensitive, uncertainty around trade policy may be putting companies on the back foot. That isn’t great for business; but, temporarily, it could mean a better supply/demand balance for those that lend to them.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief Asia Economist Chetan Ahya discusses the potential impact of reciprocal U.S. tariffs on Asian economies, highlighting the key markets at risk.
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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Today: the possibilities of reciprocal tariffs between the U.S. and Asian economies.
It’s Tuesday, February 11, at 2pm in Singapore.
President Trump’s recent tariff actions have already been far more aggressive than in 2018 and 2019. And this time around, multiple trade partners are simultaneously facing broad-based tariffs, and tariffs are coming at a much faster pace. The risk of trade tensions escalating has risen, and the latest developments may have kicked that risk up another notch.
The U.S. president is pushing a sweeping tariff of 25 per cent on all foreign steel and aluminum products. Trump has also indicated that he would propose reciprocal tariffs on multiple countries – to match the tariffs levied by each country on U.S. imports. This potential reciprocal tariff proposal suggests that Asia ex China may be more exposed to possible tariff hikes. As of now, Asia’s tariffs on US imports are, for the most part, slightly higher than US tariffs on Asian imports. And based on [the] latest available data, six economies in Asia do impose [a] higher weighted average tariff on the U.S. than the U.S. does on individual Asia economies.
The tariff differentials are most pronounced for India, Thailand, and Korea. These three economies may face a risk of a hike in tariffs by 4 to 6 percentage points on a weighted average basis, if the U.S. imposes reciprocal tariffs. Individual products may yet face higher tariffs rates but we think [the] overall impact from steel, aluminum and reciprocal tariffs will be manageable.
But look, trade tensions may still rise further given that 7 out of 10 economies with the largest trade surplus with the U.S. are in Asia. Against this backdrop, policy makers may have to look for ways to address the demands from the U.S. administration.
For instance, Japan’s Prime Minister Ishiba has committed to increasing investment in the U.S. and is looking to raise energy imports from the U.S. This is seen as a positive step to reduce the U.S. trade deficit with Japan. Meanwhile, ahead of the meeting between President Trump and India’s Prime Minister Modi later this week, India has already taken steps to lower tariffs on the U.S., and may propose [an] increase in imports of oil and gas, defense equipments and aircrafts to narrow its trade surplus with the U.S.
However, as regards China is concerned, the wide scope of issues in the bilateral relationship suggests that [the] U.S. administration would cite a variety of reasons for expanding tariffs. As things stand, China has been the only economy so far where tariff hikes have stayed in place. Indeed, the recent 10 percent increase in tariffs has already matched the increase in the weighted average tariffs that transpired in 2018 and 2019. And we still expect that tariffs on imports from China will continue to rise over the course of 2025.
To sum it up, there has been a constant stream of tariff threats from the U.S. administration. While the direct effects of [the] tariffs appear manageable, the bigger concern for us has been that this policy uncertainty will potentially weigh on corporate sector confidence, CapEx and growth cycle.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Global Head of Fixed Income and Public Policy Research Michael Zezas and Head of Global Evaluation, Accounting and Tax Todd Castagno discuss the market and economic implications of proposed tax extensions and tax cuts.
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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy.
Todd Castagno: And I'm Todd Castagno, Head of Global Evaluation, Accounting and Tax.
Michael Zezas: Today, we'll focus on taxes under the new Trump administration.
It's Monday, February 10th, at 10am in New York.
Recently, at the annual meeting of the World Economic Forum in Davos, President Trump stated his administration will pass the largest tax cut in American history, including substantial tax cuts for workers and families. He was short on the details, but tax policies were a significant focus of his election campaign.
Todd, can you give us a better sense of the tax cuts that Trump's been vocal about so far?
Todd Castagno: Well, there's tax cuts and tax extensions. So, I think that's an important place to set the baseline. The Tax Cuts and Jobs Act (TCJA), under his first administration, starts to expire in 2025. And so, what we view is, the most likelihood is, an extension of those policies going forward. However, there's some new ideas, some new contours as well. So, for instance, a lower corporate rate that gets you in the 15 per cent ballpark can be through domestic tax credits, new incentives.
I think there's other items on the individual side of the code that could be explored as well. But we also have to kind of step back and creating new policy is very challenging. So again, that baseline is an extension of kind of the tax world we live in today.
So, Michael, looking at the broader macro picture and from conversations with our economist, how would these tax cuts impact GDP and macro in general?
Michael Zezas: Well, if you're talking about extension of current policy, which is most of our expectation about what happens with taxes at the end of the year, the way our economists have been looking at this is to say that there's no net new impulse for households or companies to behave differently.
That might be true on a sector-by-sector basis, but in the aggregate for the economy, there's no reason to look at this policy and think that it is going to provide a definitive uplift to the growth forecast that they have for 2026. Now, there may be some other provisions that could add in there that are incremental that we'd have to consider.
But still, they would probably take time to play out or their measurable impact would be very hard to define. Things like raising the cap on the state and local tax deduction, that tends to impact higher income households who already aren't constrained from a spending perspective. And things like a domestic manufacturing tax credit for companies, that could take several years to play out before it actually manifests into spending.
Todd Castagno: And you’re kind of seeing that with the prior administration's tax law, the Inflation Reduction Act. A lot of this takes years in order to actually play through the economy. So that's something that investors should consider.
Michael Zezas: Yeah, these things certainly take time; and you know back in 2018 it had been a long ambition, particularly of Republican lawmakers, to reduce the corporate tax rate. They succeeded in doing that, getting it down to 21 per cent in Trump's first term. Now, Trump's talked about getting corporate tax rates lower again here. If he's able to do that, how do you think he would do that? And would that affect how you're thinking about investment and hiring?
Todd Castagno: So, there's the corporate rate itself, and it's at 21 per cent currently. There is a view to change that rate, lower it. However, there's other ways you can reduce that effective tax burden through what we've just discussed. So enhanced corporate deductions, timing differences, companies can benefit from a tax system that ultimately gets them a lower effective rate, even if the corporate rate doesn't move much.
Michael Zezas: And so, what sorts of companies and what sorts of sectors of the market would benefit the most from that type of reduction in the corporate tax burden?
Todd Castagno: So, if you think they're mosaic of all these items, it's going to accrue to domestic companies. That might sound kind of obvious, but if you look at our economy, we have large multinationals and we have domestic companies and we have small businesses. The policies that are being articulated, I think, mostly orient towards domestic companies, industrials, for instance, R&D incentives, again powering our AI plants, energy, et cetera.
Michael Zezas: Got it. And is there any read through on if a company does better under this policy – if they're big relative to being small?
Todd Castagno: There are a lot of small business elements as well. So, I mentioned that timing difference, being able to deduct a piece of machinery day one versus over seven years. So, there's a lot of benefits that are not in the rate itself that can accrue through smaller businesses.
Michael Zezas: YAnd what about for individual taxpayers, particularly the middle class? What particular tax cuts are on the table there?
Todd Castagno: So, first and foremost is the child tax care credit. So, it’s current policy, but after COVID, it was enhanced. A higher dollar amount, different mechanism for receiving funds. And so, there is bipartisan support and President Trump as well, bringing back a version of an enhanced credit. Now, the policy is a little bit tricky, but I would say there's very good odds that that comes back. You know, you mentioned the state and local tax deduction, right? The politics are also tricky, but there could be a rate of change where that reverts back to pre-TCJA.
But one of the things, Michael, is all these policies are very expensive. So, I'm just curious, in your mind, how do we balance the price tag versus the outcome?
Michael Zezas: Well, I think the main constraint here to consider is that Republicans have a very slim majority in the House of Representatives and the Senate, and they're unlikely to get Democratic representatives crossing the aisle to vote with them on a tax package this large. So, they'll really need complete consensus on whatever tax items they extend and the deficit impact that it causes this is the type of thing that ultimately will constrain the package to be smaller than perhaps some of the president's stated ambitions.
So, for example, items like making the interest payments on auto loans tax deductible, we think there might not be sufficient support for that and the budget costs that it would create. So ultimately, we think you get back to a package that's mostly about extending current cuts, adding in a couple more items like that domestic manufacturing tax credit, which is also very closely tied to Republicans larger trade ambition. And you might also see Republicans do some things to reduce the price tag, like, for example, only extend the tax cuts for a few years, as opposed to five or 10 years.
Todd Castagno: Right.
Michael Zezas: Todd, thanks for taking the time to talk.
Todd Castagno: Great speaking with you, Mike.
Michael Zezas: Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief Fixed Income Strategist Vishy Tirupattur thinks that efficiency gains from Chinese AI startup DeepSeek may drive incremental demand for AI.
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Welcome to Thoughts on the Market. I’m Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Today I’ll be talking about the macro implications of the DeepSeek development.
It's Friday February 7th at 9 am, and I’m on the road in Riyadh, Saudi Arabia.
Recently we learned that DeepSeek, a Chinese AI startup, has developed two open-source large language models – LLMs – that can perform at levels comparable to models from American counterparts at a substantially lower cost. This news set off shockwaves in the equity markets that wiped out nearly a trillion dollars in the market cap of listed US technology companies on January 27. While the market has recouped some of these losses, their magnitude raises questions for investors about AI. My equity research colleagues have addressed a range of stock-specific issues in their work. Today we step back and consider the broader implications for the economy in terms of productivity growth and investment spending on AI infrastructure.
First thing. While this is an important milestone and a significant development in the evolution of LLMs, it doesn’t come entirely as a shock. The history of computing is replete with examples of dramatic efficiency gains. The DeepSeek development is precisely that – a dramatic efficiency improvement which, in our view, drives incremental demand for AI. Rapid declines in the cost of computing during the 1990s provide a useful parallel to what we are seeing now. As Michael Gapen, our US chief economist, has noted, the investment boom during the 1990s was really driven by the pace at which firms replaced depreciated capital and a sharp and persistent decline in the price of computing capital relative to the price of output. If efficiency gains from DeepSeek reflect a similar phenomenon, we may be seeing early signs [that] the cost of AI capital is coming down – and coming down rapidly. In turn, that should support the outlook for business spending pertaining to AI.
In the last few weeks, we have heard a lot of reference to the Jevons paradox – which really dates from 1865 – and it states that as technological advancements reduce the cost of using a resource, the overall demand for the resource increases, causing the total resource consumption to rise. In other words, cheaper and more ubiquitous technology will increase its consumption. This enables AI to transition from innovators to more generalized adoption and opens the door for faster LLM-enabled product innovation. That means wider and faster consumer and enterprise adoption. Over time, this should result in greater increases in productivity and faster realization of AI’s transformational promise.
From a micro perspective, our equity research colleagues, who are experts in covering stocks in these sectors, come to a very similar conclusion. They think it’s unlikely that the DeepSeek development will meaningfully reduce CapEx related to AI infrastructure. From a macroeconomic perspective, there is a good case to be made for higher business spending related to AI, as well as productivity growth from AI.
Obviously, it is still early days, and we will see leaders and laggards at the stock level. But the economy as a whole we think will emerge as a winner. DeepSeek illustrates the potential for efficiency gains, which in turn foster greater competition and drive wider adoption of AI. With that premise, we remain constructive on AI’s transformational promise.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
DISCLAIMER
In the last few weeks… (Laughs) It’s almost like the birds are waiting for me to start speaking.
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Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explains why a resurgence in air travel is leading China’s emergence from deflation.
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Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Chinese airlines are at a once-in-a-decade inflection point, and today I’ll break down the elements of this turnaround story.
It’s Thursday, Feb 6th at 10am in Hong Kong.
Last week, hundreds of millions of people across Asia gathered to celebrate the lunar new year with their families. I was one of them and took a flight back to my hometown Nanjing. Airports were jam-packed for days, with air travel expected to exceed 90 million trips.
It’s all indicative of Chinese airlines making a comeback after a seven-year run of underperformance. In fact, we believe Airlines will be one of the first industries to emerge from China's deflationary pressures this year. And this has implications for the country's broader economy.
Although COVID impacted Airlines globally, other regions have since recovered. In China, the earnings recovery is just beginning. Since 2018, Chinese Airlines have experienced demand hits from the trade tension, currency depreciation, COVID-19, and post-COVID macro headwinds.
It’s been two years since Chinese borders lifted restrictions and air travelers are returning in force. Excess capacity has now been digested. Slower deliveries of aircrafts continue to limit supply, and it is more difficult for airlines to get new aircraft and increase their available seats. Passenger load factors will continue to strengthen this year, which means the airlines are running close to full capacity. This will increase Airlines' pricing power within the next 6 to 12 months, feeding through to earnings.
If we put that in a global context, China’s airlines industry handled around 700 million passengers in 2024, 8 per cent of global air passengers; but that 700 million passengers only account for half of China’s population. In the US, air passenger numbers can be three times its population.
Chinese airlines have just reached break-even in the past year, while many of their global peers have already generated robust profits. Chinese Airlines’ earnings and valuations have lagged global peers in both absolute and relative terms. But now, with a turnaround coming into view, Chinese Airlines have a longer runway for stronger earnings growth and share price performance than global peers.
What’s more, the August 2024 turnaround in US airlines offers several key takeaways for China. US Airlines’ share prices recovered last year, following a long period of underperformance post COVID. The wait before the inflection was long, but share prices moved up quickly once the turning point was reached, and valuation expanded ahead of earnings recovery. Big US airlines outperformed smaller players during the most recent rally. We think all these are relevant to the Chinese Airlines story.
If we look at earnings – Chinese Big Three airlines reached breakeven in 2024, making a small profit in 2025, and that profit will double in 2026. But that’s not yet the peak of the cycle; peak cycle earnings could again double the 2026 level, probably in 2027 to 2028. That’s the reason why we think Chinese airlines are on the path to doubling share prices.
To sum up, Chinese Airlines represent a once-in-a-decade opportunity for investors. With strengthened passenger load factors and a positive demand outlook, coupled with significant potential for earnings growth, this industry looks ready for takeoff.
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. For those who celebrate – 新春快乐，恭喜发财！
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