Thoughts on the Market: Banking on Deregulation
Hosted by Morgan Stanley
Episode Release Date: December 18, 2024
Introduction
In the December 18, 2024 episode of Thoughts on the Market, Morgan Stanley’s Chief Fixed Income Strategist, Vishy Tirupator, delves into the anticipated policy changes and their potential impacts on the financial markets in 2025. The discussion centers around four primary categories of policy shifts, with a particular emphasis on deregulation and its profound implications for the banking sector.
Outlook for 2025: Policy Changes and Market Impact
Vishy Tirupator opens the conversation by outlining Morgan Stanley's comprehensive outlook for 2025, developed collaboratively by strategists and economists globally. The focus is on identifying policy changes that the team is highly confident will influence market performance.
“[...] the substance, severity, and sequencing of policies will matter and will have an important bearing on how markets perform over the course of 2025.”
— Vishy Tirupator [00:00]
Key Policy Change Categories
The episode categorizes potential policy changes into four broad areas:
- Tariffs and Trade Policy
- Immigration Controls
- Tax Cuts and Fiscal Policy
- Deregulation
Tirupator emphasizes that the incoming administration is expected to prioritize tariffs, with tax cuts slated as the final area of focus.
“Our central case is for tariffs to go first and tax cuts to be last.”
— Vishy Tirupator [00:00]
Sequencing and Implementation of Policies
The discussion highlights that while policy announcements may occur rapidly, their implementation will likely be gradual. This slow rollout is particularly expected in areas such as tariffs and immigration controls, leading to a more measured impact on the economy and financial markets.
“Slower implementation will mean that the changes will also be slow and the impacts on the economy and markets likely to be a lot more gradual.”
— Vishy Tirupator [00:00]
Deregulation: The Game Changer for Banks
Deregulation emerges as the most impactful policy area for the markets. While quantifying its effects on macroeconomic indicators like growth and inflation remains challenging, deregulation is poised to create a favorable environment for banking activities.
Excess Capital and Basel III Endgame
Tirupator details that U.S. banks currently hold record levels of excess capital—$177 billion—with a weighted average Common Equity Tier 1 (CET1) ratio of 12.8%, significantly higher than the pre-COVID level of 11.4%.
“Banks in their coverage area currently are sitting on record levels of excess capital, $177 billion of excess capital and a weighted average CET1 ratio of 12.8%, which is 140 basis points higher than pre-Covid levels of 11.4%.”
— Vishy Tirupator [00:00]
The potential reproposal of the Basel III endgame in a capital-neutral manner is anticipated to prompt U.S. banks to deploy their excess capital more aggressively. This deployment is expected to manifest in increased lending, trading support, underwriting activities, securities purchases, as well as buybacks and dividends.
“If Basel III endgame is reproposed in a more capital neutral manner, we expect U.S. banks will begin deploying their excess capital into lending, supporting clients in trading and underwriting, increasing their securities purchases, as well as increasing buybacks and dividends.”
— Vishy Tirupator [00:00]
Enhancing Global Competitiveness
Adjustments to Basel III are also forecasted to enhance the global competitiveness of U.S. banks. Additionally, global banks with significant capital markets operations stand to benefit from the reproposal, fostering a more level playing field internationally.
Impact on Securities Portfolios
In response to anticipated deregulation, banks are expected to reinvest in securities they had previously avoided due to higher capital requirements. Specifically, there is an anticipated resurgence in agency Mortgage-Backed Securities (MBS) and Collateralized Loan Obligations (CLO) Asset-Backed Securities (CLOaaS).
“With the deregulation focus we expect that banks will revert to buying the assets that they have stayed away from in particular agency MBS and CLO aaas.”
— Vishy Tirupator [00:00]
The renewed demand for CLOaaS is projected to positively influence the broadly syndicated loan market, credit formation, and sponsor activity, thereby supporting a stronger resurgence in mergers and acquisitions (M&A) activities.
Broader Market Implications
The anticipated shift in bank behavior is expected to have ripple effects across various segments of the financial markets. Increased securities purchases and capital deployment by banks will likely bolster credit markets and facilitate greater M&A activities, aligning with the forecasts of Morgan Stanley’s credit strategists.
Fixed Income Perspective: Seizing Relative Value Opportunities
From a fixed income standpoint, the deregulation-driven environment presents a wealth of relative value opportunities, particularly within spread products and securitized instruments. Morgan Stanley views this as a strategic area for investment and portfolio enhancement in the coming year.
“In fixed income if you pardon the pun, we are really banking on the impact of deregulation which supports our view on the range of relative value opportunities in spread products, especially in securitized products.”
— Vishy Tirupator [00:00]
Conclusion
The episode concludes with Tirupator reiterating the significant role deregulation is expected to play in shaping the financial landscape in 2025. By proactively addressing the impacts of policy changes, particularly in the banking sector, Morgan Stanley aims to leverage emerging opportunities and navigate the evolving market dynamics effectively.
Disclaimer: The proceeding content is informational only and based on information available when created. It is not an offer or solicitation nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for everyone.