Standing by Our Outlook

Summary

Podcast Summary: "Standing by Our Outlook" – Morgan Stanley's "Thoughts on the Market"

Episode Details

• Title: Standing by Our Outlook
• Host: Serena Tang, Chief Cross Asset Strategist, Morgan Stanley
• Guest: Vishy Tripator, Chief Fixed Income Strategist, Morgan Stanley
• Release Date: June 6, 2025

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Introduction to Morgan Stanley's Mid-Year Outlook

In this episode of "Thoughts on the Market," Serena Tang and Vishy Tripator delve into Morgan Stanley's recently published mid-year outlook. Released two weeks prior, the outlook represents a collaborative endeavor integrating the firm's economic perspectives with high-conviction strategic ideas. The primary recommendation is to adopt an overweight position in U.S. equities and U.S. core fixed income sectors, including U.S. Treasuries and investment-grade (iG) corporate credit.

Reconciling Divergent Economic and Market Narratives

One of the central themes of the discussion revolves around the pushback Morgan Stanley has received due to apparent dissonance between their economic and market narratives.

• Economic Outlook vs. Market Positioning:

  Vishy highlights, "[...] Our economists call for a significant weakening of economic growth from about 2.5% in 2024 to 1% in 2025 and 2026, and the Fed doesn't cut rates in 2025 but cuts seven times in 2026" (00:55). This projection suggests a slowing economy without tipping into recession, which some investors find at odds with the firm's optimistic stance on U.S. assets.

• Morgan Stanley's Response to Pushback:

  To address concerns, Vishy explains that the firm views the economic and market trajectories as "different plot lines across different asset classes" (00:55). This means that while economic growth is expected to decelerate, the strategic asset allocations remain favorable due to factors like anticipated policy easing and strong credit fundamentals.

Diving into U.S. Equity and Fixed Income Recommendations

The podcast emphasizes Morgan Stanley's confidence in U.S. assets, despite broader economic headwinds.

• Equities:

  Serena points out that historical analysis shows equities can perform well even in low-growth environments with low inflation. She notes, "When you have rather unencouraging growth, that tends to map onto a slightly risk-off scenario. And historically that's also a backdrop where you see the dollar strengthen" (03:39). However, Morgan Stanley anticipates a magnitude of dollar weakening by around 9%, which is a more aggressive stance than the consensus.

• Fixed Income:

  Vishy elaborates on the fixed income strategy, stating, "Our expectation of rate cuts, slowing growth but not tipping into recession, and our idea that these spreads are really not going very far from where they are now gets us to a total return of about over 10% for investment grade corporate credit" (07:44). This underscores the firm's bullish outlook on investment-grade corporate credit and securitized credit.

U.S. Dollar Forecast and Policy Uncertainty

A significant portion of the discussion centers on the forecasted weakening of the U.S. dollar and the implications of policy uncertainty.

• Dollar Weakness:

  While acknowledging that some dollar weakness is a consensus view, Vishy attributes Morgan Stanley's more pronounced expectation to their assessment of policy uncertainty: "The policy uncertainty adds a greater degree of risk premia for taking on U.S. assets" (04:34). This additional layer contributes to their forecast of a greater depreciation in the dollar compared to competitors.

• Market Size and Liquidity:

  Serena underscores the dominance of U.S. markets, highlighting that "60% of liquid high-quality fixed income paper is actually denominated in U.S. dollars" (06:52). This immense size and liquidity make U.S. assets a cornerstone for globally diversified portfolios, reinforcing their recommendation to remain overweight despite currency considerations.

Corporate and Securitized Credit Insights

Addressing the less-discussed but consensus-boring area of corporate credit, Vishy shares positive sentiments:

• Investment-Grade Corporate Credit:

  The firm anticipates stable spreads and a total return exceeding 10%, making it an attractive proposition for fixed income investors. Vishy emphasizes, "This actually is a pretty good outcome for credit investors. For fixed income investors in general that calls for continued allocations to high-quality credit in corporate credit as well as in securitized credit" (07:44).

Conclusion and Strategic Takeaways

Serena wraps up the discussion by reiterating Morgan Stanley's distinctive outlook, emphasizing:

• Rate Cuts and Policy Easing: A significantly higher number of expected rate cuts in 2026 than currently priced by the market.
• Dollar Depreciation: An anticipated weakening of the U.S. dollar by approximately 9%.
• Asset Allocation Recommendations: Maintaining an overweight position in U.S. equities and core fixed income assets, with a specific focus on U.S. Treasuries and investment-grade corporate credit.

She concludes, "As much as we're not arguing U.S. exceptionalism can continue on forever over the next six to 12 months, we are constructive on U.S. assets" (08:20). Serena advises investors to hedge currency risk to navigate potential bouts of volatility, ensuring that their exposure to U.S. assets remains strategically advantageous.

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Key Takeaways:

• Overweight in U.S. Equities and Core Fixed Income: Despite a projected economic slowdown, Morgan Stanley remains bullish on U.S. assets due to anticipated policy easing and strong credit fundamentals.
• Aggressive Dollar Weakness Projection: The firm expects the U.S. dollar to weaken by around 9%, factoring in policy uncertainty and risk premia.
• Positive Outlook on Corporate Credit: Investment-grade and securitized credits are poised for strong returns, offering attractive opportunities for fixed income investors.
• Strategic Allocation with Currency Hedging: Emphasizing the importance of maintaining exposure to U.S. assets while mitigating currency risks through hedging strategies.

This episode provides a comprehensive overview of Morgan Stanley's strategic positioning amidst divergent economic indicators and market sentiments, offering valuable insights for investors navigating the current financial landscape.

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Transcript

[A]

Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's Chief Cross Asset strategist.

[B]

And I'm Viseetrupator, Morgan Stanley's chief Fixed Income Strategist.

[A]

Today's topic pushback to our outlook. It's Friday, June 6th at 10:00am in New York. Morgan Stanley Research published our mid year outlook about two weeks ago, a collaborative effort across the department bringing together our economist views with our strategist high conviction ideas. Right now we're recommending investors to be overweight in U.S. equities, overweight in core fixed income like U.S. treasuries, like U.S. iG corporate credit. But some of our views are out of consensus. So I want to talk to you Vishy, about pushback that you've been getting and how we push back on the pushback.

[B]

Right. So the biggest pushback I've gotten is a bit of a dissonance between our economics narrative and our markets narrative. Our economics narrative, as you know, calls for a significant weakening of economic growth from about for the US 2.5% growth in 2024 goes into 1% in 2025 and in 2026 and Fed doesn't cut rates in 2025 and cut seven times in 2026. And if you look at a somewhat uninspiring outlook for the US Economy from our economists reconciling an uninspiring economic outlook on the US Economy with the constructive view we have on US Assets, equities, credit, Treasuries, that's been a source of contention. So reconciling an uninspiring outlook on the US Economy with a constructive view on risk assets as well as risk free assets in the US Economy. So equities credit as well as government bonds has been a somewhat contentious issue. So how do we reconcile this? So my pushback to the pushback is the following that they are different plot lines across different asset classes. So our economists have slowing of the economy but not an outright recession. Our economists don't have rate cuts in 2025 but but have seven rate cuts in 2026. So if you look at the total number of rate cuts that are being priced in by the markets today, roughly about two rate cuts in 25 and about between two and three rate cuts in 2026. We expect greater policy easing than what's currently priced in the markets. So that makes sense for our constructive view on interest rates and in government bonds and duration. That makes sense from a credit point of view. We enter this point with a much better credit fundamentals in Leverage and coverage terms, we have the emergence of a total yield based buyer base which we think will be largely intact at our expectations. And you layer on top of that the idea that growth slows but doesn't fall into recession is also constructive for higher quality credit. So that explains our credit view from an equities view, the drawdowns that we experienced in April, our equity strategist thing, marks the worst outcomes from a policy point of view that we could have had. That has already happened. So looking forward, they look for EPS growth over the course of next 12 months, they look for benefits of deregulation to kick in. So along with that seven rate cuts get them to be comfortable in being constructive about their views on equities. So all of that ties together and.

[A]

I think what you mentioned around macro not being the markets is important here because when we did some analysis on historical periods where you had low growth and low inflation, actually in that kind of a scenario equities did fine and corporate credit did fine. But also in an environment where you have rather unencouraging growth, that tends to map onto a slightly risk off scenario. And historically that's also a kind of backdrop where you see the dollar strengthen. This time out we have a very out of consensus view. Not that the dollar will weaken, that seems quite consensus. But the degree and magnitude of dollar weakening, where have you been getting the most pushback on our expectations for the dollar to shape by around 9% from here?

[B]

So the dollar weakness in itself is not out of consensus, largely driven by narrowing of rate differentials, growth differentials. I think some of the difference between the extent of weakness that we are projecting comes from the assessment on the policy uncertainty. So the policy uncertainty adds a greater degree of risk premia for taking on U.S. assets. So in our forecast we take into account the not only the differentials in rates and growth, but also in the policy uncertainty and the risk premia that the investors would demand in the face of that kind of policy uncertainty. And that really explains why we are probably more negative on the outcome for US dollar than perhaps our competition.

[A]

The risk premium part I think bring us to one of the biggest debate we've been having with investors over not just the last few weeks, but over the last few months. And that is on US exceptional. Now clearly we have a view that US assets can outperform over the next six to 12 months. But why aren't we factoring in higher risk premium for holding any kind of US assets? Why should US assets still do well?

[B]

So as I said earlier, we are calling for the economy to slow without tipping into recession. We are also calling for greater amount of policy easing than what is currently placed in the markets or both those factors are constructive. So I think we also should keep in mind the sheer size of the US markets. The US government bond markets for example are 10 times the size of comparably rated European bond markets. Government bond markets put together the US equity markets is four, five times the size of the European equity markets. Same thing for investment grade corporate credit bonds. The market is many, many times larger. So the sheer size of the bond US assets makes it very difficult for a globally diversified portfolio to substantially under allocate to US assets. So what we are suggesting therefore is that allocate to U.S. assets where there are all these opportunities we described. But if you are not a US investor hedge the currency risk. Not hedging currency risk had worked in the past, but we are now saying hedge your currency risk.

[A]

And the market size and liquidity point is interesting. I think after the Outlook was published we had a lot of questions on this and I think it's underappreciated. How about sort of 60% of liquid high quality fixed income paper is actually denominated in US dollars. So at the end of the day, or at least over the next six to 12 months it does seem like there is no alternative. Now Vishy, we've talked a lot about where we're getting pushback. I think that one part of the outlook where very little discussed because very highly consensus is credit and the consensus is credit is boring. So how do you see corporate credit and maybe securitized credit fit into the wider allocation views on fixed income borrowing.

[B]

Is good for a fixed income investor perspective. Sereno our expectation of rate cuts slowing growth but not tipping into recession and our idea that these spreads are really not going very far from where they are now gets us to a total return of about over 10% for investment grade corporate credit. That actually is a pretty good outcome for credit investors. For fixed income investors in general that calls for continued allocations to high quality credit in corporate credit as well as in securitized credit.

[A]

So just to sum up, Morris Allied Research has very differentiated view this time around on how many times the Fed can cut which is a lot more than what markets are pricing in at the moment, how much yields can fall and also how much weakening in the US dollar that we can get. We are recommending investors to be overweight U.S. equities and overweight U.S. core fixed income like U.S. treasuries and like U.S. iG corporate credit. And as much as we're not arguing U.S. exceptionalism can continue on forever over the next six to 12 months, we are constructive on U.S. assets. That is not to say policy uncertainty won't still create bouts of volatility over the next 12 months, but it does mean that during those scenarios, you want to sell US dollars rather than US assets. Fishy. Thank you so much for taking the time to talk.

[B]

Great speaking with you, Serena.

[A]

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