Podcast Summary: Thoughts on the Market – "How Will Credit Markets Fare in 2026?"

Hosts: Andrew Sheats (Global Head of Corporate Credit Research, Morgan Stanley), Lisa Shallet (Chief Investment Officer, Morgan Stanley Wealth Management)
Date: December 19, 2025

Episode Overview

This episode dives into the prospects for global credit markets moving into 2026, focusing on themes of inflation moderation, central bank policy, corporate "animal spirits," and how these intersect to influence credit market performance. Lisa Shallet interviews Andrew Sheats about Morgan Stanley's credit market outlook, exploring drivers behind inflation, policy scenarios, asset allocation considerations, and key risks.

Key Discussion Points and Insights

1. Outlook for Inflation in 2026

Timestamps: 00:24–02:17

• Moderating inflation:
  • Morgan Stanley anticipates a "resilient global growth backdrop with inflation moderating and central banks easing policy gradually."
  • Main factors behind the constructive inflation outlook:
    • Oil prices: Morgan Stanley is "very cautious, very negative on oil prices." Anticipated increased supply relative to demand is expected to push prices lower, aiding inflation moderation.

      "We think that there's going to be more supply of oil over the next year than demand for it, and so lower oil prices should help bring inflation down." — Andrew Sheats [01:09]

    • Shelter and housing:
      • Rental markets have been soft, and a lag in data means shelter inflation is "relatively soft," helping pull inflation lower in the near term.
      • However, structural housing shortages may push rents higher further out.
    • Fiscal policy and corporate behavior:
      • The environment is characterized by supportive fiscal policy, and corporates "are really embracing animal spirits with more spending ... more capital investment, generally more M&A."
      • Net: Inflation should remain above central bank targets but trend gradually lower.

2. Central Bank Policy: Gradual Easing and Credit Market Implications

Timestamps: 02:17–03:54

• Gradual versus aggressive rate cuts:
  • Sheats favors a gradual approach from central banks, arguing that it signals economic health and reduces credit risk.

    "The biggest risk to credit would be that this outlook for growth that we have is just too optimistic, that actually growth is weaker than expected ... and in that scenario, the Fed would be justified in cutting a lot more." [02:57]

  • Historically, periods when the Fed cuts rates aggressively correspond to economic weakness—bad for credit and equities—whereas gradual cuts typically accompany stable conditions.

    "Periods where the Fed is cutting more gradually tend to be more consistent with policy in the right place, the economy being in an okay place." [03:41]

3. Corporate "Animal Spirits" and Market Impacts

Timestamps: 03:54–05:07

• Shift in corporate risk-taking:
  • With positive growth and supportive policy, companies are becoming more aggressive, a "challenge" for credit markets.

    "Corporates have been impressively restrained over the last several years ... those reasons for waiting are falling away." [04:08]

  • Expect a significant uptick in debt issuance (~$1 trillion net supply in US investment grade).

    "We see roughly a trillion dollars of net supply ... that's a huge uptick from this year. And we think that drives spreads wider." [04:53]

  • Equity markets may benefit from this enthusiasm, but it's likely to pressure credit market spreads.

4. Asset Allocation and Regional Dynamics

Timestamps: 05:07–06:31

• Divergence between equities and credit:
  • Sheats draws parallels to 1997-98 and 2005, when stocks rose strongly while credit spreads widened.

    "Those were all years where equities were up double digits, where credit spreads were wider, where yields were somewhat range bound, where corporate aggression was increasing." [05:39]

  • Portfolio preferences:
    • Favor "small and mid cap stocks in the US over large caps."
    • Prefer "high yield over investment grade" on a risk-reward basis.
    • European credit may outperform, as the US is leading the "animal spirits" cycle.

5. Key Risks

Timestamps: 06:31–07:48

• Potential weaknesses:
  • Weakening growth: Rising US unemployment is a classic credit market risk, though Morgan Stanley expects this to be temporary.

    "Usually when the unemployment rate is rising, that's a pretty bad time to be in credit." [06:36]

  • Unrestrained AI-related corporate spending:
    • Huge AI investment – by large, wealthy companies – could see them issue more debt regardless of widening spreads, adding pressure.

    "If you were to ever have an issuer or a set of issuers who were just less price sensitive ... this might be the group." [07:29]

Memorable Quotes

• On market backdrop:

  "Fiscal policy is very supportive. And corporates ... are really embracing animal spirits with more spending, more spending on AI, more capital investment, generally more M&A." — Andrew Sheats [01:37]

• On risks of easing:

  "Periods where the Fed is cutting more gradually tend to be more consistent with policy in the right place, the economy being in an okay place." — Andrew Sheats [03:41]

• On market divergence:

  "We see better risk reward in stocks than in credit. I think it's a market where we want to be in somewhat smaller credits or somewhat smaller equities." — Andrew Sheats [06:02]

Key Takeaways by Segment

| Segment | Topic | Timestamps | Key Takeaway | |-------------|-----------|---------------|-------------------| | 1 | Inflation Outlook | 00:24–02:17 | Moderating inflation with risks skewed to the upside in the long-term | | 2 | Central Banks & Credit | 02:17–03:54 | Gradual Fed rate cuts preferred for credit stability | | 3 | Corporate Aggression | 03:54–05:07 | Uptick in risk-taking could widen credit spreads despite rising equities | | 4 | Asset Allocation | 05:07–06:31 | Prefer stocks/smaller caps, high yield; cautious on US investment grade credit | | 5 | Risks | 06:31–07:48 | Watch for growth disappointments or unrestrained AI-driven corporate borrowing |

Episode Flow & Tone

Conversational and analytic, with both hosts referencing recent data and historical context, they blend market theory with actionable insights. The tone remains cautious but constructive, giving listeners criteria to watch as 2026 approaches.