Podcast Summary: "A Whiff of Stagflation"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: A Whiff of Stagflation
• Release Date: August 7, 2025

Introduction

In the episode titled "A Whiff of Stagflation," Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley, delves into the current state of financial markets amid ongoing tariff-related tensions. Released on August 7, 2025, the discussion centers on whether recent economic indicators signal the onset of stagflation—a troubling combination of stagnant economic growth and rising inflation.

Market Resilience Amid Tariff Pressures

Andrew Sheets opens the episode by highlighting the resilience of financial markets despite the persistent noise surrounding tariffs in 2025.

Andrew Sheets [00:00]: “For all the sound and fury around tariffs in 2025, financial markets have been resilient. Stocks are higher, bond yields are lower, credit spreads are near 20-year lows, and market volatility last month plummeted.”

Sheets underscores that despite concerns since February about the potential negative impacts of tariffs, markets have so far navigated these challenges effectively. Key indicators such as stock performance, bond yields, and credit spreads have remained favorable, suggesting that the initial fears may have been overestimated.

Emerging Signs of Stagflation

However, Sheets introduces a note of caution, suggesting that recent data may hint at the beginnings of stagflation, a scenario that could disrupt the positive market trajectory observed earlier in the year.

Andrew Sheets [01:15]: “It might be starting to show up in the data right now, with more to come over the next several months.”

He explains that while growth had remained stable, inflation had been decreasing, and corporate earnings were solid, recent indicators are beginning to paint a different picture. The metaphor of a "wide receiver celebrating on the five-yard line" illustrates the premature optimism that may be facing reality.

Key Economic Indicators Pointing to Stagflation

Sheets delves into specific economic indicators that suggest the potential emergence of stagflation:

1. Core PCE Inflation:

   • Quote:

     Andrew Sheets [02:40]: “The Fed's preferred inflation measure showed that prices were once again rising and at a faster rate.”

   • The Personal Consumption Expenditures (PCE) price index, favored by the Federal Reserve, indicates a resurgence in inflation rates, contradicting earlier trends of cooling prices.

2. US Jobs Market Health:

   • Quote:

     Andrew Sheets [03:10]: “A key report on the health of the US jobs market showed weak jobs growth.”

   • Weakening job growth suggests reduced economic activity, which, when paired with rising prices, aligns with stagflationary concerns.

3. Institute for Supply Management (ISM) Surveys:

   • Quote:

     Andrew Sheets [03:45]: “Respondents are real people in the middle of real supply chains, cited lower levels of new orders and higher prices being paid.”

   • The ISM surveys reveal a contraction in new orders and increased costs, reinforcing the narrative of rising operational challenges amidst slowing demand.

These indicators collectively point toward higher prices coupled with slower economic growth—a defining characteristic of stagflation.

Forecasting Slower US Growth

Looking ahead, Sheets shares Morgan Stanley economists' projections, which anticipate a significant slowdown in US economic growth in the latter half of the year.

Andrew Sheets [04:30]: “US growth will look a lot slower in the second half of the year than the first. And specifically it's in the next three months, which should show higher rates of month over month inflation while also seeing slower activity.”

This forecast suggests that the economy may experience higher monthly inflation rates alongside declining economic activity over the upcoming months, marking a shift from the more optimistic first half of the year.

Implications for Financial Markets

Sheets discusses the potential repercussions of these economic trends on financial markets, emphasizing that the resilience seen thus far may not fully buffer against the emerging challenges.

Andrew Sheets [05:15]: “If these forecasts are correct, it's not that markets have already passed the test, it's that the teacher is only now handing it out for credit.”

This metaphor highlights that the true test of market resilience might yet be to come. While credit spreads remain attractive and corporate performance is generally strong, the combination of slower growth and rising inflation presents a novel challenge, particularly during the traditionally more volatile August-September period.

Conclusion and Market Outlook

Concluding the episode, Sheets advises that the forthcoming months could be uncomfortable for markets, potentially leading to modest widening of credit spreads. Despite this, factors such as attractive yields and robust corporate performance provide a buffer against severe downturns.

Andrew Sheets [06:00]: “We think this could make the next several months uncomfortable and drive some modest spread widening. But this mix of slower growth and higher inflation, well, it's new.”

The anticipation of slower growth paired with higher inflation introduces a unique dynamic that hasn't been prevalent earlier in the year. As such, market participants should brace for potential volatility and adopt cautious strategies moving forward.

Closing Remarks

Andrew Sheets wraps up the episode by encouraging listeners to stay informed and engaged with Morgan Stanley's market insights.

Andrew Sheets [06:30]: “Thank you as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.”

He reiterates that the information provided is purely informational and not financial advice, urging listeners to consider their personal financial circumstances when making decisions.

Final Thoughts

"A Whiff of Stagflation" provides a comprehensive analysis of the current economic landscape, highlighting both the resilience and the emerging vulnerabilities of financial markets in 2025. Andrew Sheets effectively balances optimistic market indicators with cautionary signals, offering listeners a nuanced understanding of potential future developments.