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Welcome to Thoughts on the Market. I'm Andrew Sheats, head of Corporate Credit Research at Morgan Stanley. Today I'm going to revisit our story for 2025 and what could make things better or worse. It's Thursday, January 9th at 2pm in London. Based on the number of out of office replies, I have a sneaking suspicion that many investors took advantage of the timing of holidays this year for a well deserved break. With this week marking the first full week back, I thought it'd be a good opportunity to refresh listeners on what we expect in 2025 and realistic scenarios where things are better or worse. Our base case is that credit holds up well this year, doing somewhat better in the first half of 2025 than the second. Credit likes moderation, and while we think the shift in U.S. policy leadership generally means less moderation and a wider range of economic outcomes, this shift doesn't arrive immediately on Morgan Stanley's forecast. The bulk of the disruptive impact from any changes to tariffs or immigration policy hits in 2026. Meanwhile, credit is entering 2025 with some pretty decent tailwinds. The economy is good. The all in yield the total yield on US investment grade corporate bonds at above 5.4% is the highest to start any year since January of 2009, which we think helps demand. And while we think corporate confidence and aggression will rise normally a bad thing for credit, this is going to be coming off of a low conservative starting point. We think that credit spreads will be modestly tighter by mid year relative to where they finished 20:24 and then start to widen modestly in the second half of the year as the market attempts to price that greater policy uncertainty in 2026. We think that issuers in the financial and utility sectors outperform and we think bonds between 5 and 10 year maturity will do the best. The bear case is that we exit the current period of moderation more quickly. At one end, a deregulatory push by a new administration could usher in an even faster rise in corporate confidence and aggression, leading to more borrowing and riskier dealmaking. At the other extreme, the strong current state of the economy and jobs market could make further gains harder to come by. If the rise in unemployment that our economists expect in 2026 is larger or arrives earlier, credit could start to weaken well ahead of this. So how could things be better, especially given the relatively low tight starting point for credit spreads? Well, we'd argue that the current mix of data for credit is borderline ideal. Reasonable growth, falling inflation, still low levels of corporate aggressiveness and still high yields that are attracting buyers. Recall that the tightest levels of credit in the modern era, which are still tighter than today, are occurred during a period with similar characteristics, the mid-1990s. When thinking about the mid-90s as a bull case, there's a further detail that's relevant and topical, especially this week. At that time, interest rates stayed somewhat high and the Fed only lowered short term rates modestly because the economy held up. In short, in the best environment that we've seen for credit, less action by the Federal Reserve was fine so long as the economic data was good. This is a bull case rather than our base case because there are also a number of key differences, with the mid-1990s, not the least being a much worse trajectory today for the US Government's budget. But in a scenario where things change less and the status quo lasts longer, it could come into play. 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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